(f) Low Import Duty on Alcoholic Beverages

599. Chile claims that a second point worth noting is that Chile is not protecting its industry as the European Communities claims. If that would have been the case Chile would have concentrated its "protectionist battery" on the tariff rate. A truly effective protectionist approach would have been to increase its applied tariff from 11 % up to 25 % (its own bound rate). Chile argues that it is moving in an opposite direction than that suggested by the European Communities: Chile is about to reducing its tariff to an a-cross-the-board rate of 6% (certainly including the most diverse spirits). Instead of protecting its producers, Chile is liberalizing unilaterally.
600. According to Chile, products of some countries like Mexico and Canada, face no duty because they have signed free trade agreement with Chile. The European Communities can also do the same if they decide to accept its invitation to begin negotiations for a free trade agreement early next year.
601. In rebuttal, the European Communities claims that this argument of Chile conceals the fact that since the 1970s Chile has applied a single flat rate to imports of all products. This is considered as one of the basic principles of Chile's trade policy. If the Chilean authorities were to make now an exception to that principle in favour of the pisco industry, it would be difficult for them to resist similar requests from other domestic industries.
602. The European Communities further notes that, as noted by Chile itself, two of the main producers of spirits (Mexico and Canada) have already concluded Free Trade Agreements ("FTAs") with Chile, while the EC Commission has formally proposed to the EC Council the opening of negotiations with Chile for the conclusion of an Association agreement comprising the establishment of an FTA. Similarly, the US Executive has requested fast-track authority to negotiate a FTA with Chile. It is clear, therefore, that in the long term tariffs could not afford to Chile's pisco industry the desired level of protection. In fact, the perspective of concluding an FTA with the European Communities was precisely one of the reasons invoked by the pisco industry during the process of adoption of the New Chilean System in order to justify its request for limiting the reduction of the taxes on whisky. ²⁸⁷

V. Third-Party Arguments

A. Canada

1. Introduction

1. Canada indicates that it has a substantial interest in this dispute. According to Canada, Chile's tax regime imposes a much higher tax burden on imported distilled spirits than that imposed on the directly competitive or substitutable domestic distilled spirit, pisco. The taxes afford protection to the domestic pisco industry by denying imported distilled spirits, including Canadian whisky, the competitive opportunities available to pisco. This has an adverse impact on the ability of Canadian distilled spirits to compete effectively with pisco; this situation discourages efforts by Canadian exporters, and thus serves to frustrate penetration of the Chilean market. Canada restates that it was a complainant in the Japan - Taxes on Alcoholic Beverages II ²⁸⁸ case, and as a consequence, has an active interest in the legal issues which arise from a very similar dispute.
2. Canada has reviewed the submissions of the European Communities and Chile, and supports the EC position in this proceeding.

2. Legal Arguments

3. Canada welcomed the outcome of the Japan � Taxes on Alcoholic Beverages II case and was pleased with the principles set out by the Appellate Body for the interpretation and application of Article III:2 of GATT 1994. Canada notes that the issues which arise in the context of the Chilean liquor tax regime bear strong resemblance to matters which were under dispute in Japan � Taxes on Alcoholic Beverages II²⁸⁹, and accordingly, the panel's disposition of the present dispute should be guided by the principles established in the panel and Appellate Body Reports ²⁹⁰ in that case. These principles were followed recently in a panel decision in another dispute, Korea - Taxes on Alcoholic Beverages. ²⁹¹

(a) "directly competitive or substitutable"

4. Canada notes that the European Communities correctly points out that Article III:2, second sentence, applies not only to products that are actually competitive or substitutable in a particular market, but also to those that are potentially competitive or substitutable. ²⁹² However, in Canada's view this should not be a central issue in this dispute.
5. Canada believes that the European Communities has adduced conclusive evidence of existing competition between pisco and imported distilled spirits in the Chilean market. ²⁹³ The reaction of the pisco industry in Chile to proposed reductions in the taxes on whisky (and increases in taxes on pisco) provides compelling evidence for the panel to deduce that there is direct competition between pisco and imported distilled spirits.
6. With respect to potential competition, Canada notes that the Appellate Body in Japan � Taxes on Alcoholic Beverages II held that GATT Article III:

[p]rotects potential competition ... of the equal competitive relationship between imported and domestic products. ²⁹⁴

7. Also in connection with the issue of potential competition, Canada supports the arguments made by the European Communities, and submits that the reasoning of the panel in Korea - Taxes on Alcoholic Beverages ²⁹⁵ is compelling for the resolution of the present dispute.
8. Moreover, the imported products, such as Canadian whisky, unquestionably fall within the meaning of "substitutable" products. From Canada's perspective, it is particularly noteworthy that Chilean whisky and pisco drinkers "each prefer the other spirit as a first alternative". ²⁹⁶ Thus, it is submitted that the products at issue are both directly competitive and substitutable.

(b) "not similarly taxed"

9. In Canada's view, there is no doubt that pisco and the imported spirits are not similarly taxed. The Panel should reject Chile's attempt to divert attention away from the fundamental question of whether this particular measure in this particular set of circumstances constitutes dissimilar taxation. All aspects of the measure, from its transitional phase through to its final form, involve more than a de minimis differential in the taxation of directly competitive or substitutable products.
10. For example, under the transitional phase whisky is currently taxed at 65% ad valorem, while pisco is taxed at only 25% ad valorem. Although the rate for whisky will be reduced over the next few years, the lowest rate it will achieve during the transition phase is 53%, while pisco remains at 25%. It is indisputable that this constitutes dissimilar taxation.
11. Canada further argues that, even in its final form (i.e., the "New Chilean System") the measure taxes the products dissimilarly. Chile appears to take the position that the products are taxed similarly because the differences in taxation correspond to differences in alcohol content. Such an argument is untenable for several reasons. First, the measure is not purely a tax on alcohol content. The tax is calculated on the value of the beverage as a whole. Second, if it were purely a tax on alcohol content one would expect a uniform rate per degree of alcohol. However, the rate per degree of alcohol for pisco at 35^o is 0.771%, while whisky at 40^o is taxed at 1.175% per degree of alcohol, a level which is 50% higher. Third, if it were purely a tax on alcohol content one would not expect the same rate of tax to be applied to beverages with different alcohol strengths. However, the tax rate for whisky at 40^o (47% ad valorem) is the same as that applicable to gran pisco at 50^o, despite the ten degree difference in alcohol content. ²⁹⁷
12. Canada states that in any event, the measure is a tax on the value of the beverage, not the value of that which is purportedly being taxed - alcohol content. Viewed from this perspective, the tax of 47% of the value of a bottle of whisky at 40^o alcohol content, is dissimilar to the 27% ad valorem tax on a directly competitive or substitutable bottle of pisco with 35^o alcohol content. ²⁹⁸
13. In short, according to Canada, Chile is attempting to hide a discriminatory regime behind the facade of a purportedly "objective" product difference. However, dissimilar taxation is evident irrespective of whether the tax is viewed as tied to the value of the beverage, or to alcohol content. If Chile's transitional and new tax regimes on spirits are accepted by the Panel, this would provide WTO Members with a blueprint for circumventing their Article III:2 second sentence obligation simply by establishing spurious product categories. The Chilean regime is a thinly disguised discriminatory measure that maintains the protection of the domestic pisco industry. If this regime were to be found consistent with GATT Article III:2, other Members may be tempted to implement similar regimes in order to protect domestic production, with the ultimate effect that Article III could be seriously undermined.
14. Canada concludes, that the Chilean argument that there is no jurisprudence establishing that taxes must be proportional, should not cloud the issue whether Chile's taxes are dissimilar. In Canada's view, an examination of the taxation rate per degree of alcohol or of the taxation rate per bottle, demonstrates that the taxes applicable to the majority of domestic pisco are not similar to the taxes for the majority of the directly competitive or substitutable imported distilled spirits.

(c) "so as to afford protection"

15. Canada recognises that an ad valorem tax is not inherently inconsistent with Article III:2, second sentence. Rather, it is the manner in which Chile is applying this particular ad valorem tax that is contrary to Article III:2, second sentence. As previous panels have found, and the Appellate Body has affirmed:

Article III:2 does not prescribe the use of any specific method or system of taxation. ... 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. ²⁹⁹

16. Canada argues that several aspects of the design, architecture and structure of Chile's tax regime establish its protective application. First, the sheer magnitude of the tax rate differential in this case is sufficient to establish that the measure is applied so as to afford protection to the domestic pisco industry in Chile. Second, the measure's structure ensures that the vast majority of Chile's production of distilled spirits (primarily pisco) will continue to be eligible for the lowest possible tax rate (27%), while almost all imported distilled spirits will continue to be taxed at the highest rate (47%). Protection for pisco is further ensured by legislation requiring certain imported distilled spirits (notably those that appear to be most competitive with and substitutable for pisco, such as whisky) to have a minimum alcohol strength of 40^o. As applied, the tax rates would create a wide, protective buffer zone for domestic pisco in relation to imported distilled spirits.
17. Canada argues that the combination of these and the other factors identified by the European Communities is to deny imported distilled spirits the competitive opportunities available to Chilean pisco. Canada notes that, similar to the situation in Japan � Taxes on Alcoholic Beverages II, ³⁰⁰ the Chilean measure fails to guarantee equality of competitive conditions between the imported and domestic products, and makes it difficult for imported distilled spirits to penetrate the Chilean market. In effect, it "isolates" pisco from foreign competition by imported distilled spirits.
18. Canada notes, that while the European Communities correctly challenges the absence of a legitimate policy purpose, it is important that its assertion not be interpreted to suggest that the existence of such a purpose would make the regime consistent with Article III:2. The fact that a measure may have a non-protectionist policy objective does not make that measure consistent with Article III:2, second sentence. ³⁰¹ As noted by the Appellate Body in Japan � Taxes on Alcoholic Beverages II :

If the measure is applied to imported or domestic products so as to afford protection to domestic production, then it does not matter that there may not have been any desire to engage in protectionism in the minds of the legislators or the regulators who imposed the measure. It is irrelevant that protectionism was not an intended objective if the particular tax measure in question is nevertheless, to echo Article III:1, "applied to imported or domestic products so as to afford protection to domestic production".³⁰²

19. Canada further notes that it is equally important to remember that the Appellate Body has made it clear that it is not necessary to provide evidence of protectionist intent in order to prove that a measure affords protection to domestic production. ³⁰³ However, this does not mean that the statements of Chilean officials and the Chilean pisco industry are irrelevant. Their statements regarding the need and means to protect the pisco industry help to confirm the protective design, architecture and structure of the measure.
20. Canada argues that, in any event, claims about the protection of public health are not supported by the facts. Such claims can only be viewed as ex post facto justification, in the light of statements by Chilean officials and pisco industry representatives, to the effect that the taxation regime is designed to protect the pisco industry from competition by imported distilled spirits.
21. Canada stresses that Chile cannot justify the dissimilar taxes on the basis that certain Chilean products may be subject to the higher tax rates, while certain imported products may benefit from the lower tax rates. There is nothing in Article III:2, nor any of the GATT or WTO panel or Appellate Body reports, that can be used to justify a taxation measure that benefits the majority of a domestic industry's production, and places the majority of the directly competitive or substitutable products at a competitive disadvantage to the domestic products. To the contrary, following the reasoning of the Appellate Body in the Japan � Taxes on Alcoholic Beverages II case, if there is dissimilar taxation of some imported products in comparison with directly competitive or substitutable domestic products, this is sufficient to meet the test of "not similarly taxed".³⁰⁴
22. Canada concludes that Chile misconstrues the concept of equality of competitive opportunities, by suggesting that foreign producers can adapt their production to benefit from lower taxes. In Canada's view, the converse is true, i.e. if foreign producers must adapt their production and thereby lose the value of their product name in order to benefit from the lower tax, their imported products would be at a competitive disadvantage to the vast majority of pisco, which would not have to meet these burdens.

B. Mexico

1. Introduction

23. Mexico does not agree with Chile that the Transitional System is not at issue in this dispute. On the contrary, Mexico considers that since the system has been incorporated into the transitional period, it corresponds to "the matter referred to the DSB", and that the Panel must determine whether the two systems i.e. the Transitional and New Chilean Systems are inconsistent with Article III.2 of the GATT 1994.
24. As mentioned by the European communities in their submission, the products at issue are, on the one hand, pisco, and, on the other hand, all the other distilled spirits falling within the heading HS 22:08 of the Harmonized System (HS) nomenclature. The European Communities provided an illustrative list of these products, expressly including tequila.
25. Mexico insists that tequila and pisco are "like products" in the sense of Article III.2, first sentence, of the GATT 1994, but is merely requesting the Panel to find that tequila and pisco are directly competitive or substitutable products ³⁰⁵ in the sense of Article III.2, second sentence, of the GATT 1994.
26. In this connection, Mexico agrees with the parties to the dispute in their endorsement of the conclusions of the Appellate Body in Japan � Taxes on Alcoholic Beverages II ³⁰⁶ according to which the following rules must be applied to determine the inconsistency of an internal tax measure with Article III.2, second sentence:

1. The imported products and the domestic products must be "directly competitive or substitutable products" which are in competition with each other;
2. the directly competitive or substitutable imported and domestic products must not be "similarly taxed"; and
3. the dissimilar taxation of the directly competitive or substitutable imported and domestic products must be applied "� so as to afford protection to domestic production".

To continue with Legal Arguments

²⁸⁷ See EC Exhibit 30.

²⁸⁸ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra.

²⁸⁹ Ibid., p. 27 [sic], in which the Appellate Body set out the issues:

Canada notes that these are three separate issues. Each must be established separately by the complainant for a panel to find that a tax measure imposed by a Member of the WTO is inconsistent with Article III:2, second sentence.

²⁹⁰ Panel Report on India - Patent Protection for Pharmaceutical and Agricultural Chemical Products, adopted on 2 September 1998, WT/DS79/R, para. 7.30, the panel indicated that panels:

²⁹¹ Panel Report on Korea - Taxes on Alcoholic Beverages, supra.

²⁹² Canada states that imported products that may only be potentially competitive with a domestic product should not be categorically excluded from the scope of Article III:2, second sentence. Otherwise, internal regulatory regimes that favour domestic production to such an extent that imported products are effectively barred from entering the domestic market could be rendered beyond challenge.

²⁹³ According to Canada, the products at issue share similar physical characteristics, the same end-uses, the same HS heading, the same sales outlets, and even share the same shelf space (see, for example, subsections IV.D.3-6 of the EC's first written submission). There is also evidence of significant cross-price elasticity and elasticity of substitution (see, for example, subsection IV.D.7. of the EC's first written submission). Of course the ultimate corroboration for this view is that both Chilean authorities and the pisco industry have expressly and implicitly recognized that pisco and other distilled spirits are directly competitive and substitutable (See, for example, subsection IV.D.8 of the EC's first written submission).

²⁹⁴ Appellate Body Report on Japan � Taxes on Alcoholic Beverages II, supra., p. 16.

²⁹⁵ Panel Report on Korea - Taxes on Alcoholic Beverages, supra., paras. 10.47 - 10.50.

²⁹⁶ 1997 SM survey (referenced at para. 130, and EC Exhibit 21at page iv).

²⁹⁷ The measure provides that the tax rate applicable to spirits with an alcohol content over 39� is 47%. See paragraph 52 and Table 5 of the EC's first written submission.

²⁹⁸ Canada points out, that as noted by the EC (at paragraph 173 of EC First Submission), such a tax differential is greater than de minimis.

²⁹⁹ Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 32 [sic], citing the Panel Report on Japan � Taxes on Alcoholic Beverages I, supra., para. 5.9 c).

³⁰⁰ Ibid., p. 34 [sic], where the Appellate Body, in discussing the protective application of the measure, quotes paragraph 6.35 of the Panel Report as follows:

³⁰¹ Canada notes that if a WTO Member wants to maintain a measure that is inconsistent with Article III:2, it must meet the conditions set out in GATT Article XX.

³⁰² Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 31 [sic].

³⁰³ In Japan - Taxes on Alcoholic Beverages II, supra., p. 31), in describing what must be shown in order to establish that a tax is "protective", the Appellate Body stated:

³⁰⁴ Ibid., p. 27. Moreover, it is noteworthy that in United States - Section 337, the panel found:

Panel Report on United States � Section 337, supra., para. 5.14.

³⁰⁵ Panel Report on Korea � Taxes on Alcoholic Beverages, supra., para. 10.38, agrees with the statement by the Appellate Body in Japan � Taxes on Alcoholic Beverages II, supra., that the category of "directly competitive or substitutable products" is broad.

³⁰⁶ Appellate Body Report Japan - Taxes on Alcoholic Beverages II, supra., p. 24.