(a) The Magnitude of the Tax Differentials

1.155. The complainants argue that in Japan - Taxes on Alcoholic Beverages II, the Appellate Body found that the very magnitude of the difference in taxation between shochu and other distilled spirits and liqueurs was sufficient evidence to conclude that the Japanese Liquor Tax Law was applied so as to afford protection to the domestic production of shochu.⁹⁸

1.156. According to the complainants, the situation is similar in the present dispute. It argues that the tax differentials between soju and other distilled spirits and liqueurs are so large that they constitute sufficient evidence in themselves that the Liquor Tax Law and the Education Tax Law are applied so as to afford protection to the domestic production of soju.

1.157. The complainants state that the tax differentials at issue in this dispute appear to be even bigger than those taken into consideration by the Panel and the Appellate Body in Japan - Taxes on Alcoholic Beverages II.⁹⁹ They add that, it must be recalled that the tax differentials between soju and other distilled spirits and liqueurs would be much larger but for the successive changes introduced by Korea since 1990 in response to pressure from the Community.

(b) The Product Categorisation is Arbitrary

1.158. The complainants are of the view that the Liquor Tax Law defines soju almost exclusively in negative terms, by excluding from a very broad, catch-all formula any type of distilled spirits which happen to be imported in significant quantities. According to the complainants, the lack of specificity of the legal definition of soju is further attested by the overlap between that definition and the legal definitions of other residual categories (e.g. the sub-category defined in Article 3.9 E of the Liquor Tax Law). In the complainants' view, this clearly shows that the application of a lower rate of tax to soju does not correspond to any distinguishing characteristic of soju, but is merely aimed to afford protection to Korea's domestic production of distilled spirits.

1.159. For instance, the complainants argue that according to their respective legal definitions, the only difference between diluted soju and gin is that the latter has juniper berries and plant flavourings added before distillation¹⁰⁰. However, according to the complainants, this obviously minor difference entails a tax differential equivalent to more than 90% of the import CIF value of a bottle of imported gin. In the complainants' view, this huge tax differential is clearly disproportionate and can only be explained as being aimed at affording protection to the domestic production of soju.

(c) Domestic Soju is "Isolated" from Imports of Soju

1.160. The complainants further note that in Japan - Taxes on Alcoholic Beverages II, both the Panel and the Appellate Body noted that:

1.161. According to the complainants, the situation is similar in the present case. The complainants argue that Korean soju is effectively "isolated" from competition from foreign soju. It is alleged that imports of soju into Korea have always been negligible. It is argued that in 1997 for instance, the imported volume of soju was just 1,625 litres, which allegedly represents barely 0.0002% of the total soju sales in Korea. According to the complainants, therefore, it is indisputable that by favouring soju vis-a-vis other liquors, Korea protects a "domestic production".

1.162. The complainants further argue that Korean soju is even more "isolated" from imports of foreign soju than Japanese shochu was from foreign shochu in Japan - Taxes on Alcoholic Beverages. It is argued that in that case, Japan could point to the existence of a significant, even if small in relative terms, flow of shochu imports (between 1-2%). In contrast, it is argued that imports of soju into Korea are virtually non-existent.

1.163. The complainants assert that as in the case of shochu in Japan - Taxes on Alcoholic Beverages II, one of the reasons why Korean soju is "isolated" from imports of foreign soju is the high level of the import duties on that product. It is argued that currently, the bound rate on soju is 79% and the applied rate 30%. In comparison, it is alleged that in Japan - Taxes on Alcoholic Beverages II, the bound and applied rates on shochu were 26.7% and 17.9%, respectively. It is further argued that the applied import duty rate on soju (30%) is higher than the applied rate on any other category of distilled spirits and liqueurs (15%-20%).

(d) Soju Accounts for the Vast Majority of the Korean Production of Distilled Spirits and Liqueurs

1.164. According to the complainants, it may be estimated that soju accounts for more than 95 % of the Korean production of distilled spirits and liqueurs. Thus, by applying a lower tax rate to soju, Korea is affording protection not just to its domestic production of soju but more generally to its entire domestic industry of distilled spirits and liqueurs.

(e) Almost all Whisky and Brandy Sold in Korea is Imported

1.165. The complainants argue that whereas imports of soju are almost non-existent, virtually all the sales of whisky and brandy, as well as a significant proportion of the sales of white spirits and liqueurs are imported. In the complainants' view, this makes the Korean liquor tax system even more protective in effect than the tax measures at issue in Japan - Taxes on Alcoholic Beverages I and II, where a majority of sales within the more taxed category of "whisky/brandy" was domestically produced.

(f) There is a Long History of Tax Discrimination and Protectionism

1.166. The complainants further argue that the Korean soju industry has traditionally benefited from a very high degree of protection against imports. According to this view, until 1989 the Korean market for distilled spirits and liqueurs was almost closed to imports through the combined application of quantitative restrictions and dissuasive import duties. Since then, the argument continues, Korea has been forced to lift the import quotas and to negotiate with the complainants a reduction of the applied customs duties as part of the 1993 Agreement. The complainants assert that in light of Korea's past record of protectionism in this sector, it becomes evident that the measures at issue are but a last ditch attempt by Korea to continue to afford protection to its domestic soju industry against imports of western-style liquors.

1.167. The complainants respectfully request the Panel to find that:

(a) General

1.168. Korea notes that in bringing this case before the Panel, the United States and the European Communities have called into question the validity of the Korean tax regime on alcoholic beverages, claiming that this regime discriminates against some imported spirits, to the benefit of a Korean distilled alcoholic beverage called 'soju', and in violation of Article III:2 of the GATT. Korea concedes, as the complainants point out, that it imposes a different rate of tax on soju than it imposes on certain imported alcoholic beverages. However, in Korea's view, not every difference in rates of tax amounts to a violation of Article III:2.

1.169. Korea asserts that Article III:2 is perhaps the provision of the GATT that treads most heavily upon national sovereignty. In Korea's view, a nation's taxation system is the product of a long and intricate domestic political process. Korea argues that taxes are built up over years, and reflect different and evolving policy goals. No country imposes a single rate of tax on all products. Korea also notes that the GATT contains no requirement that countries harmonise their tax systems. Korea asserts that the fundamental purpose of Art. III:2 is to avoid protectionism.

1.170. Korea further argues that the prohibitions of Art. III:2, while honouring their anti-protectionist purpose, must be strictly interpreted. In Korea's view, before the tax rates of imported and domestic products can be compared, the competitive relationship between these two products must be strong, if not very strong indeed.

1.171. Korea's position is that according to Article III:2, imported products ought not be taxed less favourably than competing domestic products. Korea further argues that where products are perfect substitutes, or 'like', no difference in tax treatment can be tolerated. Where products are not 'like', but are still 'directly competitive or substitutable', the argument continues, there is more room for tax differences, as long as they do not have a protectionist effect.

(b) The Korean Tax System

1.172. Korea proceeds to give an explanation of its internal tax system. It states that it has 32 different types of taxes, which are largely divided into national and local taxes. Korea further states that like other countries, it distinguishes between direct taxes and taxes on goods and services. Unlike some other countries in Korea the share in total tax receipts of indirect taxes is much higher than direct taxes.¹⁰²

1.173. Korea notes that all alcoholic beverages are subject to several taxes, such as value added tax, liquor tax and education tax. The latter two taxes, as applied to certain imported alcoholic beverages, are disputed in this case.

i) The Liquor Tax

1.174. Korea notes that the Liquor Tax Law was enacted in 1949, and has been amended more than twenty times since. An important step in the development of the Liquor Tax Law was the change from a specific tax system to an ad valorem tax system in 1968.¹⁰³ According to Korea, the reason for this alteration was mainly that the Korean legislature wanted to raise taxes in proportion to the prices of products. It is of some significance, notes Korea, in view of the allegations that Korea's taxes are protectionist, that at the time of enactment of the Liquor Tax Law, and at the time of the change to an ad valorem system, Korea had very little imports of liquor.

1.175. Korea notes that the parts of its Liquor Tax Law that are relevant to this case are contained in the general provisions and in the chapter dealing with imposition. In the general provisions, a description is given for each drink in such way that it sets the requirements as to the content of each of the liquors in order to fit into the classification of the Liquor Tax. The section of the law dealing with imposition fixes the rates which apply to each particular group of liquors. The descriptions in the law determine the different applicable rates, thus, Korea concedes imposing a different tax rate on standard soju and whisky.

1.176. However, Korea argues that the complainants attempt to create the mistaken impression that the law's very structure reveals a protectionist intent.¹⁰⁴ According to Korea, the reality is different. For a long time, soju was the only spirit subject to liquor taxes. Korea notes that though the law's definition was broad, it covered only what was known. Over time, other spirits were marketed, and as they appeared, new tax categories were created.

1.177. Korea notes that the Liquor Tax relates to spirits and beverages containing at least 1% of alcohol. The persons falling under the Liquor Tax are either manufacturers of alcoholic beverages supplying from their factory, or importers. These persons pay taxes on the basis of the price at the time of delivery, when the beverages are delivered from a factory, or, when the liquors are imported, on the basis of the CIF plus duty price.

1.178. Korea further notes that the applicable tax rates on the alcoholic beverages are described in the Liquor Tax Law.¹⁰⁵ The tax system and the applicable rates have evolved over time. The applicable rate does not depend on the origin of the liquor. Korea presents the following rates that purportedly apply to the distilled beverages in dispute:

1.179. Korea states that being a high-volume, common drink that Koreans usually consume with meals, standard soju is in a class of its own, and so is distilled soju, being an artisanal drink, that is unique to Korea.

1.180. Korea notes that there is also a substantial domestic production of liqueurs, general distilled spirits and, particularly, of whisky, that fall under the higher tax rates.

1.181. According to Korea, the liquor taxes are an important tool for the government of Korea to raise revenue. According to the most recently available figures, liquor taxes amounted to 3.52% of national tax revenues.¹⁰⁸ Their share in indirect taxes represented 9.08%. The largest contributor to the liquor taxes traditionally has been beer, which is mostly domestically produced, which accounts for 69% of the Liquor Tax revenues in 1996.

ii) The Education Tax

1.182. Korea states that in addition to the Liquor Tax, an education tax is levied. According to Korea, Education Tax is an earmarked tax, meaning that the revenues collected through the Education Tax can only be used for the specific purpose of improving the educational system. The Liquor Tax regime is not the only regime that has an Education Tax. Korea asserts that there are ten other regimes to which the Education Tax is attached, such as tobacco consumption tax, property tax and transportation tax. Likewise, taxpayers liable for the payment of liquor taxes are also subject to the education tax. In Korea's calculation, the revenues generated by liquors in the education tax proceeds amount to 12.5%.

1.183. Korea states that the tax basis for the Education Tax, as levied on payers of the liquor tax, is the Liquor Tax corresponding to each kind of drink. The Education Tax applies as follows: alcoholic beverages whose ad valorem tax rate is higher than 80% are subject to 30% education tax on the amount of the Liquor Tax, and alcoholic beverages with an ad valorem tax below 80% are subject to 10% Education Tax.

1.184. Korea notes that the Education Tax is levied irrespective of the origin of the products. The proceeds of the Education Tax are allocated exclusively to the improvement of Korea's educational system, notably at the mandatory education level from primary to middle school.

To continue with Legal Analysis

⁹⁸ Ibid.

⁹⁹ In Japan - Taxes on Alcoholic Beverages II, the taxes in dispute were specific taxes per litre of beverage instead of ad valorem taxes. This makes it extremely difficult to compare the tax differentials at issue in the two cases. Nevertheless, it is worth noting that, according to the complainants, in Japan - Taxes on Alcoholic Beverages II the differences in specific taxes translated into a difference in tax/price ratios between shochu and whisky of between 10 % and 32 % of their retail sales price (See Panel Report on Japan - Taxes on Alcoholic Beverages II, supra, at para 4.159). In comparison, in the present case, the tax differential between soju and whisky may represent as much as 91.5 % of the CIF import value of whisky.

¹⁰⁰ See the legal definitions of diluted soju and gin at Articles 3.1 and 3.9 C of the Liquor Tax Law, respectively.

¹⁰¹ Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.35, cited by the Appellate Body Report on the same case, supra., p. 31.

¹⁰² In 1994, for instance, according to OECD methodology, the share of indirect taxes amounted to 43.4% of total tax revenue in Korea, whereas the comparable figure for the United States was 17.9%. The Korean figure for 1996 (predicted) is 43.7%.

¹⁰³ In this respect, the Korean liquor taxes differ from the liquor taxes at issue in Japan - Taxes on Alcoholic Beverages II, which were specific.

¹⁰⁴ See EC first submission, at para. 24; US first submission, at para. 24.

¹⁰⁵ Article 19(2).

¹⁰⁶ Examples of 'liqueurs' are Insam (ginseng) ju, Ogapiju, Bailey's, Grand Marnier, and Kahlua.

¹⁰⁷ Examples of 'general distilled alcoholic spirits' are koryangju, rum, gin, and vodka.

¹⁰⁸ This percentage is based on figures from 1996. In the two preceding years the revenue collected from the liquor tax was 3.54% and 3.53%.