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Korea - Taxes on Alcoholic Beverages

Report of the Panel

(Continued)


The Current Korean Market for Distilled Liquors

1.31. The United States submits that the Korean market for distilled alcoholic beverages, valued at approximately 2 trillion won in 1989, has been one of the largest in Northeast Asia. However, the United States adds that the Korean market for distilled spirits and liqueurs was virtually closed to imports until the late eighties. Until 1 January 1989, imports of distilled spirits in bulk were subject to quotas, and imports of distilled spirits in bottles were prohibited and thereafter subject to quantitative restrictions until 1 January 1990. Applied tariffs were prohibitive until 1991. Currently, the applicable import duty is 20% for all distilled spirits and liqueurs, except brandy (which is subject to a 15% import duty) and soju (which is subject to a 30% import duty).

1.32. The United States argues that in light of this background, the Korean market for alcoholic beverages has been dominated by traditional beverages, such as soju, with a relatively low alcohol content (25%) and bottled for mass consumption. In 1996 sales of soju amounted to 89.825 million nine-litre cases (i.e., 808 million litres), which represents as much as 94% of the distilled spirits market.

1.33. The United States further argues that imports of soju into Korea are insignificant. Last year Korea allegedly imported less than 2000 (1,625) litres. However, Korea exports large quantities of soju. During the first eleven months of 1996, exports of soju totalled 43 million litres, which represents about 5% of Korean soju production. The main export market is alleged to be Japan.

1.34. According to the United States, almost all soju sold in Korea is diluted soju. Distilled soju is estimated to account for less than 1% of the total sales of soju. The United States claims that although diluted soju is generally inexpensive, distilled soju can fetch very high prices, similar to those paid for imported premium brands of whisky.

1.35. The United States asserts that in the last ten years, the Korean government's relaxation of several import barriers has increased the competitiveness of the domestic market for alcoholic beverages, even though the retail prices for Western-style liquors remain much higher than the prices for diluted soju.

1.36. The United States argues that manufacturers of soju have addressed what are generally perceived by Korean consumers as its negative attributes compared with the imported liquors: poor quality, bad flavour, hangover effects, etc. This has led to the emergence of a new segment of so-called "premium soju" brands, whose distinctive characteristics are a milder taste, the use of flavouring (e.g., with honey), and/or ageing processes and more sophisticated bottle designs. The prices for premium diluted soju brands are between two and three times higher than those for standard diluted soju. It is estimated that sales of premium soju represented 6% of soju sales in 1996 and probably reached 10% in 1997.

1.37. The United States further argues that in addition to developing new types of soju for consumption in Korea, soju makers have also begun to exploit the export market for soju. Exports have risen dramatically in the last few years.

1.38. According to the United States, Korean consumption of whisky has increased by about 30% annually since 1994. Between 1992 and 1996, the Korean market for whisky increased from 315 million won to 880 million won. Moreover, whisky bottled abroad makes up an increasing share of this market, growing from 1.7% of this market in 1992 to 46.7% of the market in 1996.

1.39. However, the United States adds that although imports of distilled spirits have grown steadily, they still represent only around 3.5% of the Korean market. In most other OECD countries, the share of imported spirits is allegedly between 30% and 40%.

C. Korea

1.40. According to Korea, the complainants spend considerable time arguing that Korea has a history of protecting its soju industry. Korea states that no case has been brought against it for these alleged violations. In Korea's view, therefore, these allegations are irrelevant to the case at hand, and they should be disregarded.

1.41. Korea also notes that in the same way that the complainants wish to gloss over the differences between the Korean and Japanese markets, they also wish to gloss over the characteristics of the Korean market and products that do not fit their line of argument. Korea notes for example, that the complainants treat 'soju' as one product. According to Korea, however, Korean distilled soju is very different from what the complainants refer to as 'diluted' soju. In Korea's view, the latter is certainly not a 'dilution' of the former.

1.42. Korea further argues that no Korean producer or consumer would consider distilled and diluted soju to be substitutes. Korea further states that although the complainants mention the existence of important differences between a 'diluted' soju and 'distilled' soju, the complainants dismiss these differences by saying that distilled soju occupies less than 1% of the soju market.

1.43. Korea argues that, having so dismissed distilled soju, the complainants proceed to use examples drawn from the exceptions in order to support general statements about all soju.

1.44. According to Korea, this dispute is about 'diluted' soju, ('standard' soju),20 which represents more than 99% of all 'soju' sold in Korea. Further, according to Korea, the question in this case is whether Korea's system of taxing distilled beverages discriminates against imported distilled alcoholic beverages, to the advantage of standard soju. Of those western-type liquors, Korea argues that the Panel must be cognisant that whisky is by far the most important, representing the greatest proportion of all the imported distilled beverages.

1.45. Korea seeks to show that its system for the taxation of alcoholic beverages is not discriminatory, because the products at issue in this case are simply not in competition. According to Korea, the United States and the European Communities try to establish that competitive relationship by making generalisations such as "all are drunk with the same purposes: thirst-quenching, socialization", that they are made from the oxymoronic "same large variety of raw materials", by drawing specific examples from clearly exceptional cases, or -- their last resort-- by arguing that the products are in 'potential' competition with each other.

1.46. Korea gives a general background about alcoholic drinks. Korea states that if one travels around the world, one will encounter a seemingly infinite variety of alcoholic beverages, many having a long and interesting history. Korea further argues that throughout the ages, virtually every culture in the world discovered that the natural process of decomposition of certain raw materials, typically fruits and vegetables, led to sometimes tasty results. Over time, through trial and error, the process of creating certain alcoholic beverages has become increasingly refined.

1. Features of Distilled Alcoholic Beverages

1.47. Korea states that within the broad category of alcoholic beverages, one can distinguish distilled beverages. According to Korea, to make a distilled alcohol, one first starts with fermented raw material. That fermented matter is put through a process of refinement and concentration, called distillation.21 Beverages that have been distilled are generally referred to as 'spirits', and spirits are the products at issue in this case.

1.48. Korea further states that distilled liquors can be derived from materials as varied as grain, corn, rice, fruit, sugar cane or beets, potatoes, or tapioca. Korea asserts that the selection of raw materials for the manufacture of distilled alcoholic beverages may be traced to different geographical, cultural and consumer requirements and can play an important role in determining the ultimate qualities of the finished product.

1.49. Korea notes that another distinction is sometimes drawn between 'brown' and 'white' spirits. According to Korea, this distinction refers to the production process and appearance of the beverages: brown spirits are brown (e.g., whisky or cognac); white spirits are clear (e.g., Korean soju or gin). Korea further states that brown spirits are generally matured in wooden casks and derive their flavour mainly from this process and from the original distilled ingredients. White spirits are not aged before bottling and instead rely on the addition of ingredients during the distillation process, or afterwards, to provide their distinctive flavour. These ingredients differ from one drink to another (e.g., gin derives its special flavour from the juniper berry).

2. Consumer Behaviour

1.50. Korea argues that consumer preferences for alcoholic beverages vary from country to country. Certain countries have their own national drink. For instance, argues Korea, in France, wine is the national drink, in Germany it is beer, and in Japan it is sake. Korea adds that some national drinks are virtually unknown in other countries. According to Korea, this is the case for Korean soju, which is hardly known outside Northeast Asia and Korean communities abroad.

1.51. Korea further argues that these national drinks reflect the different cultures and traditions of the various countries. In addition, argues Korea, the climate, food and history of a country also determine the customs of its people and the way they drink alcoholic beverages. Thus, according to Korea, in hot countries one drinks certain alcoholic beverages to quench one's thirst, while in cold countries one drinks certain alcoholic beverages to keep warm. In other countries people drink particular alcoholic beverages for mere entertainment purposes, i.e., in bars, night clubs or posh hotels. In other countries one drinks particular alcoholic beverages as an accompaniment to a meal.

1.52. Korea further asserts that in France, for instance, it is common to drink wine over a meal. In Korea's view, this is because the nuanced flavour of wine complements the food French people eat. However, with spicy food one is unlikely to order a beverage such as wine, because such food would overwhelm wine's subtle flavours. In Korea, the argument goes, Koreans drink soju with their spicy food. Soju goes well with Korean barbecue and other Korean meals, because the drink's harshness cuts the spiciness of the food.

1.53. Korea further argues that people can also drink alcoholic beverages either mixed, on the rocks or straight, cold or hot or a combination of both. According to Korea, soju is never drunk mixed, whereas whisky, vodka and Japanese shochu are drinks which commonly are drunk both straight and mixed.

3. Price

1.54. Korea further argues that alcoholic beverages can vary widely in price. Korea gives as an example, a bottle of bordeaux which has allegedly been known to fetch thousands of dollars at auction, while a bottle of potato-based alcohol can be very cheap. In Korea's view, one of the factors affecting the price of an alcoholic beverage is the type of raw materials used to produce it. Additional manufacturing processes, such as ageing, increase the value and price of a product, partly because only a selected portion of the product is suitable for ageing. Prices will also be affected by distribution costs and margins, product image, consumer demand, etc.

4. Korean Soju

1.55. Korea notes that despite their similarity in names, a sharp distinction must be drawn between 'diluted' or 'standard' soju on the one hand, and distilled soju on the other hand. Standard soju is not a diluted form of distilled soju.22

1.56. According to Korea, standard soju is a very common beverage, and millions of litres are sold each year.23 Korea asserts that it is made from cheap raw materials: joojung (ethyl alcohol), which is drawn from fermented sweet potatoes, tapioca or corn and distilled so as to obtain as pure an alcohol as possible. To make standard soju, that alcohol (joojung) is not further distilled, but is diluted with water, and six to seven additives are added.24 Korea adds no further ageing or colouring is permitted by law. Korea asserts that this drink has a relatively low alcoholic strength for a spirit: 25%.

1.57. Korea further argues that another unusual characteristic of standard soju is that, unlike other spirits, it is commonly consumed with meals. This is also recognised outside Korea, in areas with important Korean communities. Korea cites as an example Santa Clara, California, where Korean restaurants that only have a license to sell low alcohol drinks are permitted a special exemption to sell standard soju as well. According to Korea, this is a recognition of the fact that it is customary for Koreans to drink a distilled beverage (of 25% alcohol content) with their meals.25

1.58. Korea argues that distilled soju, on the other hand, is an artisanal product,26 sold in tiny quantities (0.2% of the volume of standard soju).27 According to Korea, distilled soju is usually made from grain or rice.28 Korea states that the production process is quite sophisticated, no additives are added. By law, argues Korea, distilled soju can be aged for up to two years prior to sale. Korea also asserts that the alcoholic strength of distilled soju is 40% to 45%, which is considerably stronger than standard soju. Korea also argues that moreover, distilled soju has a distinct taste, which is smoother than standard soju. Distilled soju is 10 to 20 times more expensive than standard soju, pre-tax, and is packaged in special ceramic bottles, and is often offered as a gift.

1.59. Korea states that it should be noted that the Korean liquor tax law classifies standard soju and distilled soju separately and attaches a different tax rate to each, 35% and 50% respectively. Korea also notes that while the United States acknowledges that standard soju and distilled soju have the same rate of Education Tax (10%), it fails to mention that the liquor tax on distilled soju is 50%, while the liquor tax on standard soju is 35%. Korea also notes that another mistaken attempt at trivialising the distinctions between distilled and standard soju is the EC assertion that the distinction in the tax law was introduced only in 1991, and that this was in response to pressure from the European Communities. According to Korea, the distinction was made as early as 1962.

1.60. Korea notes that in recent years certain "up-market" varieties of standard soju have been introduced, which are commonly referred to as 'premium' soju. The composition of "premium" is slightly different from standard soju, giving the drink a somewhat milder taste.29 The producers charge a higher price for this variety, up to twice the price for standard soju before tax. According to Korea, to justify this higher price, they sometimes make exaggerated claims.

1.61. Korea also argues that the complainants focus on these claims to draw inferences for the entire soju market,30 or even to question the credibility of information Korea gave during the consultations which took place prior to this Panel proceeding, implying that Korea drew a false distinction between distilled and standard soju.31 In Korea's view, the reality is, however, that premium soju is no more than an upgraded commodity. It is classified as standard soju in the liquor tax law. Premium soju only represented 4.46% of standard soju sales in 1996 and 5.39% in 1997.32

5. Changes Since 1990

1.62. Korea asserts that there is a strong undertone in the complainants' submissions that there has always been something wrong with Korea's liquor and education taxes, and under pressure from the EC and the US, Korea finally came to recognise this. Korea further states that the complainants suggest that the changes Korea introduced since 1990 came too slowly, and ultimately did not remove the illegal nature of the taxes.

1.63. According to Korea, the European Communities and the United States have indeed gone to great lengths to influence Korea's domestic policies in the recent past. Korea submits that in the interest of avoiding friction with important trading partners and allies, Korea has tried to accommodate US and EC demands by foregoing tax revenue. In Korea's view, this was not an admission of fault.

1.64. Korea notes that the European Communities alleges that decreases in Korea's liquor tax were 'almost totally offset by a simultaneous increase of the applicable education tax rate'.33 According to Korea, the European Communities should have also mentioned that at the time that the education tax was increased from 10% to 30%, the defence tax (30%) was repealed. Thus, in Korea's view, there was an overall reduction in the applicable tax rate.

1.65. Korea presents the following table that purports to show the reduced tax burden on whisky since 1991:

(in %) Whisky liquor tax Education tax Defence tax Combined
surtax burden
Combined
tax burden
Before 1991 200 10 30 80 280
Before 1994 150 30 - 45 195
Before 1996 120 30 - 36 156
Since 1996 100 30 - 30 130

To continue with Claims of the Parties


20 There is a disagreement between the complainants and Korea on whether to use the term diluted soju or standard soju. For purposes of clarity, we adopt the term diluted soju. Within the category of diluted soju are two sub-categories of premium diluted soju and standard diluted soju. No substantive determination is implied by this decision regarding terminology. We also note that this appears to be the terminology used by the Korean Fair Trade Commission in the decision submitted by Korea (Attachment 1 to Korea's first submission).

21 Distillation is defined in Webster's dictionary as 'a process that consists of driving gas or vapour from liquids or solids by heating and condensing to liquid products. . .'

22 Korea asserts that the word 'soju' is a term which has become generic.

23 The exact figure for standard soju taxed volume in 1996 is 787 195 kl. (Sources: National Tax Administration, Statistical Yearbook of National Tax 1996 (1997); Customs Administration & Korean Traders Association, Statistical Yearbook of Trade 1996 (1997)). The exact figure for standard soju taxed volume in 1997 is 814 159 kl. (Source: National Tax Administration, not yet published.)

24 Sugar, citric acid, amino acid, solbitol, mineral salt, stevioside, and aspartame. These additives all serve a particular purpose to enhance the taste of soju , i.e., sugar, to make it sweet; citric acid, to give soju a sour taste; amino acid, to enhance its flavour and act as a sweetener, adding a seaweed-like taste; solbitol, a form of sweetener which has a thick sweet taste; mineral salt, which acts as a catalyst to bring a change of taste to all the additives; stevioside, which has strong light sweet taste 150 to 300 times sweeter than sugar; and aspartame (nutrasweet), which is a chemical flavour enhancement 200 times sweeter than sugar.

25 According to Korea, 'Today, soju and a platter of barbecued meat are as inseparable in South Korea as beer and hot dogs or margheritas and chips in the United States', San Jose Mercury News, http://infi.net/global/cgi-bin/sj/slwebcli_post.pl.

26 The artisans who make distilled soju are recognised as 'Human Treasures' by Korean Governmental Decree. Their skill is recognised as an 'Intangible Cultural Asset'. One such example (Moon Bae-Sool) is shown in US Exhibit D.

27 The exact figure for distilled soju consumption in 1996 is 1325 kl. Source: National Tax Administration, Statistical Yearbook of National Tax 1996 (1997).

28 The complainants state that distilled soju is made of potato or grain. Korea claims that in reality potatoes are not used. The leading brands of distilled soju (Moon Bae-Sool and Andong Soju) are made from grain or rice.

29 For instance, in the leading brand of 'premium' soju, Kimsatgat, honey replaces stevioside as one of the seven additives.

30 To illustrate, the 15 pages of advertisements included in the EC first submission only include two advertisements for standard soju (about 95% of the soju market), all the rest being advertisements for premium soju (4 to 5% of the soju market).

31 According to Korea, the EC, in support of this suggestion, cited advertisements for a standard soju brand which claimed that this soju was aged. However, the Korean Fair Trade Commission, in a decision of 30 November 1996, found that this claim constituted false advertising. The decision is reproduced in Attachment 1.

32 According to Korea, in 1996, total taxed volume of premium soju was 35 108 kl (including the leading brands 'Chamnamoo' produced by Jinro, 'Kimsatgat' produced by Bohae and 'Chungsanri' produced by Kyoungwoul). In 1997, total taxed volume was 43 873 kl (including the same brands). (Source: National Tax Administration). The EC and US estimate, unsubstantiated, that premium soju sales represented 6% of total soju sales in 1996 and increased to 10% in 1997 is therefore incorrect. (See EC first submission at para. 54 and US first submission at para. 41.) Note that the total taxed volume of standard soju was 787 195 kl in 1996 and 814 159 kl in 1997.

33 EC first submission, para. 57.