2. Violation of Article III:2, First Sentence

1.151. The United States considers that vodka is "like" soju and that, under Article III:2 first sentence, Korea must eliminate any tax on vodka that exceeds the tax on soju. The US view is that Korea wrongly suggests that the absence of "perfect substitutability," the presence of minor differences in physical characteristics and production processes, differences in price, and differences in the end-uses in a particular market prevent two products from being "like."

1.152. The United States argues that Korea's argument that "like" products include only those that are "perfectly substitutable," has no basis in the text of Article III:2 or in Appellate Body reports, because if products were perfectly substitutable, they would likely be identical. The United States notes that in Canada - Certain Measures Concerning Periodicals, the Appellate Body noted that perfectly substitutable products would "fall within" the scope of "like" products,²¹⁰ but that does not mean that only perfectly substitutable products can be considered "like" products. According to the United States, the text of Article III:2 that refers to "like" products (in French, produits similaires) avoids the obvious tax discrimination that could result between similar products that do not share every single characteristic and accordingly are not "perfectly substitutable."

1.153. The United States further argues that, although the Appellate Body has clarified that the term "like" in Article III:2 must be narrowly construed, it is well established in GATT practice that products do not have to be identical to be considered "like" products.²¹¹ Korea's insistence that minor differences such as alcohol content and additives prevent two distilled spirits from being "like," runs directly counter to findings such as that in United States - Measures Affecting Alcoholic and Malt Beverages, in which the panel considered a low-quality style of Mississippi wine made from a special "scuppernong" kind of grape to be "like" all other kinds of wine.²¹² The United States further notes that in Japan - Taxes on Alcoholic Beverages I, taxes on alcoholic beverages, vodka and shochu were considered "like" products even though vodka was filtered differently. The US view is that Korea's argument that in a few instances vodka might be made of different raw materials than soju is not relevant if it does not affect aspects of the product identifiable to the consumer. According to the United States, whatever the original starch source, it is ethyl alcohol from various sources that is used in the production of US vodka, Korean soju and Japanese shochu. The production process allegedly varies only by filtration methods and level of dilution with water, resulting in minimal differences in the products produced.

1.154. The United States also argues that Korea's attempts to distinguish vodka from soju exaggerate the importance of the attribute. With respect to diluted soju, Korea has identified alcohol content as an important physical difference. According to the United States, the alcohol content of diluted soju is bottled at about 25%, while vodka is bottled at about 40%. But the United States notes that the WTO Japan panel conclusively rejected the notion that a difference in alcoholic strength of two products precluded a finding of likeness, on the basis of the simple observation that "alcoholic beverages are often drunk in diluted form."²¹³

1.155. According to the United States, such a difference in alcohol content does not even exist with respect to distilled soju. The United States notes that Korea, with respect to distilled soju, emphasizes the taste. In the US view, any such difference in flavour is probably linked to the distillation process rather than raw material, since vodka and soju are often derived from the same raw materials. In this regard, soju is no more different from vodka than Japanese shochu B, which is also obtained through a non-continuous (pot-still) distillation process.

1.156. The United States also argues that the fact that vodka has now been placed in its own tariff heading in Korea's schedules (2208.60) is also irrelevant. According to the United States, it was previously in the same basket category as soju (2208.90), but was broken into a separate heading to correspond to changes in the 1996 Harmonized System, which created a separate category to reflect the vast international trade in the product.

1.157. The United States further argues that Korea's emphasis on consumer tastes and habits as a dispositive factor in determining whether two products are "like" is also misplaced. According to the United States, the original identification of this factor derives from the Report of the Working Party on Border Tax Adjustments.²¹⁴ However, the United States notes that the report emphasized that the interpretation of "like" or "similar" products "should be examined on a case-by-case basis," which "would allow a fair assessment in each case of the different elements that constitute a 'similar' product."

1.158. According to the United States, Japan - Alcoholic Beverages I and II did not consider consumer tastes and habits to be significant in determining likeness where the market was previously restricted. The United States further argues that although the 1987 GATT panel agreed that in theory both objective factors and "the more subjective consumers' viewpoint" should be considered, it chose to disregard the "subjective" factor of "traditional Japanese habits" on the following basis:

1.159. The United States asserts that for the same reasons, the same panel also disregarded Japan's argument that differences in prices between local shochu and imported distilled spirits could prevent a finding of "like." According to the United States, the panel "was of the view that 'like' products do not become 'unlike' merely because of differences . . . in their prices, which were often influenced by external government measures (e.g. customs duties) and market conditions (e.g. supply and demand, sales margins)." Further, according to the United States, under the circumstances presented in the Japan dispute (a long history of protection, as in Korea), the panel considered that giving any weight to factors such as consumer traditions in a country or differences in price would run counter to the objective of Article III:2, by "creating different prices and consumer categories and hardening consumer preferences for traditional home products."²¹⁶ In the US view, such reasoning is equally compelling in this dispute.

1.160. With respect to vodka, the United States argues that Korea's attempt to draw a stark distinction between vodka and soju does not correspond to the very similar physical attributes and manufacturing processes of these products. Vodka is often made from the same grain-based neutral spirits as soju. Although a little costlier, white birch charcoal filtration produces virtually the same results as using other types of charcoal filtration -- and accordingly this difference did not prevent the Japan - Taxes on Alcoholic Beverages II panel from finding that vodka and shochu are "like" products. The United States also claimed that it is also wrong to emphasize alcoholic strength as a dispositive factor in selecting a distilled spirit. Once they are prepared, many mixed drinks, such as vodka cocktails have a lower alcohol content than straight soju. As determined by the panel in the Japan case, a difference in the alcoholic strength of two products "did not preclude a finding of likeness, especially since alcoholic beverages are often drunk in diluted form.

1.161. The United States argues that, with respect to the taste and sensation of the products, it is not the raw materials that are responsible for the so-called "stinging sensation" supposedly imparted by soju. If this were true, then all spirits could and can claim a "stinging sensation in the mouth and throat", since the raw materials are similar in many other spirits. For example, Archer Daniels Midland Company's grain neutral spirits are used for both soju and Smirnoff vodka (produced in the United States). The claimed unique "cold" mouth feel may come from the fact that soju, like vodka, is usually refrigerated before consumption. Moreover, although Korea cites to "harshness" as a unique desirable characteristic of standard soju compared to the smoothness or mildness of Western-style spirits, as the representative from the European Community pointed out, the advertisement in its submission for Jinro Bisun, produced by Korea's largest producer of soju (Attachment 6), boasts how it is a "mild" one, the same way Western-style spirits are marketed.

1.162. The United States also argued that as a factual matter, the characterization of Korean soju as unique is also at odds with the view of even the top Korean soju producer Jinro. On its Internet home page, Jinro sets out the following question: "What is Soju?" It provides the following response: "Jinro Soju, a sort of vodka-like spirits which began life in the 13th century, is the traditional Korean liquor. . ."(US Exhibit Q.) Similarly, an Internet search reveals the description of soju by an apparently French Canadian food critic as "la vodka coreene" (Korean vodka). (US Exhibit R.)

3. Violation of Article III:2, Second Sentence

1.163. The United States reiterates that Korea's taxes on imported distilled spirits in addition to vodka are applied so as to afford protection to domestic production of soju, in violation of Article III:2, second sentence. The United States notes that as set out by the Appellate Body in the Japan case, a violation of the second sentence requires three elements to be shown. First, the products must be directly competitive or substitutable; second, the products must be taxed in a way that is not "similar"; and third, the measure must be applied so as to afford protection to domestic production. According to the united States, Korea's attempted defence has focused accordingly on the first element, substitutability, and the vast majority of the Panel's questions also pertain to this element.

(a) The Text

1.164. The United States argues that Korea, in attempting to show that soju does not compete with imported distilled spirits, mainly relies on the argument that in order for products to be considered "directly competitive or substitutable," the complaining parties must show that "actual competition" between soju and all distilled spirits is occurring on the Korean market for all end uses. In the US view, although the complaining parties have shown actual competition and common end uses for most of the products in question, it is also potential competition with imported distilled spirits that is at issue in this dispute. The United States adds that Korea's legal interpretation is belied by an examination of the ordinary meaning of the relevant provisions, taken in their context, and in light of their object and purpose, as required under principles of international treaty interpretation.²¹⁷

1.165. The United States argues that the overriding purpose in Article III:2, second sentence is the incorporation as an obligation of the objective stated in Article III:1, that taxes should not be applied so as to afford protection to domestic production. The interpretive note to the second sentence, that it applies only "where competition was involved, between, on the one hand, the taxed product, and on the other hand, a directly competitive or substitutable product which was not similarly taxed" must be read in light of this overall purpose.

1.166. According to the United States, Korea's argument that competition must be actual runs counter to the text of the interpretive note and the purpose of the central obligation. The phrase "competition was involved" is more likely to mean the situation where competition is presented, rather than where competition is "currently occurring for every use," as suggested by Korea. Further, in the US view, this interpretation is more consistent with other terms in Article III:2, because in addition to proscribing protective taxation between directly competitive products, the interpretive note applies to "directly substitutable" products.²¹⁸ The United States further argues that the word "substitutable" is one that clearly shows the application of the second sentence to potential substitution -- i.e. it means able to be substituted; it does not require a test of whether and how many products are currently being substituted. The French text, in the US view, underscores the application of the obligation to potentially competitive products even more clearly: "un produit qui peut lui être directement substitué" (a product that can be directly substituted for the taxed product).

1.167. The United States further argues that the scope of the obligation to include potential competition is also consistent with the obligation in Article III:4, which requires national treatment for "like" domestic and imported products. According to the United States, the Article III:4 obligation has long been understood to apply to regulations that "might adversely modify the conditions of competition" between imported and domestic products, regardless of current trade.²¹⁹

1.168. The United States refers to the United States -- Section 337 of the Tariff Act of 1930 case, wherein it was noted that the Article III:4 obligation "calls for effective equality of opportunities" for imported products, rather than particular export volumes. ²²⁰ The United States further notes that the 1949 Working Party Report on Brazilian Internal Taxes takes the view that Article III:2, first sentence applies, "whether imports from other contracting parties were substantial, small, or non-existent," and stresses their "potentialities as exporters."²²¹ Similarly, concerning Article III:2 second sentence, unless "directly competitive or substitutable" is interpreted as applying to potential competition, its scope will be much narrower and permit the perpetuation of unfair competitive conditions that result from protected markets.²²²

1.169. The United States argues further that the application of Article III:2 to potential competition is also confirmed by GATT and WTO cases that have emphasized the distorting effect of past restrictions in the market. Japan -- Taxes on Alcoholic Beverages I disregarded traditional Japanese habits in determining that vodka and shochu were "like," emphasizing that they resulted from past protection.²²³ Japan -- Taxes on Alcoholic Beverages II similarly noted that "consumer surveys in a country with . . . a [discriminatory] tax system would likely understate the degree of potential competitiveness between substitutable products."²²⁴ The United States also notes that the Appellate Body in Canada - Certain Measures Concerning Periodicals had a similar response to Canada's arguments that static market shares over 30 years showed a lack of "direct competition." It noted, "this argument would have weight only if Canada had not protected the domestic production of Canadian periodicals through, among other measures, the import prohibition of Tariff Code 9958 and the excise tax of Part V.1 of the Excise Act."²²⁵

1.170. The United States argues that Korea is also wrong to insist that in order to be substitutable, products must be substitutable for all economic uses, such as consumption in restaurants or as an accompaniment with Korean food. According to the United States, although the GATT and WTO panels and the Appellate Body in the Japan case praised the concept of examining uses in a given market, as a practical matter they did not provide much weight to consumer tastes and habits. In the US view, the GATT Japan panel specifically noted that there was direct competition and substitutability as between all the liquors in dispute "even if not necessarily in respect of all the economic uses to which the products may be put."²²⁶ More recently, in Canada - Measures Concerning Periodicals, the Appellate Body specifically found that the products in question were directly competitive or substitutable even if they were poor substitutes for certain purposes.²²⁷ According to the United States, such an approach is consistent with other GATT panel findings, such as the application of Article III:2 in EEC - Measures on Animal Feed Proteins to products that were substitutable only "under certain conditions."²²⁸ In the US view, the products involved -- skim-milk powder on the one hand, and oilseeds, cakes and meals, dehydrated fodder and corn gluten feed, on the other -- confirm the appropriate broad scope of the term "directly competitive or substitutable."

(b) Drafting History

1.171. The United States argues that the drafting history of the GATT 1947 supports the broad textual interpretation of the scope of "directly competitive or substitutable." According to the United States, prior to the Geneva drafting session, the text of what became the second sentence of Article III:2 was not in the nature of an obligation and referred only to competitive products. At the Geneva session, according to the United States, delegates discussed the scope of the language that eventually provided the basis for the present obligation. Concerning which products would be compared, some country delegates cited examples of domestic and imported products that could be "competitive" and trigger the application of the legal obligation. These included quite broad categories of products, such as domestic apples and imported oranges;²²⁹ domestic linseed oil and imported tung oil;²³⁰ and domestic synthetic rubber and imported natural rubber.²³¹

1.172. The United States further notes that the record discloses that no disagreement was expressed by delegates with the breadth of these specific examples of "competitive" products, including the reference to apples and oranges. In Havana, when the text of the legal obligation on national treatment was approved, the Chairman of the Sub-committee reported "only one important change in substance" from the Geneva text. Provisions for a negotiated elimination of discriminatory internal taxes in the previous draft evolved into to their outright elimination.²³²

1.173. According to the United States, at that point, the term "directly competitive or substitutable" was added in the text. After adoption of the present text and interpretive note, one additional question was raised concerning examples of what might be considered "directly competitive or substitutable products" for purposes of the interpretive note to Paragraph 2. One delegate allegedly asked if "coal vs. fuel oil" and "tramways vs. busses" could be considered directly competitive or substitutable. Another delegate allegedly noted the need for actual cases in order to interpret the provision, but opined that such products were not substitutable. A third delegate, however, allegedly stated that decisions could not be made except in relation to a particular factual situation, but that a tax on coal in a particular case might be designed to protect the fuel oil industry.²³³ In the US view, this comports with the Appellate Body's finding in Japan-Taxes on Alcoholic Beverages II that determinations are to be made on the basis of "all relevant facts," when examining each of the "number of means" for identifying the "broader category of products that might be described as 'directly competitive or substitutable.'"²³⁴

1.174. The United States concludes that the examples discussed in the drafting history show that the comparison of internal taxes on domestically produced soju, on the one hand, and imported distilled spirits, on the other, is well within the scope contemplated by the drafters. The emphasis was obviously not on particular attributes of the products such as physical characteristics, production processes, or quality, but on the ability of the products to be used in the same manner, and the extent to which a government acted to protect a domestic product to prevent such substitution in its market.

To continue with Directly Competitive or Substitutable

²¹⁰ Appellate Body Report, p. 28.

²¹¹ Japan - Taxes on Alcoholic Beverages I, supra., para. 5.6 "minor differences do not prevent products [from] qualifying as "like"); U.S. - Taxes on Petroleum and Certain Imported Substances, supra, (liquid hydrocarbon products although not identical were "like" crude oil and natural gas because they served substantially same end uses).

²¹² BISD 39S/206, 276-77.

²¹³ Panel Report on Japan - Taxes Alcoholic Beverages II, supra., para. 6.23.

²¹⁴ BISD 18S/97, 102.

²¹⁵ Japan - Taxes on Alcoholic Beverages I, supra, para. 5.7.

²¹⁶ Ibid., at para. 5.9.

²¹⁷ See Article 31 of the Vienna Convention on the Law of Treaties.

²¹⁸ According to the United States, although the English text of the interpretative note is ambiguous on the point, the French translation appears to suggest that the word "directly" also applies to the word "substitutable." Either way, it does not have implications for this dispute.

²¹⁹ Italian Discrimination Against Imported Agricultural Machinery, adopted on 23 October, 1958, BISD 7S/60, 64.

²²⁰ BISD 36S/345, 386-87.

²²¹ GATT/CP.3/42, adopted 30 June, 1949, II/181, 185.

²²² The United States believes that this interpretation is all the more compelling because the second sentence is meant to compensate for the narrow interpretation required of the term "like" in Article III:2, first sentence, as acknowledged by the panel and Appellate Body in the Japan - Alcoholic Beverages case.

²²³ Japan - Taxes Alcoholic Beverages I, supra, para. 5.7.

²²⁴ Panel. Report on Japan - Taxes on Alcoholic Beverages II, supra, para. 6.28.

²²⁵ Appellate Body Report on Canada - Certain Measures Concerning Periodicals, supra, p. 28.

²²⁶ Japan - Taxes on Alcoholic Beverages I, supra, para. 5.7.

²²⁷ Appellate Body Report on Canada - Certain Measures Concerning Periodicals, supra, p. 28.

²²⁸ BISD 25S/49, 63-64, adopted on 14 March, 1978.

²²⁹ E/PC/T/A/PV/9, p. 7.

²³⁰ E/CONF.2/C.3/SR.11, p. 1 and Corr.2.

²³¹ E/CONF.2/C.3/SR.11, p. 3.

²³² E/Conf.2/C.3/SR.40, p.1.

²³³ E/Conf.2/C.3/SR.40, p. 2.

²³⁴ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., at p. 25.