4. Reach of Japan/Korea � Taxes on Alcoholic Beverages cases

334. Chile disagrees with the EC's evident determination to portray the New Chilean System as a replication of the tax systems of Japan and Korea that previous panels found inconsistent with Article III:2, second sentence. The New Chilean System is fundamentally different from the Japanese and Korean tax systems for alcoholic beverages, both of which discriminated based on type of distilled spirits and both of which favoured a type that was and could be only supplied domestically for all practical purposes. By contrast, the New Chilean System does not differentiate by type of distilled spirit, but instead applies an identical tax scale, imposing an identical ad valorem tax depending on degree of alcohol content to all distilled spirits (except beer and wine) regardless of type and whether imported or domestic. Ironically, the European Communities asks the Panel to condemn the Chilean system by analyzing that system in terms of effects on a subjective classification system (i.e., type) that Chile explicitly abandoned as a matter of tax classification in enacting Chilean Law 19,534.
335. Chile contends that the EC effort to wrap this case in the mantle of successful challenges of the Korean and Japanese systems fails because it ignores fundamental differences between the cases and the systems. The Panel should reject the EC's unjust and ill-founded effort to stretch prior rulings in ways that do not conform with the language, practice, or intent of Article III:2.
336. Chile explains that while there are many differences between the Japanese and Korean cases and this case involving Chile, the most fundamental difference is that the systems at issue in the Japanese and Korean cases both taxed by type of distilled spirits, whereas the New Chilean System taxes all types identically, according to alcohol content and value.
337. Chile maintains that the European Communities tries to avoid this distinction by ignoring it. Thus the European Communities starts off its case with a lengthy argument about whether different distilled spirits are directly competitive or substitutable. That issue was critical in the Japan and Korea cases, precisely because those tax systems imposed different taxes according to the type of distilled spirit. Japan and Korea each created ten or more tax categories, based on different types of distilled spirit, each bearing its own separate rate or scale of taxation, with shochu in Japan and soju in Korea having the lowest rate or scale of taxation. There was virtually no doubt that the differences in taxation were more than de minimis and that imports had no prospect of benefiting from the lowest rates of taxation (since shochu and soju were effectively not imported). Thus the only critical question under Article III:2, second sentence, was whether the types of products taxed at a low rate were directly competitive or substitutable with the types taxed at higher rates.
338. In the view of Chile, the New Chilean System, however, does not so differentiate by type. That is why Chile has repeatedly pointed out that whether different types of spirits are directly competitive or substitutable in the Chilean market is essentially irrelevant under the New Chilean System, since that system does not make distinctions by type. Chile does not, in fact, consider that pisco is directly competitive or substitutable with whisky for the reasons stated in previous submissions by Chile. However, Chile does not rely on the differences between pisco and other types of distilled spirits in claiming the consistency of the New Chilean System with Article III:2, because the system does not impose taxes based on type.
339. According to Chile, the European Communities tries to obscure this fundamental difference by arguing that the effect of the New Chilean System is to tax types of distilled spirits that are customarily or by law sold at higher degrees of alcohol strength at higher ad valorem rates than types sold at lower alcohol strengths. Undoubtedly that is true, but that result does not infringe Article III:2. The reason the Korean and Japanese systems were found inconsistent with GATT 1994 was not because tax distinctions based on type of distilled spirit per se violate Article III:2. The core problem with those systems was that the effect of the particular type distinctions in those systems was to favor a particular product that was effectively not imported, and thus the type distinction had the effect of discriminating in favor of an almost exclusively national product.
340. Chile further argues that the critical flaw in the EC's analysis arises from the EC's effort to stretch the analysis of past panels considerably beyond any past precedents, including the Japan and Korea alcoholic beverage tax cases. The panels in the Japan and Korea cases were dealing with discrimination based on the subjective concept of type of distilled spirits, where products are distinguished according to how and sometimes where they are made. The use of those subjective criteria had the direct effect of limiting the benefits of the most favorable tax to a type of product which was produced locally and which, in practice, could not be imported into those countries.
341. Chile maintains that faced with an entirely different situation with the New Chilean System, the European Communities asks this Panel to go one gigantic and impermissible step further than past panels. It takes a Chilean System that differentiates by the objective standard of alcohol content, and asks the Panel to view that system in terms of its effect on different types of distilled spirits. The European Communities argues as though previous panels had established a rule that Article III requires no tax discrimination based on types of distilled spirits, and therefore that distinctions that de facto have different impacts on different types are then also inconsistent with Article III:2, or at least should be so considered.
342. Chile emphasizes that beyond the point that nothing in the Japan or Korea cases mandates such a further extension of the holding of those cases, there are very significant legal, logical and practical differences between systems such as those of Japan and Korea that codify a distinction based on a subjective and qualitative concept such as "types" of products and systems based on objective criteria applied equally to all products that are directly competitive or substitutable, regardless of type. According to Chile, the European Communities tries to give the objectively based Chilean system an aura of subjectivity by analyzing the New Chilean System on the basis of its effect on different subjective types of products. Then, ignoring or dismissing inconvenient facts � the significant and increasing quantity of pisco and other products that will be subject to high taxes and the actual and potential trade in low-tax products � the European Communities claims that the de facto discrimination by type that the European Communities claims to see in turn constitutes a de facto discrimination based on nationality. If this unprecedented theory is sustained, all that will be required to find a violation of Article III:2 will be to conjure the right kind of subjective classification system that will validate a case based on differential effects of an objective tax system. It would not even affect the analysis if the more heavily taxed type of product is produced in substantial quantities in the taxing country as well as imported, since that fact existed in the Japan case, but did not affect the Appellate Body's ruling.
343. Chile argues that many of the claims of the European Communities are absolutely wrong since the new Chilean taxation system for alcoholic beverages is based on an objective criterion and the fact that the tax paid by each product is based in two factors: alcohol content and price (i.e., ad valorem) of the product, regardless from its type, origin and labeling.
344. According to Chile, the European Communities confuses the issue when pointing out that the system is conceived so that pisco, which has a lower alcohol content, will pay less taxes, while other imported products will pay higher taxes. The truth and the correct and fair way of describing the New Chilean System is that the system is conceived so that pisco having a low alcohol content, as well as all other domestic or imported spirits of low alcohol content, will be subject to lower tax rates, while pisco with high alcohol content, as well as all other domestic or imported spirits of high alcohol content, will be subject to higher tax rates. Consequently, the higher or lower tax rate is solely determined by the alcohol content of the product and not by its origin, as the European Communities seems to suggest. In any system within this "philosophy" (i.e., to tax based on alcohol content), the result will be that those products with less alcohol will be subject to a relatively lower tax also.
345. Chile explains that concerning the ad valorem component of the new system, it has opted to maintain an ad valorem system since in an economy as open as the one in its country, competition factors, such as product price relationships, have to be preserved. The ad valorem taxation system does not alter this competitive attribute of products (i.e., price relationships), as opposed to those in which an absolute value is determined according to alcohol content, thus introducing a degree of distortion biased for the benefit of products of higher prices since the tax is a lower proportion of in its final price.
346. Chile further argues that ad valorem taxes are not illegal simply because domestic products are cheaper than imports, and thus bear less tax per unit. To take an example, EC Member States impose specific taxes on distilled spirits that, measured in ad valorem proportional terms, result in low-priced Chilean products bearing much greater proportionate taxes than spirits that the EC considers directly competitive or substitutable. The following chart demonstrates how the tax system of four Member States all impose these proportionately higher taxes on Chilean pisco than on their own domestic products.

As an example, Chile presents Table 28 ¹⁸⁴ which compare the specific tax on pisco of 35�, pisco of 40�, whisky 43�, cognac VSOP, brandy Fundador and brandy Carlos I in some EC Member States, and Table 29 ¹⁸⁵ which also compares the specific tax applied in these EC Member States in ad valorem terms.

Table 28 ¹⁸⁶

Specific Tax to Alcoholic Beverages in some EC Member States (US$/lt)

Member States	Pisco	Pisco	Whisky	Whisky*	Cognac*	Brandy*
	35°	40°	43°	43°	VSOP	Fundador	Carlos I
Spain	2.66	3.04	3.26	3.26	3.04	2.88	3.04
Great Britain	11.37	13.00	13.97	13.97	13.00	12.35	13.00
France	6.34	7.05	7.47	7.47	7.05	6.76	7.05
Germany	5.60	6.40	6.88	6.88	6.40	6.08	6.40

Table 29 ¹⁸⁷

Specific Tax to Alcoholic Beverages in some EC States
Measured in Ad Valorem Proportional Terms (%)

Member States	Pisco	Pisco	Whisky	Whisky*	Cognac*	Brandy*
	35°	40°	43°	43°	VSOP	Fundador	Carlos I
Spain	92.9	78.1	57.3	29.8	9.6	37.4	13.4
Great Britain	397.9	334.2	245.1	127.5	40.9	159.9	57.2
France	221.9	181.2	131.0	68.1	22.2	87.6	31.0
Germany	195.9	164.6	120.7	62.8	20.2	78.8	28.2

Notes: Prices in US$/lt CIF/ex-factory: Pisco 35° : US$ 2.86; Pisco 40° : US$ 3.89; Whisky 43° : US$ 5.70; Whisky* 43° : US$ 10.96; Cognac Remy VSOP* 40° : US$ 31.74; Brandy Fundador* 38° ; US$ 7.72; Brandy Carlos I* 40° : US$ 22.72.

*Prices: Duty Free

347. According to Chile, this shows that the specific tax on alcoholic beverages applied in these EC Members States is relatively higher to those alcoholic beverages with lower alcohol content. Chile indicates that it is not asking the Panel to deal with a new complaint, but rather to demonstrate that neutral, objective systems can have these disproportionate effects shown, without infringing Article III.
348. Further, Chile notes that European Communities complains that the New Chilean System is based on both alcohol content and value, which the European Communities terms a hybrid. The real EC complaint here appears to be that Chile should copy the EC Member State systems, which apply a specific tax per degree of alcohol. Again, Chile has noted that ad valorem taxes have long been endorsed by the WTO and by economists, whereas specific taxes are much more likely to distort competition. Further, there is no element of Article III that forbids using both objective criteria, which in tandem also serve the objective of making the New Chilean System materially more progressive than using a flat ad valorem rate or worse, the EC's specific tax system, which would be that much more regressive.
349. The European Communities replies that Chile insists that its New Chilean System is different from the Japanese tax system and the Korean tax system. In reality, however, the differences are only superficial.
350. The European Communities states, in response to Chile's claim that the New Chilean System does not differentiate "by type," that a trick as old as protectionism is to base regulatory distinctions on product characteristics which distinguish indirectly between domestic and imported products. Chile's system is slightly more sophisticated than the Japanese system or the Korean system, but no less protective in both purpose and effect.
351. The European Communities claims that the alcohol content thresholds chosen by Chile evidence that the New Chilean System has been devised so as to replicate the effects of the explicit tax distinctions between "types" made in the old system. The minimum alcohol content of most imported spirits is 40�, whereas 35° is the most usual alcohol content of pisco especial, which together with pisco tradicional of 30° accounts for more than 90 % of the sales of pisco. As confirmed by Chile's responses to the questions posed by the Panel, there can be no rational explanation for choosing precisely those two thresholds, other than affording protection to pisco.
352. The European Communities contests Chile's argument that another "fundamental" difference would be that its New Chilean System is based on "objective" criteria, whereas the Japanese and the Korean system were based on "subjective" criteria. Chile, however, never explains what distinguishes an "objective" criterion from a "subjective" one. The differences between whisky and shochu did not exist only in the minds of the Japanese taxmen. There are "objective" differences between shochu and whisky, including differences in alcohol content which are even larger than those between pisco and whisky. Those "objective" differences, however, were not considered as a valid justification for taxing whisky more heavily than shochu.
353. The European Communities also contests Chile's argument that shochu and soju were "effectively not imported" into Japan and Korea, respectively. This misrepresents the facts of those two cases. Shochu and soju were imported in relatively small quantities, compared to domestic production, but neither of them was an "inherently" domestic product. For example, in 1995, imports of shochu accounted for 2.4 % of the sales of shochu in Japan. ¹⁸⁸ In comparison, in 1996 imports into Chile of low strength liqueurs (the only imported products which in practice will benefit from the lowest tax rate) represented less than 0.4 % of the domestic sales of spirits with a minimum alcohol content of 35 % or less, as shown in Table 19 above. Thus, the New Chilean System is more protective than the Japanese system by Chile's own standard.
354. The European Communities maintains that Chile's strategy in this case is to divert the Panel's attention from the examination of Chile's own tax system. Chile attempts to do so by focusing the discussion on other tax systems (both real and hypothetical), which are fundamentally different from the New Chilean System. With the same purpose, Chile tries to focus the debate on a number of superficial differences between this case and previous cases.

To continue with "Direct Proportionality" Argument

¹⁸⁴ Chile Oral Statement at the First Substantive Meeting, p. 4.

¹⁸⁵ Ibid.

¹⁸⁶ Chile Oral Statement at the First Substantive Meeting, p. 4.

¹⁸⁷ Ibid.

¹⁸⁸ Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para 4.175.