3. Chile - "Objective Criteria" Argument (Cont.)

310. The European Communities asks the Panel to consider, for instance, the tax distinction made by Japan between shochu and whisky. That distinction is by no means a "subjective" one. There are "objective" differences between those two spirits, including differences in alcohol content which are even larger than those between whisky and pisco. ¹⁷² If Chile's interpretation was upheld, Japan could re-introduce the same tax differentials that have already been condemned in two panel reports, simply by replacing the explicit distinction between shochu and whisky with a distinction based on alcohol content or on any other of the "objective" characteristics (or a combination of them) that differentiate shochu from whisky.
311. The European Communities alternatively asks the Panel to consider the hypothesis that a vodka producing country (say Finland) levied a tax based on the degree of optical density (i.e., the colour of the beverage), which results in the application of a 1000 % tax on "brown spirits" and a 1 % tax on "white spirits". Would that be a "neutral" tax distinction simply because it is based on an "objective" characteristic?
312. The European Communities argues that Chile itself has conceded implicitly that the "neutrality" of a tax distinction cannot be presumed a priori. In fact, as part of its discussion under the second element of Article III:2, Chile sets out to demonstrate why the New Chilean System is actually "neutral". However, if the neutrality of a tax distinction had to be ascertained already as part of the second element, the third element of Article III:2, second sentence, would become superfluous. This point is illustrated by Chile's First Submission, where the arguments made by Chile under the second element with respect to the alleged the "neutrality" of the New Chilean System are then repeated almost without variation in connection with the third element.
313. In conclusion, the European Communities states that it would agree that Article III:2, second sentence, does not prohibit tax distinctions between directly competitive or substitutable products which are "neutral". But the "neutrality" of tax distinction is not something which can be inferred from the mere fact that the tax distinction is based on differences on alcohol content or on any other "objective" product difference. The "neutrality" of tax distinction has to be established, on case-by-case basis and having regard to all relevant factors, under the third element of Article III:2, second sentence. In Japan � Taxes on Alcoholic Beverages II, the Appellate Body found that the panel had erred "in blurring the distinction between [the issue of whether the products were similarly taxed] and the entirely separate issue of whether the tax measure in question was applied so as to afford protection". The test put forward by Chile in this case incurs in the same mistake. ¹⁷³
314. The European Communities further contests Chile's argument that in the New Chilean System "differentiation in taxation is based on alcohol content, not type of distilled spirit". This claim, however, involves an obvious fallacy. Each type of spirit is typically produced within a certain range of alcohol content. This difference has been recognised by Chile's regulations, which prescribe a different minimum alcohol content for each of the most common types of spirits. As a result, tax distinctions based on alcohol content lead necessarily to tax distinctions between types of spirits.
315. The European Communities maintains that the New Chilean System ensures that the main types of imported spirits (whisky, gin, rum, vodka and tequila, all of which have a minimum alcohol content of 40° ) are taxed at the highest rate possible: 47 %. Meanwhile, the vast majority of pisco (which has a minimum alcohol content of 30° ) is taxed at the lowest rate possible: 27 %. Thus, it is indisputable that in the New Chilean System pisco and the other spirits in dispute are still not "similarly" taxed.
316. The European Communities further argues that Japan � Taxes on Alcoholic Beverages II stands for the proposition that the application of specific taxes in direct proportion to the volume of alcohol contained in each type of distilled spirit does not constitute "dissimilar" taxation. The underlying reasoning is that, in that system of taxation, the taxed product is not the spirituous beverage but the alcohol contained in the beverage.
317. In the view of the European Communities, this reasoning is not applicable in the case at hand. The measure in dispute is an ad valorem tax and not a specific tax. And it is calculated on the basis of the value of the beverage as a whole and not on the basis of the value of the alcohol content. Therefore, unlike the measures applied by Japan, it cannot be characterised as a tax on the alcohol content. For that reason, the European Communities considers that the Panel should compare the absolute rates applied to each spirit, rather than the rates per degree of alcohol contained in each type of spirit.
318. The European Communities argues that in any event, it has demonstrated that pisco and the other spirits are also "not similarly" taxed even if one compares the rates per degree of alcohol. Each degree of alcohol in whisky, gin, vodka, rum and tequila is taxed at a rate which is more than 50 % higher than the rate applied to each degree of alcohol in pisco of 35° .
319. The European Communities points out that Chile has acknowledged this tax differential, but claims that the lack of proportionality between differences in taxation and differences in alcohol content does not constitute "dissimilar" taxation. According to Chile, a difference in alcohol content between two types of spirits (however small) could justify any conceivable difference in taxation between them (no matter how large) that a Member may chose to apply. By way of justification, Chile argues that alcohol content is an "objective" product characteristic and that distinctions based on that criterion are always "neutral".
320. The European Communities maintains that Chile's position is refuted by Japan � Taxes on Alcoholic Beverages I and II. The second panel report is particularly clarifying in this regard. In that report, the panel based its conclusion that whisky and shochu were not "similarly" taxed on the fact that the tax rate per degree of alcohol applied to whisky of 40° was higher than the rate per degree of alcohol applied to shochu of 25° . This comparison would have been totally irrelevant if, as claimed by Chile, differences in alcohol content could justify non-proportional differences in taxation. If Chile's position was correct, the panel could not have reached the conclusion that shochu and whisky were not "similarly" taxed except by comparing the rates per degree of alcohol applied by Japan to whisky and shochu with the same alcohol content, something which the panel did not consider necessary to do.
321. Agreeing with Chile in that Article III:2, second sentence, does not prohibit tax distinctions between directly competitive or substitutable products which are "neutral," however, the European Communities argues that, contrary to Chile, it believes that the "neutrality" of a tax distinction is not something which can be presumed from the mere fact that the distinction in question is based on alcohol content or on any other "objective product difference". The "neutrality" of a tax distinction has to be established, on a case-by-case basis and having regard to all relevant factors, under the third element of Article III:2, second sentence.
322. The European Communities also contests Chile's invocation as authority for its sweeping proposition that tax distinctions based on differences in alcohol content never constitute "dissimilar taxation", of a somewhat obscure passage contained in the Panel Report on Japan � Taxes on Alcoholic Beverages I:

The Panel was unable to find that the differences as to the 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 (e.g., "alcohol taxes" equally applied to all alcoholic beverages). ¹⁷⁴

323. The European Communities argues that the above passage, however, is inapposite for a number of reasons. The European Communities explains that first, it relates to the interpretation of the first sentence of Article III:2, a provision which has a different scope and structure. The test laid down by the panel is superfluous in the context of the second sentence of Article III:2, because tax distinctions between "directly competitive or substitutable products" are always permissible, provided that they are not applied "so as to afford protection".
324. The European Communities goes on to state that second, the meaning of the passage is notably ambiguous. The reading made by Chile is contradicted by several other passages in the same report where the panel stated very clearly that tax distinctions between "like" alcoholic beverages with different alcohol content may be compatible with the first sentence of Article III:2 to the extent that they can be explained as a non-discriminatory tax on the alcohol content:

The Panel was unable to find that these tax differentials corresponded to objective differences of the various distilled liquors, for instance that they could be explained as a non-discriminatory taxation of their respective alcohol contents. ¹⁷⁵

It followed from the clear wording of Article III:2 that imported liquors "shall not be subject � to internal taxes � in excess of those applied � to like domestic products". The Panel was of the view that this unqualified wording must not necessarily mean that there could never be any circumstances in which different tax treatment of "like products" was compatible with the General Agreement. The Panel noted, for instance, that GATT Article III:2 [sic] permitted the non-discriminatory taxation "of an article from which the imported product has been manufactured or produced in whole or in part", and that such a non-discriminatory alcohol tax on like alcoholic beverages with different alcoholic contents could result in different tax rates on like products. ¹⁷⁶

325. The European Communities argues that finally, Chile's reading is incompatible with the findings of Japan � Taxes on Alcoholic Beverages - II, where the Appellate Body confirmed that the "aim-and-effect" of a tax distinction is irrelevant for the purposes of the first sentence of Article III:2. ¹⁷⁷
326. Further, the European Communities maintains that the statement made by the European Communities in Japan � Taxes on Alcoholic Beverages II which is cited by Chile has been taken out of context. In Japan � Taxes on Alcoholic Beverages - II, the proponents of the "aims-and-effect" test argued that the so-called "two-step" test put forward by Canada and the European Communities was too rigid. In response to a question from the Panel, the European Communities suggested that the two-step approach could be assorted of two "flexibilities". The first flexibility was to make a "narrow" interpretation of the term "like". The second "flexibility" amounted in practice to the creation of a praetorian exception for graduated systems, subject to certain conditions aimed at ensuring their neutrality. The passage quoted by Chile purports to describe the scope of the suggested second "flexibility". Eventually, the panel, and later the Appellate Body, accepted the first flexibility, but not the second one. In any event, the second "flexibility" did not offer an unqualified exception for all tax distinctions based on alcohol content. The passage quoted by Chile refers to "proportional" tax variations, which are "equally and uniformly applied" to both imported and domestic products. Chile's tax system does not satisfy any of those requirements. Furthermore, the second "flexibility" is unnecessary in the context of Article III:2, second sentence, because the third element ("so as to afford protection") already serves that function.
327. The European Communities then concludes that in any event, the passage invoked by Chile makes it clear that tax distinctions based on "objective product differences", including distinctions based on differences in alcohol content, cannot be presumed to be "neutral". Rather, it must established in each particular case that they are "equally applied in a trade-neutral manner to all like or directly competitive liquors". As demonstrated by the analysis made by the European Communities under the third element of Article III:2, second sentence, Chile's measures do not meet this standard.
328. Also, the European Communities refers to Chile's citation of the following passage of Japan � Taxes on Alcoholic Beverages I:

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. ¹⁷⁸

The European Communities then argues that the passage is both irrelevant and misleading. It is irrelevant because the present dispute does not concern the application of two different taxation methods to domestic and imported products, but rather the application of a single taxation method which affords protection to domestic production.

329. The European Communities also explains that it is misleading because, read in isolation, it could suggest that the panel accepted that "objective" reasons could justify the application of different taxes to domestic and imported products. In reality, however, the point made by the panel was that the application of two different taxation methods to domestic and imported products (in casu the application of different methods for assessing the tax base) is not per se contrary to Article III:2. Rather, in order to establish a violation of that provision, the complainant has to demonstrate that the application of two different methods results in the imposition of a higher tax burden on imports than on domestic products. This becomes clear in the two sentences that follow the passage cited by Chile:

The Panel found that it could also be compatible with Article III:2 to allow different methods of calculation of price for tax purposes. Since Article III:2 prohibited only discriminatory or protective tax burdens on imported products, what mattered was, in the view of the Panel, whether the application of the different taxation methods actually had a discriminatory or protective effect against imported products. ¹⁷⁹

330. The European Communities points out that these two sentences have been omitted by Chile, but not in the citation of the same passage made by the Appellate Body in Japan � Taxes on Alcoholic Beverages II. ¹⁸⁰ Significantly, the Appellate Body referred to this passage in the context of its discussion of the third element of Article III:2, second sentence, and not in connection with the second element.
331. The European Communities also contests Chile's invocation of the findings of the Panel Report on United States � Taxes on Automobiles with respect to a luxury tax applied by the Unites States on vehicles over a certain threshold value. That Panel Report, however, was never adopted because both the complainant and the defendant were dissatisfied with the panel's reasoning.
332. The European Communities further points out that although the Panel Report on United States � Taxes on Automobiles is based on the so-called "aims-and-effects" approach, according to which whether or not two products are "like" depends on whether the regulatory distinction has the purpose and the effect of affording protection to domestic production, this approach was rejected by the panel, ¹⁸¹ and then by the Appellate Body in the Japan � Taxes on Alcoholic Beverages II case. ¹⁸² The Appellate Body has confirmed its rejection of that approach in EC � Measures affecting the Importation, Sale and Distribution of Bananas. ¹⁸³
333. Moreover, the European Communities argues that even under the "aims-and-effects" approach, the mere fact that a tax distinction is based on an "objective" criterion is not sufficient to exclude per se the application of Article III:2. In United States � Taxes on Automobiles the panel examined whether in casu the tax distinction had the "purpose" and the "effect" of affording protection to domestic production. According to the European Communities, Chile's strategy in the present case, however, is to prevent the Panel from conducting that type by analysis by arguing that since the products are "similarly" taxed, it is not necessary for the Panel to look at the third element of Article III:2, second sentence.

To continue with Reach of Japan/Korea � Taxes on Alcoholic Beverages cases

¹⁷² The European Communities notes that the most usual strength of shochu is 25° .

¹⁷³ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 26-27.

¹⁷⁴ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para 5.9 b).

¹⁷⁵ Ibid., para 5.9 a).

¹⁷⁶ Ibid., para 5.9 d). See also para 5.13.

¹⁷⁷ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra. See also Appellate Body Report on European Communities � Regime for the Importation, Sale and Distribution of Bananas, WT/DS27/AB/R, para. 241.

¹⁷⁸ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 c).

¹⁷⁹ Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para 5.9 c). [emphasis added by the European Communities).

¹⁸⁰ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 29.

¹⁸¹ Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.18.

¹⁸² Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 15-23.

¹⁸³ Appellate Body Report on European Communities � Regime for the Importation, Sale and Distribution of Bananas, supra., para. 241.