3. New Chilean System

(a) Arguments

131. The European Communities argues that under the New Chilean System taxes are assessed in a dissimilar manner so as to afford protection to domestic production based on the following arguments:

1. the European Communities argues that the magnitude of the tax differentials is large with a range from 27% for most pisco to 47% for most imports.
2. the European Communities notes that these large differentials in the rates do not serve any legitimate policy purpose. It cannot be for health reasons, because there is no correlation between alcohol content and heath factors related to distilled beverages. It cannot be for income redistribution, because the taxes are not just ad valorem and there is no necessary correlation between alcohol strength and value.
3. the European Communities claims that the large majority of Chile's distilled beverage production (between 70 and 80 percent, according to the European Communities) will enjoy the lowest rate of taxation, while over 95% of imports will be taxed at the highest rate.
4. according to the European Communities, the New Chilean System was the product of negotiations between the pisco industry and the Chilean government and reflects the desire of the pisco producers for protection from imports. The European Communities also points to statements made by various sectors of Chilean industry and Chilean legislators to the effect that the New Chilean System was crafted to provide protection for Chilean producers.

132. Chile responds that their system is based on completely objective factors and therefore cannot be considered to be applied in a manner so as to afford protection. According to Chile, any producer whether foreign or domestic can produce spirits at lower levels and benefit from the tax structure. Chile noted that there are a great deal of spirits produced in the European Communities at 35� of alcohol or less that could easily be exported to Chile and enjoy a lower level of taxation. Chile also noted that there is more absolute production of domestic spirits in Chile at the higher levels of taxation than there are imports.
133. Chile also states that the structure was arrived at as part of a series of compromises between various government ministries. Specifically, Chile notes that there were compromises between the desire of the Finance Ministry to maintain pre-existing levels of taxation and other elements of the government that wanted higher taxes on higher alcohol content beverages. Chile notes that such compromises are normal in a democracy and do not constitute WTO-illegal discrimination. ⁴²⁶
134. Chile argues that the Appellate Body has made it clear that statements made by legislators are irrelevant to the analysis because the subjective intent of individual legislators is impossible to discern. Chile notes that individuals may make arguments in support of their domestic industry in order to obtain better treatment and such comments may not be accurate reflections of the actual policy concerns of the government. Chile also notes that it is not surprising that the domestic industry argues for lower taxes for itself. Such lobbying of the government is perfectly normal and is found in the EC and elsewhere, too. It is also completely irrelevant, according to Chile.
135. Chile also argues that there is nothing in the GATT which requires a particular type of taxation or constrains the sovereign right of Member governments to structure their tax systems in a particular way. All that is required is that the tax system be based on objective factors and applied in a manner that allows any product, be it imported or domestic, to take advantage of the structure.
136. The European Community responds that under Chilean law, virtually all the categories of imported spirits (whisky, gin, rum, vodka and tequila) must have 40� or higher levels of alcohol. It would be impossible as a matter of law to sell whisky and these other beverages at anything other than the highest levels of taxation. Chile argued that they certainly could. Even if they had to change the product name somewhat, they could easily sell a diluted version. Adding water is the last step of the production process anyway and it would be a simple matter to add more water and sell, for example, "Johnnie Walker Light" or "Beef Eaters Lean". The European Community, as well as the third parties, objected that such a notion was absurd. Consumers wanted to buy whisky or vodka or gin. They didn't want to buy some diluted version that would taste different and be different.
137. Chile argues that if protection was what it wanted, it could raise the tariffs on spirits. Chile's binding is at 25% while the applied rate is 11%. This is evidence that the purpose of the tax structure was not protective. The European Communities responded that since the 1970's Chile has applied a single flat rate to imports of all products. According to the European Communities, this is considered as one of the basic principles of Chile's trade policy and, if the Chilean authorities were to make now an exception to that principle, it would be difficult for them to resist similar requests from other industries.

(b) Discussion

138. In light of all the evidence and arguments offered by the parties, we now proceed to examine whether the New Chilean System applies dissimilar taxes in a manner so as to afford protection to domestic production. ⁴²⁷
139. First, we address a question of interpretation important to our examination of the New Chilean System. Chile cites some of the drafting history of the provision which eventually became Article III:2 of the GATT. Chile notes that the Sub-Committee responsible for the Article reported that:

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, oleomargerine) of which there was substantial domestic production as they are against imports (say, imported oleomargerine). ⁴²⁸

140. Chile draws from this the conclusion that it is permissible to have taxation systems that may have differential impact on some products including imports and domestic products as long as the distinctions are "objective and neutral". ⁴²⁹ We agree that there may be differences between taxation of directly competitive products, but we see no basis for extending the statement of the sub-committee to mean that something described as "objective and neutral" can be used to justify dissimilar taxation. We recall the precepts of Articles 31 and 32 of the Vienna Convention, that our decisions should be guided by the treaty language itself and that resort to the negotiating history is useful either to confirm an understanding of the language of the treaty or to clarify the meaning in the case of ambiguity. In this case, the treaty language appears to be clear. Dissimilar taxation, as we have noted before, is not in and of itself, inconsistent with the requirements of Article III:2, second sentence. It is only if such system of dissimilar taxation is applied in a way so as to afford protection to domestic production that there is a violation of the GATT. In our view, this language of the Sub-Committee merely confirms that. There is no violation per se due to dissimilar taxation. It depends, in that example, on who benefits from such a taxation system and, as a corollary, who has a disadvantage. Is it the imports or some portion of the domestic industry? We see no basis for reading into this Sub-Committee report an interpretation that a system of dissimilar taxation is permissible if the criteria used to distinguish products are "objective and neutral." It says no such thing and such an interpretation would be inconsistent with the treaty language that any system which imposes dissimilar taxation in a manner so as to afford protection to domestic production is inconsistent with a Member's obligations under the GATT 1994 regardless of the alleged objectivity of the criteria chosen.
141. Chile says it agrees that Article III:2 applies beyond mere de jure discrimination to also cover de facto discrimination. However, when examined further, it seems that Chile actually is willing to extend Article III:2 beyond de jure discrimination in only the most minimal manner. According to Chile, the findings in Japan � Taxes on Alcoholic Beverages I and II and Korea � Taxes on Alcoholic Beverages are that tax systems based on "subjective" criteria such as product type names are impermissible. Chile then takes a further analytical step by asserting, therefore, that systems based on "objective" criteria are permissible. ⁴³⁰ This step is a non-sequitur. It is the case that Japan and Korea made distinctions based on types of beverages. However, the findings with respect to the second and third analytical steps under Article III:2, second sentence, were not dependent on that fact alone. As the panel stated in Korea � Taxes on Alcoholic Beverages:

The structure of the Liquor Tax Law itself is discriminatory. It is based on a very broad generic definition which is defined as soju and then there are specific exceptions corresponding very closely to one or more characteristics of imported beverages that are used to identify products which receive higher tax rates. There is virtually no imported soju so the beneficiaries of this structure are almost exclusively domestic producers. ⁴³¹

142. Thus, the panel rested its conclusion in part on the factual finding that the primary beneficiaries of the particular structure in that case were the domestic producers. At no point did the panel in that case or the panels and Appellate Body in the cases of Japan � Taxes on Alcoholic Beverages I and II state or imply that any system based on so-called "objective" factors would necessarily survive scrutiny under Article III:2.
143. Chile also contends that there is not even de facto discrimination here because the imported product could easily be diluted to take advantage of the lower available tax rates. We do not find this persuasive. Exporters should not be required to alter important characteristics of their products and, indeed, change their generic name in order to compete equally with the domestic product. ⁴³² To state it that way clearly demonstrates the flaw in the Chilean argument. It is evident that there will not be equal competitive conditions unless the foreign producers make certain important changes in their products, changes that Chile has not attempted to justify by any exception or rule of the WTO Agreements. ⁴³³ The only reason Chile offers for the foreign producers to change their products is to take advantage of preferential tax rates. A measure which imposes such requirements obviously does not provide the equal competitive conditions required by Article III.
144. Chile argues that this is a matter of intellectual property protection irrelevant to this case. According to Chile, the EC's arguments that it should not have to change it's products names in order to sell in Chile is akin to arguing that the Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) is being extended to put an affirmative obligation on Chile to support the use of names such as whisky, vodka, gin and rum. We do not share Chile's view that there is such a necessary legal connection here between the concept of protected names, such as trademarks, and generic product names. The two types of names simply are not the same. The European Communities is not here asserting a trademark in the word "whisky." There is, in fact, Chilean whisky, as there is whisky produced in many countries. The issue here is whether a producer can be forced to give up its generic name and be compelled to sell its product as something different in order to enjoy equal tax treatment.
145. Furthermore, Chile is correct that it is under no obligation to assist the European Communities or any other Member in marketing its products under particular names. However, Chile is under an obligation not to apply a discriminatory tax regime to directly competitive or substitutable imports simply because they carry particular names. Indeed, Chile's earlier arguments concerning the decisions in Japan �Taxes on Alcoholic Beverages I and II and Korea � Taxes on Alcoholic Beverages makes Chile's position on this issue untenable. According to Chile, in those cases there was protective application of tax systems based on definitions of a favoured type of spirit that was overwhelmingly produced domestically. Surely it must follow that there is impermissible discrimination if a type of spirit which is mainly imported is, by definition of generic name or type, taxed at a higher rate. ⁴³⁴ The difference is very small between a law offering favorable treatment as long as a product is called "X" and a regulation discriminating against a product if it is called "Y".⁴³⁵
146. Related to the question of "objective" criteria is the argument concerning the policy objectives of the taxation system. Chile states that the European Communities has no right to question its policy objectives in structuring the New Chilean System as long as its system is based on objective criteria. The European Communities replies that it is evidence of the protective application of a measure if the measure is inconsistent with the stated policy objectives. To a certain extent, both parties are correct in their arguments.
147. We agree with Chile that it is not for the Panel to question their policy objectives. Chile lists these objectives as: (1) maintaining revenue collection; (2) eliminating type distinctions as were found in Japan and Korea; (3) discouraging alcohol consumption; and, (4) minimizing the potentially regressive aspects of the reform of the tax system. We offer no comment on whether these are appropriate goals and objectives of tax policy. It is not for us to evaluate the measure in these terms, either to condemn it or condone it.
148. In our view, the failure of a measure to conform to its stated objectives may be indicative of certain aspects of its design structure and architecture. That is, while we will not examine the stated objective itself to determine its legitimacy, it is a relevant inquiry to examine the relationship between the stated objective and the measure in question. If a rational relationship between the stated objective and the measure is lacking, this may provide evidence of protective application, which we will take into consideration along with other factors.
149. With respect to the question of maintaining revenue neutrality, we note that there is no rational reason why such a structure as devised by Chile is necessary for this purpose. Chile has acknowledged that the same revenue result could be achieved with a single ad valorem rate at some point between 27% and 47%.
150. With respect to eliminating type distinctions, the New Chilean System does not achieve this. As discussed above, the favorable tax treatment accorded to products called "pisco" was removed. However, the system was replaced with one providing unfavourable tax treatment for any products called "whisky", "gin," "vodka" or "rum," which happen to be primarily imports.
151. With respect to discouraging alcohol consumption, the gradations based on degree of alcohol content arguably may achieve such a result, although the evidence seems to be more persuasive to the contrary. ⁴³⁶ Moreover, if there were a direct correlation such as Chile proposes then the tax differential between products with 35� of alcohol and 39� degrees of alcohol should be the same as the differential between products with, for instance, 40� and 44� of alcohol unless there is an adequate rational explanation for the difference. However, the tax rate almost doubles between 35� and 39� but is the same between 40� and 44� and such an explanation is lacking.
152. Even then, the Chilean response is somewhat beside the point, for this is a system based not just on alcohol content, but on ad valorem rates qualified by the additional criterion of alcohol content, and there appears to be no correlation between value and alcohol consumption. Or, if there is a correlation, it is more likely to be an inverse relationship. If money a consumer might set aside to purchase distilled alcoholic beverages is spent on high value products, it follows that it will result in lower absolute levels of alcohol consumption than if spent on low value products.
153. With respect to minimizing the regressive aspects of the tax reform, this is only true if the factual situation were to remain static. As it currently stands in the Chilean market, the lower priced spirits generally are also the lower alcohol content products, thereby reinforcing the progressive nature of the tax system if the market shares do not change prior to implementation. However, this is a coincidence of factors, not anything inherent in alcoholic beverages. For instance, in many markets there are quite low priced whiskies sold at the same alcohol content as high priced whisky. Expensive cognac sold in Chile will have a lower alcohol content than a relatively inexpensive vodka or rum, etc. As Article III is meant to protect competitive opportunities, not market shares, Chile cannot base its justification of the system on currently existing facts, (e.g., distribution of market shares across the tax rates) which may exist partially, or even primarily, due to the tax system itself.
154. Chile argued that the New Chilean System was a result of a series of compromises between these competing objectives so it is not totally linked to any one objective. We recognize that legislation is generally the result of compromises. However, the mere fact that compromises are necessary cannot justify the resulting legislation if it is otherwise inconsistent with WTO obligations. Furthermore, it is difficult for Chile to, on the one hand, justify its tax system based on the stated objectives, but then, on the other hand, argue that the objectives are not reached due to legislative compromises. As we noted above, if the stated objectives and the measure are inconsistent, it may provide evidence confirming the discriminatory design, structure and architecture of a measure. We find that to be the case here.
155. To assist in evaluating the overall design, structure and architecture, we review the New Chilean System in the context of its predecessor systems. The prior systems through the Transitional System have imposed dissimilar taxation to all products not called "pisco." Pisco is a term limited to certain Chilean production according to Chilean law. As we have concluded above, this dissimilar taxation is greater than de minimis and was, and will continue to be, applied so as to afford protection to domestic production. The New Chilean System eliminated the de jure discrimination in these systems and moved to taxation on the basis of a combination of alcohol content and value. These levels were not arbitrarily chosen and applied. Between 70 and 80 percent of Chilean production consists of products with less than 35� alcohol content and, therefore, enjoy the lowest tax rate of 27%. Over 90% of pisco is in this category, pisco being the spirit enjoying de jure discrimination in its favor until 1 December 2000. However, under Chilean regulations, most of the imported beverages have generic names that require them to contain at least 40� of alcohol. Thus, almost 95% of current imports will be taxed at the highest rate of 47% or lose their ability to retain their name (their generic name, not their brand names) The beverages would also require a change of an important physical characteristic, namely their water/alcohol ratio. This is a clear case of a de jure discriminatory system being replaced by an at least equally de facto discriminatory system. ⁴³⁷
156. As a last matter relating to the objective of the New Chilean System, Chile argues that it cannot have intended the system to be protective, for if protection was the goal Chile could have raised tariffs which are currently at 11%, but bound at 25%. Once again, we note that a lack of protective actions with respect to tariff rates is irrelevant to an examination to the completely different issue of whether a system of taxation is applied in a manner so as to afford protection to domestic production. Therefore, the fact that Chile could take protective actions that would be permissible under Article II, but chooses not to, is simply irrelevant to a finding that the New Chilean System is inconsistent with Chile's obligations under Article III.
157. Chile has also argued that the New Chilean System cannot be found to be applied in a manner so as to afford protection to domestic production because there actually are more domestic products at the highest level of taxation than imports. Most of this domestic production consists of high alcohol content versions of pisco.
158. It is important at this juncture to recall that Article III is meant to protect competitive opportunities. There is no question that the structure of the New Chilean System will distort competition between directly competitive domestic products and products which are now imported and ones that might reasonably be considered potential imports. First of all, it does not save a measure from running afoul of Article III:2, second sentence, merely because there are domestic products taxed at the same level as the imported products, as we noted in the previous section. ⁴³⁸ Second, as Chile itself has noted, there is considerable world-wide supply capacity of potential imports, the majority of which would be taxed at the highest level. The potential imports have the right to equal competitive opportunities to the Chilean market which they cannot receive under the New Chilean System. Were all distilled alcoholic beverages taxed at the same level, or at a level reflecting no more than de minimis differences, then it is entirely possible that the percentages of domestic versus imports at 40� alcohol content or above would change dramatically. That is, lower value, high alcohol content imports could become more viable in the marketplace, particularly as consumers become more familiar with the products. In effect, Chile offers the result of its discrimination over a long period of time as a justification for perpetuating it. On balance, we find the most persuasive evidence to be that roughly 75% of domestic production will enjoy the lowest tax rate and that over 95% of current (and potential) imports will be taxed at the highest rate unless the imported products change their alcohol content and abandon their generic, familiar product names.
159. In sum, considering: (1) the structure of the New Chilean System (with its lowest rate at the level of alcohol content of the large majority of domestic production and its highest rate at the level of the overwhelming majority of imports); (2) the large magnitude of the differentials over a short range of physical difference (35� versus 39� of alcohol content); (3) the interaction of the New Chilean System with the Chilean regulation which requires most of the imports to remain at the highest tax level without losing their generic name and changing their physical characteristics; (4) the lack of any connection between the stated objectives and the results of such measures (recognizing that "good" objectives cannot rescue an otherwise inconsistent measure); and, (5) the way this new measure fits in a logical connection with existing and previous systems of de jure discrimination against imports, we find that the dissimilar taxation assessed on directly competitive or substitutable imports and domestic products is applied in a way that affords protection to domestic production.

VIII. Conclusions

1. In light of the findings above, we reach the conclusion that the domestic distilled alcoholic beverages produced in Chile, including pisco, and the imported products presently identified by HS classification 2208, are directly competitive or substitutable products. Chile's Transitional System and New Chilean System provide for dissimilar taxation of the imports in an amount that is greater than de minimis levels. Finally, the dissimilar taxation in both systems is applied in a manner so as to afford protection to Chile's domestic production. We therefore conclude that there is nullification or impairment of the benefits accruing to the complainant under GATT 1994 within the meaning of Article 3.8 of the Dispute Settlement Understanding.
2. We recommend that the Dispute Settlement Body request Chile to bring its taxes on distilled alcoholic beverages into conformity with its obligations under the GATT 1994.

⁴²⁶ We note that when we use the term "discrimination" in this discussion, we recognize that there are different nuances to the term depending on whether one is referring to the first or second sentence of Article III:2. Any difference in tax level for like products would be discrimination under the first sentence, while for directly competitive or substitutable products there is only discrimination when greater than de minimis dissimilar taxation is applied so as to afford protection to domestic production. Thus, we use the term "discrimination" here in a broad sense to encompass the latter meaning, recognizing that it would necessarily include the former, too.

⁴²⁷ Chile has repeatedly urged us to take into consideration the tax systems of other Members when evaluating the New Chilean System. It is a well settled point of GATT/WTO jurisprudence that such other systems are irrelevant to an evaluation of the Member's measure which is the subject of the specific dispute.

⁴²⁸ Reports of the Committees and Principal Sub-Committees, ICITO 1/8, 64 (Geneva, Sept. 1948).

⁴²⁹ See First Submission of Chile, paras. 34-35.

⁴³⁰ See Report, para. 4.399, Chile Second Submission, para. 28 and Chile's Statement at the Second Meeting, paras. 26-31.

⁴³¹ Panel Report on Korea � Taxes on Alcoholic Beverages, supra., para. 10.102 (emphasis added).

⁴³² Chile argues that there is an inconsistency between arguing that products are directly competitive and substitutable and arguing that they should not be forced to change distinctive physical characteristics and names. We do not agree. Products which are directly competitive or substitutable have differences between them or they would be "like." Indeed, even like products do not need to be identical. It is perfectly logical for marketers to emphasize one product's distinctive qualities in order to compete effectively with other directly competitive products. We are not dealing with commodities here.

⁴³³ For instance, as justified by legitimate technical requirements or for health and safety reasons excepted under Article XX.

⁴³⁴ We note that the Chilean regulation regarding alcohol content (Decree 78/1986 implementing Law No. 18,455) is not at issue in this dispute. We make no findings with respect to the consistency of this measure.with Chile's WTO obligations. Rather, what we are reviewing, in part, are the results of the interaction of that Decree with the Chilean spirits taxes which are the measures at issue. Decree 78/1986 constitutes one of the relevant facts of this case.

⁴³⁵ We note that in making its projections of the fiscal impact of the New Chilean System, the Chilean Finance Ministry assumed that whisky, vodka, gin, rum and tequila would continue to be sold using their generic names.

⁴³⁶ See EC Answers to Question C. 4 and EC Exhibit 62.

⁴³⁷ We note that, for most types of spirits, the New Chilean System will actually increase the discrimination against them compared to pisco.

⁴³⁸ See Appellate Body Report on Canada � Periodicals, supra., p. 29. See also Panel Report on Korea � Taxes on Alcoholic Beverages, supra., para. 10.100, fn. 412; and Panel Report on United States � Section 337, supra., para. 5.14.