3. Chile - "Objective Criteria" Argument

279. Chile replies that there is no precedent for holding inconsistent with GATT 1994 a system of taxation that does not discriminate based on nationality and that employs strictly objective criteria for any differentiation in taxes. Indeed, the same panels that condemned the Japanese System � and even the European Communities itself in arguing those cases � observed that distinctions based on objective and neutral criteria are permissible under Article III:2.
280. Chile also states that Article III does not prohibit a tax or regulation simply because, as a result of the application of objective criteria, some or even many imported products are by some measures treated worse than some or many like or competing domestic products. The drafting history of Article III makes this clear. In the latter stages of the drafting of what became Article III of the GATT, the negotiating Sub-Committee responsible for this Article reported:

The Sub-Committee was in agreement that under the provisions of Article 18 [Article III of the GATT], regulations and taxes would be permitted which, while perhaps having the effect of assisting the production of a particular domestic product (say, butter) are directed as much against the domestic production of another product (say, domestic oleomargarine) of which there was a substantial domestic production as they are against imports (say, imported oleomargarine). ¹⁵⁶

281. In the view of Chile, the logic of this unanimous understanding of the negotiators is compelling. All WTO Members make tax and regulatory distinctions that fall unevenly by some measures among products that might be considered like or directly competitive or substitutable in the sense of Article III. Sometimes these distinctions will mean that many domestic products will, by some measures, be taxed or regulated more favorably than many like or competing imports. But that is not a violation of Article III, where criteria for the distinctions are objective and neutral.
282. Chile also argues that past panels have repeatedly acknowledged these considerations, noting also that Article III is not intended to be used as a tool for harmonizing the tax systems of the WTO Members, ¹⁵⁷ and WTO Members retain almost complete freedom with respect to domestic policies that do not distinguish between the origin or destination of goods. ¹⁵⁸ In United States - Measures Affecting Alcoholic and Malt Beverages, the panel noted that:

The purpose of Article III is not to harmonize the internal taxes and regulations of contracting parties, which differ from country to country. ¹⁵⁹

283. Chile further argues that in Japan � Taxes on Alcoholic Beverages I, the panel affirmed this principle with respect to Article III:2, noting that this Article "prohibits only discriminatory or protective taxation of imported products but not the use of differentiated taxation methods as such ..." ¹⁶⁰ The panel went on to say "that Article III:2 does not prescribe the use of any specific method or system of taxation ..." ¹⁶¹ This position was also endorsed by the Appellate Body in Japan - Taxes on Alcoholic Beverages II. ¹⁶²
284. Chile then claims that the EC argument against the Chilean system ignores these precepts of Article III, and instead asks the Panel to strike down an objective and neutral tax system merely because a result of the application of that system is that those EC beverages of high alcohol content (and high price) will face higher taxes than those Chilean beverages (primarily certain kinds of pisco) that are of relatively low alcohol strength (and price). In making this argument with respect to the New Chilean System, the European Communities ignores that many European products, including those most similar to pisco, will benefit from the same lower rates of tax, while other European products could be adapted for the Chilean market merely by diluting with water the current relatively high strength of the products -- as the European Communities has suggested could be done by pisco producers. Equally, the European Communities ignores that under the New Chilean System many Chilean distilled spirits, including Chilean whisky, brandy and gin and very substantial quantities of pisco that are marketed at relatively high prices and alcohol strength, will face the highest rate of taxation.
285. Chile then concludes that the New Chilean System thus presents precisely the kind of regulatory system that Article III is not intended to condemn:

1. there is no distinction in taxation based on origin or on type;
2. many imports can benefit from the lowest tax and all others could be easily diluted for that purpose;
3. many domestic products of Chile will face the highest tax rates under the New Chilean System; and
4. the objective standards mean that foreign producers can readily adapt their products to lower their taxes by a simple process.

286. In its support, Chile adds that the Appellate Body has properly noted that "Article III protects expectations not of any particular trade volume but rather of the equal competitive relationship between imported and domestic products". ¹⁶³ Foreign and domestic producers have an equality of competitive opportunities, as they have an equal opportunity to adapt their production, if they so choose, in the way implicitly preferred under the New Chilean System, i.e., by reducing alcohol content.
287. Further, Chile notes that the European Communities itself in this matter recognizes that "the New Chilean System abolishes formally the distinction between pisco and the other types of distilled spirits". The criterion of alcohol content is neutral and objective, and one that past panels and the European Communities itself have cited as an example of a tax category corresponding to objective product differences.
288. Chile further argues that the panel in Japan - Taxes on Alcoholic Beverages I endorsed use of alcohol content as a permissible objective means of taxation. The panel suggested that the application of different tax rates would be consistent with Article III:2 if the different tax rates were based on objective criteria, and relative alcohol content was specifically cited and endorsed as an example of an approach that could be acceptable. In rejecting the Japanese tax structure subject to dispute in Japan - Taxes on Alcoholic Beverages I, the panel observed that it:

was unable to find that the differences as to applicability and non-taxable thresholds of the ad valorem taxes were based on corresponding objective product differences (e.g., alcohol contents) and formed part of a general system of internal taxation equally applied in a trade-neutral manner to all like or directly competitive liquors. ¹⁶⁴

289. It should be observed, according to Chile, that the panel did not object to the existence of non-taxable thresholds, nor did the panel require that the system apply taxes in direct proportion to alcohol content. Rather, the panel found the Japanese system deficient in applying a different scale to different types of distilled spirits that had been found directly competitive or substitutable.
290. In its further support, Chile points out that in the United States - Taxes on Automobiles case, the European Communities argued that the Japanese tax system examined by the panel in Japan - Taxes on Alcoholic Beverages I, "did not correspond to a rational overall system for taxing all liquors, such as one based on alcohol content".¹⁶⁵
291. Chile also notes that the European Communities itself, in its challenge of the Japanese system of taxation of alcoholic beverages specifically commended both alcohol content and value as acceptable neutral ways of varying taxes on like and directly competitive practices. In this respect, the European Communities argued that the panel in its analysis of an alleged violation of Article III should:

determine whether the category as a whole is taxed in excess of the corresponding category of domestic products. This would not be the case if the proportional variations in taxation on the basis of, e.g., alcohol content, are equally and uniformly applied to this category of like products, both domestic and imported. ¹⁶⁶

292. Chile further notes that similar views have been expressed before the European Court of Justice ("ECJ"). The ECJ in Case 170/78, Commission v United Kingdom, 1983 ECR 2265 noted that:

[T]he Commission has recommended that spirits should be charged at a higher rate of duty according to alcoholic strength than liqueur wines. It appears, therefore, to have accepted that there are social reasons for imposing a relatively higher rate of taxation on beverages with a higher alcoholic content.

293. In the view of Chile, on the contrary, the European Communities argues that under the New Chilean System many spirits imported from the European Communities are and will be of relatively high alcohol content, and therefore more heavily taxed, while many spirits produced in Chile are and will be of relatively lower alcohol content and hence less heavily taxed. While those points are true, they present an incomplete picture of the facts and an inadequate basis to find a violation of Article III:2. Much Chilean pisco is taxed at the lowest rate of 27%, but Chile also produces a large volume of products containing 40° alcohol content or more, including domestically produced whisky, gran pisco, pisco reserved, 40° brandy, rum, gin, and vodka, and these products will be taxed at a rate of 47%, the highest tax bracket. It is also significant that many distilled spirits produced in Europe and elsewhere contain 35° alcohol or less and will be taxed in Chile at a rate of 27%, including aguardiente, grappa, fruit liquors, cocktails, other liquors, and even shochu. Therefore, just as some domestically produced products benefit from the lowest tax bracket, it is equally true that a significant amount of domestically produced whisky and gran pisco faces the highest tax rate of 47%.
294. Chile further provides Chart 3 to show the growing volume of sales of premium grades of pisco with relatively high alcohol content that will face the highest rates of taxation under the New Chilean System.
295. Chile also presents tables showing the best available information concerning production and sales of various types of distilled spirits in Chile. ¹⁶⁷
296. Chile then concludes that in any event, where objective standards are applied, GATT Article III does not require that internal taxes and measures must always result in proportional effect on imported and domestic products. To take an obvious example, ad valorem taxes are permissible under GATT, even though imported products that are higher priced or already face customs duties may thereby have to face higher tax per unit than domestic products. The European Communities itself has endorsed the idea that horsepower or engine displacement taxes are permissible. Chile agrees, even though such taxes almost certainly fall disproportionately heavily on automobiles of the type that Americans or Canadians are more likely to produce.
297. Chile further rebuts the EC argument that the New Chilean System cannot be characterized as a tax on alcohol content because it is based on an ad valorem tax rather than a specific tax. The European Communities states that the Chilean tax, although varying according to alcohol content, is "assessed on the value of the beverage, which is not directly related to the value of the alcohol content" and thus cannot be "characterized as a tax on the alcohol content". It is not clear what point the European Communities is trying to make here or how it furthers their argument, but in any event their analysis is fundamentally irrelevant and leads to an incorrect conclusion. The New Chilean System is based on both alcohol content and ad valorem; two criteria that have been recognized and accepted by previous panels under GATT as objective criteria.
298. Chile further argues that panels have even found that different systems could be used for imported and domestic products, if objectively based. It is not necessary for this Panel to go that far in this dispute, since the New Chilean System applies an identical system without regard to whether distilled spirits are imported or domestically produced. Nevertheless, it is instructive that the panel in Japan - Taxes on Alcoholic Beverages I noted that:

Article III:2 does not prescribe the use of any specific method or system of taxation � there could be objective reasons proper to the tax in question which could justify or necessitate differences in the system of taxation for imported and for domestic products. ¹⁶⁸

This position was also endorsed by the Appellate Body in Japan - Taxes on Alcoholic Beverages II. ¹⁶⁹

299. Chile also argues that the overriding requirement of Article III:2 is not to discriminate in favor of domestic goods and against imported goods on the basis of national origin of a product. Almost all cases brought to GATT and WTO panels under Article III:2 have involved measures that, on their face, afforded more favorable treatment to some or all domestic goods than to imported goods.
300. Chile explains that a legislator should also be aware that a measure that formally does not discriminate based on nationality may nevertheless be found to contravene Article III:2, second sentence, if the effect of the measure is to make more favorable treatment available exclusively or virtually exclusively to domestic products to the disadvantage of imported products. GATT and WTO panels have gone furthest in extending the concept of de facto discrimination based on national origin of a product in the recent alcoholic beverage taxation cases against Japan and Korea. Both of those countries had tax systems in which one type of distilled spirit was taxed at a far lower rate than other distilled spirits. Further, in each case, domestic producers accounted for virtually all domestic consumption of shochu or soju, because various measures effectively prevented imports of shochu/soju from competing in the domestic market. In these circumstances, where there was no possibility for foreign producers to obtain the benefits of the low tax accorded to shochu/soju, and where the panel found that the favoured product was like or directly competitive or substitutable with other types of distilled spirits, these systems were held to contravene Article III:2.
301. In the view of Chile, on the other hand, laws and regulations based on objective criteria such as those used in the New Chilean System have rarely been challenged in the GATT and have never been successfully challenged, even when the tax system may result in less favorable treatment for some or many imported goods than for some or many domestic goods. For example, in the United States - Taxes on Automobiles case, the panel found that the United States had not breached Article III:2 by imposing a luxury tax on vehicles above a certain threshold value. ¹⁷⁰ The U.S. tax resulted in far higher taxes on certain European products, which dominated the U.S. market for cars priced significantly above the threshold price and thus accounted for the vast majority of the revenue collected from the tax on European cars. However, far more imports, including a significant number of imports in the price categories most directly competitive with U.S. "luxury cars," paid a minimal tax or no tax at all.
302. Chile further argues that while the reasoning of the United States - Taxes on Automobiles panel (the so-called "aim and effects" test) was not followed subsequently by the Appellate Body, it believes that the result would have been the same under the three part test applied by the Appellate Body in Japan � Taxes on Alcoholic Beverages II. ¹⁷¹ The luxury tax imposed by the United States was based on objective criteria (a tax on the value of cars in excess of a fixed luxury level) that applied to both domestic and imported cars, and imported cars could and did benefit from the tax exemption granted to all cars below the exemption.
303. Chile then points out that comparing that system to the Chilean system of taxation of alcoholic beverages, it might be noted that it is easier as a practical matter for foreign producers to adapt the alcohol strength of their product than for car producers to reduce their prices.
304. Chile also notes that similarly, even though specific taxes such as those imposed on alcoholic beverages in several EC Member States have a marked discriminatory effect on low priced imported products relative to high priced domestic products such as Scotch whisky or even imported high priced products such as U.S. or Canadian whisky, Chile has believed that a challenge of such tax systems under Article III (or Article I which requires most favoured nation treatment with respect to matters covered by Article III:2) would probably not be successful because the tax standard is objective, even if its effect disfavours low price products.
305. Chile also argues that it is likewise inconceivable that members of the WTO, particularly developing country members, thought or think that, in joining the WTO and accepting thereby the obligations of Article III:2, they were foregoing the right to use fiscal policy tools such as luxury taxes or exemptions or reduced taxes for goods purchased primarily by poor consumers, even if such policies result in higher taxes on many imports than on many like or directly competitive products.
306. The European Communities replies that Chile's defence in this case is built upon the argument that tax distinctions linked to differences in alcohol content do not constitute "dissimilar taxation" because they are "objective" and "neutral". While those two terms are constantly repeated by Chile, their precise meaning is nowhere explained. As shown below, the legal test embodied in Chile's argument would lead in practice to unacceptable consequences.
307. The European Communities argues that to begin with, one may wonder what qualifies as an "objective" tax distinction. Or, rather, one should ask what does not qualify as an "objective" tax distinction. Differences between spirits with respect to factors such as ingredients, colour or even taste are no less "objective" than differences in alcohol content. They are as readily observable and can be measured with the same precision. In view of that, why should tax distinctions based on one or more of those characteristics be treated differently than the tax distinctions based on alcohol content?
308. The European Communities further states that on the other hand, if one accepts the view that "objective" tax distinctions between products may never constitute "dissimilar" taxation, the second sentence of Article III:2 becomes redundant. Indeed, the existence of two "directly competitive or substitutable" products presupposes, by definition, that there is some sort of "objective" difference between them. Otherwise, they would be "like" products and any difference in taxation between them would be caught by the first sentence of Article III:2.
309. The European Communities states that the relationship between the two terms of Chile's test is also far from clear. Does Chile consider that tax distinctions based on "objective" differences are per se "neutral"? That proposition can be easily refuted. Many tax distinctions based on "objective" differences are demonstrably protectionist, both in purpose and in effect.

To continue with Chile - "Objective Criteria" Argument

¹⁵⁶ Reports of the Committees and Principal Sub-Committees, ICITO 1/8, 64 (Geneva, Sept. 1948).

¹⁵⁷ See Panel Report Japan - Taxes on Alcoholic Beverages I, supra.

¹⁵⁸ Panel Report on United States - Measures Affecting Alcoholic and Malt Beverages (hereafter, "United States - Malt Beverages"), BISD 39S/206, para. 5.25 and Panel Report on United States - Taxes on Automobiles, 33 I.L.M. 1397 (1994), para. 3.108.

¹⁵⁹ Panel Report on United States - Malt Beverages, para. 5.71.

¹⁶⁰ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 b).

¹⁶¹ Ibid., para. 5.9 c).

¹⁶² See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 26.

¹⁶³ Ibid., p. 16 (citations omitted).

¹⁶⁴ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 b).

¹⁶⁵ Panel Report on United States - Taxes on Automobiles, supra., para. 3.92 (emphasis added by Chile). Chile also referred to Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.45.

¹⁶⁶ Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.48.

¹⁶⁷ Chile First Submission, Annex III.

¹⁶⁸ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 c).

¹⁶⁹ See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 26.

¹⁷⁰ See Panel Report on United States - Taxes on Automobiles, supra.

¹⁷¹ See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra.