3. New Chilean System

419. The European Communities claims that the following factors and circumstances constitute evidence that the New Chilean System will also be applied "so as to afford protection" to Chile's domestic production:

1. the magnitude of the tax differentials;
2. the tax distinctions do not serve any legitimate policy purpose;
3. the majority of Chile's domestic production of distilled spirits is taxed at the lowest tax rate;
4. nearly all imports are taxed at the highest tax rate;
5. the New Chilean System reflects the terms previously agreed by the Chilean authorities with the pisco industry; and
6. the positions taken by the pisco industry during the amendment process of the ILA involve a recognition that maintaining a tax differential between low strength pisco and whisky will afford protection to the pisco industry as a whole.

420. Chile replies that it is readily apparent, if the Panel chooses to consider this element, that the New Chilean System does not operate "so as to afford protection to domestic production". The European Communities offers up six reasons that the New Chilean System should be considered "to afford domestic protection". None of the six contentions have merit when applied to the New Chilean System.
421. In the view of Chile, it is also essential to note in this regard that, unlike systems based on distinctions between different types of distilled spirits, it is a relatively simple matter for foreign and domestic producers to adapt to the neutral and objective standards of the Chilean system. A whisky producer cannot readily become a pisco producer, but a producer of any spirit of 40° alcohol can readily dilute the product to 35° . The European Communities already produces many products (grappa, fruit liqueurs, etc.) that qualify for the lowest taxes and even more products that would qualify if only, as the European Communities suggests be done for pisco, some water is added to the current high alcohol products before bottling. Article III simply does not obligate sovereign Member governments to harmonize their neutral taxation system to the convenience of foreign producers in the way sought by the European Communities in this case. The New Chilean System affects domestic producers of spirits in the same manner as it affects importers of alcoholic beverages, and does not prevent foreign producers of spirits from importing any low alcohol content spirits benefiting from a lower level of taxation on the basis of their alcohol content.
422. Chile further states that the European Communities devotes many pages listing excerpts from Chile's legislative debate about the new taxation system. Some of these examples show that legislative representatives of the regions that produce pisco in Chile were seeking to minimize the adverse effects of a New Chilean System on pisco producers and, because adverse effects could not be avoided, also sought other governmental help for their constituents. At least in the case of the legislative history, the European Communities, while presenting a distorted picture, did note many remarks from legislators who announced that the new system was eliminating discrimination against foreign products. Chile submits that if such developments infringe Article III or are even evidence of such infringement, then all WTO Members are in deep peril, not least the European Communities.
423. Chile points out that the Appellate Body has already cautioned against this kind of subjective effort to discern motivation. In Japan - Taxes on Alcoholic Beverages II, the Appellate Body stated that the issue of "affording protection to domestic production" is an objective question of effect, not a subjective question of the intent of legislators. ²²⁴

(a) Magnitude of Tax Differentials

424. The European Communities points out that in Japan - Taxes on Alcoholic Beverages II, the Appellate Body observed that the very magnitude of the difference in taxation between Japanese shochu and other distilled spirits was sufficient evidence to conclude that the Japanese Liquor Tax Law was applied so as to afford protection to the domestic production of shochu. ²²⁵
425. The European Communities then maintains that under the new system the tax differentials will still be large enough to be, in and of themselves, evidence of protective application. Indeed, in the case of spirits of 40° or more other than whisky the tax differentials will be even larger than under the preceding system.
426. In response, Chile first contests the citation by European Communities of "the magnitude of the tax differentials of the New Chilean System". The EC's analysis of this point fails for the same reason that the EC's allegations of dissimilar taxation fail. The EC's argument makes no more sense than a claim that ad valorem taxes are illegal in any country where imports are generally more expensive than the domestic products with which they compete. The differential in the New Chilean System is nil because all products face the same tax scale and all products have the same opportunity to be adapted in a way that will minimize their tax burden.
427. Chile argues that perhaps the European Communities may see the fallacy of its logic more clearly if that logic is applied to the systems of taxation of alcoholic beverages that are used by EC Member States. Chile has already shown, in Tables 28 and 29 above, how the use of specific rate taxes per degree of alcohol (which is the tax system used by a number of EC Member States) discriminates against low price beverages and in favor of higher priced beverages, which are more commonly produced in the European Communities. These points are elaborated further in Tables 34 and 35 below. Applying the same logic that the European Communities seeks to apply to the New Chilean System, the EC Member States would be guilty of violating Article III:2, second sentence. In the European Communities, the result of the use of specific taxes is that pisco is taxed relatively heavily compared to expensive cognac. According to the European Communities, cognac and pisco are directly competitive and substitutable. Cognac is thereby protected from imported pisco (evidenced by the low import penetration in the European Communities of pisco and other imported brandies).
428. Chile further maintains that even ignoring for the moment the discrimination in ad valorem terms that arises from a specific rate tax, the EC Member States would still be in violation of Article III:2 if the EC's analysis in this dispute were applied to the Member States who impose taxes per degree of alcohol content. The tax per degree of alcohol results in a substantially higher tax on two beverages of the same price, for example, one having 46� alcohol, the other 35�. Therefore, in both absolute and ad valorem terms, an imported Gran Pisco would face a substantially higher tax than a low-alcohol European product such as Campari. By the theory that the European Communities seeks to apply to Chile, this means that the EC Member States' systems have the result of discriminating by type, and a type of imported spirit (Gran Pisco) is taxed significantly more heavily than the directly competitive or substitutable domestic product, Campari.
429. According to Chile, by the application of the EC's logic, the differences in tax on different types of competing spirits that result from Member State tax systems similarly would easily be found to operate "so as to afford protection to domestic production". The difference in tax alone might be enough to establish the protective effect of the EC Member States' taxation systems. In addition, one might note the obvious "architectural" features favoring low alcohol beverages such as those commonly produced in the European Communities, which means only certain types of distilled spirits are favoured in these countries. To complete the analogy to the logic that the European Communities seeks to apply to Chile, one might also seek evidence that some politician from the area where the low �taxed product is made had boasted of his or her success in helping the domestic industry. Thus guilt under Article III:2 would be complete, by the standard of analysis that the European Communities wishes to apply to Chile in this dispute.
430. Chile notes that the European Communities will perhaps protest that the EC system is nevertheless GATT-legal because it is necessary, in terms of Article XX of GATT 1994, to protect human health from the effects of alcohol. That explanation, however, is difficult to sustain in the face of other EC alcoholic beverage laws that prescribe minimum alcohol content, and that tax the alcohol content of wine and beer much less than distilled spirits. As the European Communities points out in the literature appended to its responses to the Panel's questions, some EC authorities believe that health problems are connected to the issue of amount of alcohol consumed, not the concentration in different beverages.
431. Chile further notes that in pointing out the above, it is not asking the Panel to find the EC Member States guilty, an issue that is not even before this Panel. Chile is seeking to demonstrate, however, the fallacy and dangers of the EC analysis, which seems to have been drawn more from the Scotch Whisky Association's crusade to equalize alcohol taxes in the EC Member States than from a correct analysis of Article III:2.
432. Chile then extends its analysis to demonstrate that the alleged protection that the Chilean taxation system provides to pisco is far less significant than the protection offered to whisky by the taxation system applicable in various EC Member States, as can be observed in the following table. ²²⁶ In effect, the Chilean taxation system offers a 16% protection to spirits of 35� or less (including pisco 35�) vis-à-vis spirits of 39� or more (including whisky), regardless of national origin. Protection for pisco of 40� or more is nil. In contrast, the taxation system of several Member States of the European Communities results in between 23% and 44% protection for whisky vis-à-vis pisco 35�; and between 13% and 26% protection for whisky vis-à-vis pisco 40�. This is due, as Chile has pointed out in several instances, to the fact that pisco costs much less than whisky, and thus is affected proportionally much more than whisky by a specific tax.

Table 34 ²²⁷

Degree of Protection of Whisky in Comparison to Pisco
in some Country Members of the European Communities

	Price (US$/lt)			Price ratio		Protection Special Tax
	Pisco 35�	Pisco 40�	Whisky 43�	Whisky/Pisco 35�	Whisky/Pisco 40�	Whisky/Pisco 35�	Whisky/Pisco 40�
CIF/ex-factory	2.60	3.60	5.70	2.19	1.58
Price after duty
Spain	2.86	3.89	5.70	1.99	1.47
United Kingdom	2.86	3.89	5.70	1.99	1.47
France	2.86	3.89	5.70	1.99	1.47
Germany	2.86	3.89	5.70	1.99	1.47
Price after duties and special tax
Spain	5.51	6.93	8.96	1.63	1.29	23%	13%
United Kingdom	14.23	16.89	19.67	1.38	1.16	44%	26%
France	9.20	10.94	13.17	1.43	1.20	39%	22%
Germany	8.46	10.29	12.58	1.49	1.22	34%	20%

Table 35 ²²⁸

Degree of Protection of Pisco with Regard to Whisky in Chile

	Price (US$/lt)			Price ratio		Protection Special Tax
	Pisco 35�	Pisco 40�	Whisky 43�	Whisky/Pisco 35�	Whisky/Pisco 40�	Whisky/Pisco 35�	Whisky/Pisco 40�
CIF/ex-factory	2.30	3.30	6.00	2.61	1.82
Price after duties
Chile	2.30	3.30	6.66	2.90	2.02
Price after duties and special tax
Chile	2.92	4.85	9.79	3.35	2.02	16%	0%

433. The European Communities notes that Chile raised the argument that the EC system of taxation of spirits affords protection to the EC domestic production because, on an ad valorem basis, pisco is taxed more than the EC spirits. Chile explained that its intention in making this argument was not to question the compatibility of the EC system with Article III:2, but rather to illustrate the point that "neutral" tax distinctions may nevertheless have an incidental protective effect.
434. The European Communities goes on to state that Chile's argument is not only irrelevant for this dispute, but also wrong, both as a matter of law and of fact. First and foremost, the EC system is based on the application of a uniform specific tax per hectolitre of pure alcohol to all the products containing ethyl alcohol. ²²⁹ Thus, unlike in the Chilean system, in the EC system all ethyl alcohol is equally taxed, irrespective of the product in which it is contained. Therefore, the question whether protection is afforded to domestic production through "dissimilar" taxation does not even arise.
435. The European Communities maintains that in any event, the EC system does not have the effect alleged by Chile. EC produced spirits are often less expensive than imported spirits. This can be easily demonstrated with the help of Chile's own price data. Table 15 above shows that Canadian whisky, US whisky and Mexican tequila are more expensive (and, therefore, less taxed in ad valorem terms under the EC system) than a relatively expensive brand of Scotch whisky such as Johnnie Walker Red Label.
436. The European Communities further argues that when sold in the EC market, Chilean pisco may be as expensive as good quality EC spirits. Tables 34 and 35 above compare the producer's ex-factory price of pisco in Chile with the retail prices of some EC spirits (including insurance, freight and distribution expenses) charged by a duty-free supplier (presumably, also in Chile). Given the differences in level of trade, it would have been surprising if Chilean pisco was not less expensive than the EC spirits. The table below compares the actual retail prices in a supermarket in Brussels of pisco especial Capel of 35° (a relatively inexpensive brand in Chile) and a sample of well-known (and relatively up-market) brands of EC produced spirits. It shows that, contrary to Chile's claims, pisco is taxed in ad valorem terms at a similar rate as the EC spirits.

Brand (all bottles are 70 cl)	Price (BEF)	Tax (BEF)	Equivalent Ad valorem rate
Pisco Capel 35°	410	155.6	37.95 %
Vodka Smirnoff	415	166.7	40.17 %
Gin Gordon's	409	166.7	40.76 %
Brandy Veterano	477	160	33.54 %
J. Walker Red Label	494	177.8	35.99 %

Source: Retail prices at the supermarket Delhaize Chazal, Brussels, on 28/10/98. See EC Exhibit 64.

437. With regard to the effect of specific taxes, Chile maintains that Tables 34 and 35 above are accurate. In those tables, the calculations indicated in the first 3 columns (labelled pisco 35�, pisco 40� and whisky 43�) are based on after customs price for pisco in Europe, and producers prices for whisky. ²³⁰ From those tables it can easily be seen that a specific tax levied on alcohol content produces a dissimilar taxation, if the comparison is made on an ad valorem base. Chile asks the Panel to note that this dissimilarity is much larger that the dissimilarity generated by the Chilean system alleged by the European Communities. For clarity purposes, Table 35 above is summarized below:

Specific Tax on Alcoholic Beverages in some EC Member States
Measured in Ad Valorem Terms (%)

Member State Estimated Price	Pisco 35� US$ 2.90	Pisco 40� US$ 3.90	Whisky 43� US$ 5.70
Spain	92.9	78.1	57.3
Great Britain	397.9	334.2	245.1
France	221.9	181.2	131.0
Germany	195.9	164.6	120.7

To continue with Legislative Objective

²²⁴ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 27-28.

²²⁵ Ibid.

²²⁶ Chile explains that the methodology that was used for the calculation of the Protection of the Special Tax of Whisky (in the selected country members of the European Communities) is:

²²⁷ Chile Rebuttal Submission, Annex B, p.13.

²²⁸ Chile Rebuttal Submission, Annex B, p. 14.

²²⁹ Council Directive 92/83/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92) and Council Directive 92/84/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92).

²³⁰ Chile adds that after customs price of Pisco was estimated considering producers price in Chile, transportation to Europe and related insurance costs and customs duties in Europe. Producers price of whisky, was estimated in US$ 5.70.