B. Products in Issue

7. The products in issue in this dispute are all distilled spirits falling within the heading 22.08 of the Harmonised System ("HS") nomenclature, including, but not limited to the following:

• all kinds of pisco falling within HS 2208;
• all kinds of whisk(e)y falling within HS 2208.30 (hereafter, "whisky");
• all kinds of brandy obtained by distilling grape wine or grape marc and falling within HS 2208.20 (hereafter, "brandy");
• all kinds of rum and taffia falling within HS 2208.40 (hereafter, "rum");
• all kinds of gin and geneva falling within HS 2208.50 (hereafter, "gin");
• all kinds of vodka falling within HS 2208.60 (hereafter, "vodka");
• all kinds of liqueurs falling within HS 2208.70, such as anisettes, curacao, cream liqueurs, emulsions and bitters (hereafter, "liqueurs"); and
• all kinds of aquavit, korn, fruit brandies (such as plum brandy, cherry brandy, pear brandy and cider brandy), ouzo and tequila falling within HS 2208.90 (hereafter, "aquavit", "korn", "fruit brandies", "ouzo" and "tequila", respectively).

1. Pisco

8. Under Chilean law, the term "pisco" is a protected geographical indication, the use of which is reserved exclusively for wine distillates produced and bottled in certain regions of Chile from certain varieties of muscat grapes grown in those regions. ⁷
9. Article 28 (a) of Law No. 18,455/85 ⁸ provides that the designation "pisco":

[...] is reserved for aguardiente produced and bottled, in units for consumption, in the regions III and IV, made by distillation of genuine potable wine obtained from the varieties of grapevines to be determined by regulation, planted in the said regions.

10. The term aguardiente, in turn, is defined in Decree 78/1986 ⁹ (which implements Law No. 18,455/85) as follows:

A distillate of wine, to which no additives have been added except sugar and water. ¹⁰

11. Decree 78/1986 also specifies that pisco may be produced only from wine obtained from one or more of the following varieties of grapes of the species Vitis Vinifera L: Chasselas Musque Vrai, Moscatel Amarilla, Moscatel Blanca Temprana, Moscatel de Alejandría or Italia, Moscatel de Austria, Moscatel de Frontignan, Moscatel de Hamburgo, Moscatel Negra, Moscatel Rosada or Pastilla, Moscato de Canelli, Muscat Orange, Pedro Jiménez and Torontel. ¹¹ In practice, most pisco is made by blending spirits distilled from two or more of these types of grapes.
12. The so-called zona pisquera currently comprises Regions III (Atacama) and IV (Coquimbo). These two regions lay between the parallels 27 and 32, some 600 kilometres north of Santiago, and are characterised by a very dry and sunny climate. The grapes for the production of pisco are grown along a series of narrow valleys irrigated by rivers flowing from the Andes into the Pacific, the so-called five valles pisqueros: Copiapó, Vallenar, Elqui, Limarí and Choapa.
13. The production of pisco is dominated by two large co-operatives, each grouping several hundred associated grape growers: Cooperativa Agrícola Pisquera Elqui Ltda (hereafter "Capel") and Cooperativa Agrícola Control Pisquero de Elqui y Limarí (hereafter "Control"). It is estimated that, together, Control and Capel account for more than 90 % of the sales of pisco.
14. The main stages in the production process of pisco may be summarised as follows:

1. harvesting and grinding of the grapes;
2. fermentation of the grape-juice in large earthenware or steel containers in order to produce wine, with an alcohol strength of approximately 14° ;
3. distillation of the wine in copper pot stills. ¹² The raw spirit obtained at the end of this phase has about 55° -60° ;
4. maturation of the raw spirit in wooden containers for a relatively short period of time, usually not exceeding several months. The best quality brands may be stored in American oak casks for a longer period; and
5. finally, the spirit from the different distilleries is centralised to be blended, diluted with de-mineralised water in order to obtain the desired alcohol strength, filtered and bottled.

15. By law, the four types of pisco must have an alcohol content of no less than 30° ; the four types of pisco are designated asthe following alcohol content: ¹³

• Pisco corriente or tradicional between 30° and 35° ;
• Pisco especial between 35° and 40° ;
• Pisco reservado between 40° and 43° ;
• Gran pisco 43° or more.

16. According to the explanations provided by the Chile during the consultations, Chile's pisco industry is currently producing and selling pisco of the following alcohol contents: ¹⁴

• Pisco corriente or tradicional 30° , 32° , 33°
• Pisco especial 35° ¹⁵
• Pisco reservado 40°
• Gran pisco 43° , 46° and 50°

17. According to the regulations in force, the four different types of pisco are distinguished solely in terms of their alcohol strength. ¹⁶ As already indicated by its name, pisco tradicional or corriente used to be the largest selling type of pisco. Over the last few years, however, it has been overtaken by pisco especial, which is now the best selling pisco category. Pisco reservado and gran pisco account for about 9 % of the market.
18. Although there are no official statistics on the production or sale of the different types of pisco, the European Communities submitted market data compiled by AC Nielsen, a private market organization employed by the European distilled spirits industry to estimateto the market share of each type of pisco, as follows: ¹⁷

Table 3 ¹⁸

Pisco sales by category

	Aug 94/July95	Aug 95/July96	Aug96/July97
Tradicional	46.2 %	35.8 %	34.5 %
Especial	40.8 %	49.8 %	51.4 %
Reservado	5.5 %	6.4 %	6.3 %
Gran Pisco	4.4 %	4.8 %	4.2 %
Pisco sour19	3.0 %	3.2 %	3.7 %

Basis: % of total sales of pisco

19. Chile provides information concerning production and sales of various types of distilled spirits in Chile. The following table 4 indicates the data for 1997: ²⁰

Table 4

Volume in Thousands Litres and Value in Thousands of US$

	Production 1997		Imports 1997		Exports 1997		Apparent Consumption 1997
Type of Spirits	Volume	Value	Volume	Value	Volume	Value	Volume	Value
Total, Pisco of different alcoholic beverages content*	40,977.9		0.0	0.0	301.6	933.3	40,676.3
Pisco 30� *	16,276.5
Pisco 35� *	20,969.0
Pisco 40� - 46� *	3,732.5
Aguardiente minimum 30�			9.1	37.9
Aguardiente minimum 50�
Other grape spirits			94.4	336.2	106.1	266.0
Brandy, cognac, armagnac (minimum 38�)
Grapa (minimum 30�)
Whisky (minimum 40�)			2,484.7	13,799.7	0.2	3.6
Rum and other spirits of sugar cane (minimum 40�)			642.8	1640.8	0.3	1.6
Gin and geneva (minimum 40�)			198.9	967.8	0.0	0.0
Other Spirits			1,679.9	6,412.9	111.3	287.2
Vodka (minimum 40�)			389.9	1,246.4	0.0	0.1
Liqueurs			183.1	1,359.6	41.7	71.8
Other spirits			1,106.9	3,806.9	69.6	215.3

Sources:
(1) Production:
- Piscos according to alcoholic strength: Control Pisquero Ltd. and Capel Ltd.
-Aguardiente; Brandy, Cognac, Armagnac; grapa; whisky; rum and other spirits of sugar cane; gin and geneva; vodka; other distilled spirits; fruit liqueurs; anisette, anise liqueur; arack, pastis, anesone; bitter liqueurs; cocktails; other spirits: Asociación de Licoristas de Chile.
(2) Exports and Imports: Central Bank of Chile.


Notes:
(i) Bold type represents the sum, where possible, of the rows below.
(ii) The row vodka (minimum 40�) is underlined for emphasis, since there are import and export statistics for the years 1996 and 1997.

20. Finally, the merger of the two largest producers of pisco, Control and Capel, was authorised by Chile's competition authority as of 30 October 1998. Their combined market share is 90%. In giving this authorisation, the competition authority indicated that pisco had a high degree of competition with other alcoholic beverages, such as wine, beer and whisky, given the practice of ingesting pisco mixed with a non-alcoholic beverages, and therefore, in the market for alcoholic beverages, and despite the fact that the merger of the applicant co-operative companies would result in a combined share of the pisco market of 98%, there are alternative products which consumers of alcoholic beverages could choose to drink.

2. The Other Spirits in Issue

21. The names of the main types of distilled spirits at issue in this dispute, other than pisco, are permitted to be used only for those alcoholic beverages which are defined by Decree 78/1986 in the following terms²¹:

1. Whisky: "The distillate of the alcoholic fermentation of malted or unmalted mashes of grain, which is subjected to ageing processes in wooden vessels, whether or not coloured with natural caramel".²²
2. Brandy: "Aguardiente aged in vessels of noble wood, whether or not coloured with natural caramel, and whether or not sweetened with sugar".²³
3. Gin: "Beverage obtained by flavouring rectified alcohol from starchy raw materials with distillates, macerations or essential oils from juniper berries".²⁴
4. Vodka: "Beverage obtained from alcohol from starchy raw materials, with or without maceration of grass".²⁵
5. Liqueurs: "The product prepared from potable ethyl alcohols, distillates, fermented alcoholic beverages, whether or not mixed with each other, and with or without natural or synthetic aromatic extracts. It may contain sweeteners, water, colorants or any other permitted additive".²⁶

22. Decree 78/1986 also prescribes the minimum alcohol content requirements for the use of the main type names of distilled spirits in dispute, as follows²⁷:

Table 5 ²⁸

Legally required minimum alcohol strength in Chile

Whisky, rum, tequila, gin	40°
Brandy, cognac, armagnac	38°
Aguardiente, fruit aguardiente, grappa	30°
Fruit liqueurs	25-34°
Anisettes	25-40°
Bitters	25-30°
Cocktails	12-16°
Other liqueurs	25-28°

C. History of taxation of alcoholic beverages in Chile

23. Between 1916 and 1954, pisco was totally exempted from the excise taxes imposed on the other alcoholic beverages. Between 1954 and 1974, pisco was taxed at a rate that was half of the rate applied to all the other liquors.
24. In 1974, Decree-Law No 826/74 introduced a 40 % ad valorem tax on all categories of spirits, including pisco. ²⁹ At the same time, however, Decree-Law 826/74 imposed a 50 % surcharge ("recargo") on all imported beverages. ³⁰
25. In 1977, Decree-Law 826/74 was amended by Decree-Law 2,057/77, which abolished the recargo. ³¹ Simultaneously Decree-Law 2,057/77 lowered the rate of tax on pisco from 40 % to 25 %, while the tax on other spirits was reduced from 40 % to 30 %.
26. In June 1979, Decree-Law No 826/74 was repealed and replaced by the ILA, a new tax applied in conjunction with the Value Added Tax system. ³² At first, the ILA was applied at the same rates as the tax which it had replaced, i.e., 25 % on pisco and 30 % on all other distilled spirits. ³³ But in December 1983 the rate on distilled spirits other than pisco was increased from 30 % to 50 %, while the rate applied to pisco was unchanged at 25 %.³⁴
27. On 23 January 1984, the ILA was amended again in order to lower the applicable rate on distilled spirits other than pisco and whisky from 50 % back to its previous level of 30 %. ³⁵ At the same time, the rate on whisky was further increased from 50 % to 55 %. ³⁶ Thus, following these changes, the ILA was applied at three different rates: 25 % on pisco; 55 % on whisky and 30 % on all other distilled spirits.
28. In May 1985, the rate on whisky was increased once again from 55 % to 70 %. ³⁷ Following this change, the ILA rates have remained unmodified until the amendment approved in November 1997.
29. The table below summarises the evolution of the applicable rates between 1974 and the entry into force of Law 19,534 on 1 December 1997.

Table 6 ³⁸

Evolution of taxes rates between 1974 and 1997

	Pisco	Whisky	Other spirits
With effect from 12/74	40 %	40%*	40 %*
With effect from 12/77	25 %	30 %	30 %
With effect from 7/79	25 %	30 %	30 %
With effect from 12/83	25 %	50 %	50 %
With effect from 1/84	25 %	55 %	30 %
With effect from 5/85	25 %	70 %	30 %

* imported spirits subject to the 50 % recargo until 1977.

To continue with Claims of the Parties

⁷ The European Communities points out that according to the explanations provided by Chile during the consultations, the protected geographical indication for pisco was "made official" in 1931 by means of Decree-Law 181. See Chile's answers to questions from the EC dated 22 July 1997 (EC Exhibit 1).

⁸ Law No. 18,455, of 31 October 1985, laying down rules for the production, preparation and marketing of ethyl alcohol, alcoholic beverages and vinegar (hereafter, "Law 18,455/85") (EC Exhibit 12).

⁹ Decree No. 78 of 31 July 1986 implementing Law 18,455/85 (hereafter, "Decree 78/1986") (EC Exhibit 13).

¹⁰ Ibid., Article 1.2.

¹¹ Ibid., Article 56.

¹² According to the European Communities, the stills are similar to those used by the producers of Cognac. The distillation process may be described as a "batch" process, rather than a continuous process, although rectifiers are sometimes used to boost the strength of the spirit.

¹³ Decree 78/1986, Article 56.

¹⁴ Chile's answers to questions from the EC dated 24 February 1998 (EC Exhibit 2).

¹⁵ According to the European Communities, the brand "Control de Guarda" appears to be sold also at 36° . See EC Exhibit 51.

¹⁶ Article 13 of Decree 78/1986 (EC Exhibit 13).

¹⁷ The European Communities submits the source of Table 4 as EC Exhibit 24.

¹⁸ EC First Submission, Table 1.

¹⁹ The European Communities notes that pisco sour is not a variety of pisco but, rather, a cocktail made with pisco. Specifically, Decree 78/1986 (Article 58) defines pisco sour as "[�] the cocktail produced and bottled in regions III and IV, prepared with pisco, lemon juice or natural lemon flavouring [�]". Table 3 shows the share of pre-mixed pisco sour.

²⁰ Chile First Submission, Annex III, Table 7. Chile additionally provides the following estimates by the domestic industry of pisco production in 1998 (January to September): Pisco 30� - 8,613.0, Pisco 35� - 20,730.0; Pisco 40� to 46� - 2,465.0; Aguardiente min. 30� - 45.0; and Aguardiente min. 50� - 480.0 (million litre).

²¹ According to the European Communities, Decree 78/1986 contains no definition of rum.

²² Decree 78/1986, Article 1.42 (EC Exhibit 13).

²³ Ibid., Article 1.5.

²⁴ Ibid., Article 1.11.

²⁵ Ibid., Article 1.41.

²⁶ Ibid., Article 1.17.

²⁷ Ibid., Article 12.

²⁸ EC First Submission, Table 2, with corrections made by the Panel based upon Decree 78/1986, Article 18 (EC Exhibit 13)..

²⁹ Article 3 of Decree-Law No. 826, of 27 December 1974 (hereafter, "Decree 826/74") (EC Exhibit 5).

³⁰ Ibid.

³¹ Decree-Law No. 2,057 of 30 November 1977 amending Decree-Law 826/74 (hereafter "Decree 2,057/77")(EC Exhibit 7), Article 1.2.

³² Decree No 2,752, of 21 June 1979, integrating the taxes on alcoholic beverages within the VAT system (hereafter, "Decree 2,752/79") (EC Exhibit 8). According to the European Communities, this Decree-Law brought the taxation of alcoholic beverages within the scope of Decree-Law 825/74.

³³ Ibid., Article 1.3.

³⁴ Article 4.III of Law No. 18,267, of 1 December 1983 amending Article 42 of Decree 825/74 (hereafter, "Law 18,267/83") (EC Exhibit 9).

³⁵ Article 1 of Law No. 18,289, of 23 January 1984 amending Article 42 of Decree 825/74 (hereafter, "Law 18,289/84") (EC Exhibit 10).

³⁶ Ibid.

³⁷ Article 4.III of Law 18,413/85 (EC Exhibit 11).

³⁸ EC First Submission, Table 7.