D. "not similarly taxed"

1. General

89. The Appellate Body in Japan � Taxes on Alcoholic Beverages II stated that "to be 'not similarly taxed', the tax burden on imported products must be heavier than on 'directly competitive or substitutable' domestic products and that burden must be more than de minimis in any given case". ⁴¹¹ The Appellate Body noted that this determination must be made on a case-by-case basis.
90. In our view this means that panels should look at the particular market in question and the products themselves. That is, there is no set level of tax differential which can be considered de minimis in all cases. This follows from the Appellate Body's observation that with respect to "like products" the similarities between the products are so strong that it can be presumed that any differential in taxation will have an impact on the market. However, when products are somewhat different, but are still directly competitive or substitutable, then de minimis differences in taxation are permissible because it is not necessarily true that small differences in tax levels will have an effect in the market.
91. For some products a very small difference in tax levels could be de minimis, a difference that would be too large to be considered de minimis for other products. As always in cases such as these, the determination must be based on examination of the market in question, the market of the respondent Member. However, caution must be used because the very taxes in question, as well as other governmental policies, may have had an impact on the market resulting in difficulty determining whether a relatively small level of differentiation is de minimis or does indeed have a discernable effect on the market.
92. We must also note that this examination of whether products are similarly taxed or not involves no evaluation of the purpose or effect of the differences. Dissimilar taxation is not in itself inconsistent with Article III:2, second sentence. It is only inconsistent if such tax differentials are applied in a manner so as to afford protection.

2. Transitional System

93. The Transitional System took effect on 1 December 1997 and lasts until 1 December 2000. The Transitional System continues the pre-existing system of differentiation based on three categories of distilled beverages: pisco, whisky and "other spirits." Prior to the beginning of the implementation of the Transitional System, whisky was taxed at 70% ad valorem, while other spirits were taxed at 30% and pisco at 25%. The rates for pisco and other spirits remain the same throughout the period of the Transitional System. For the 12 months beginning on 1 December 1997 the rate on whisky dropped to 65%, falling to 59% for the 12 months beginning on 1 December 1998, to be reduced further to 53% for the final twelve month period the Transitional System is in effect.
94. The European Communities argues that these tax differentials are quite large and, even at the lowest differential in the final period of the Transitional System, the rate for whisky (53%) is more than double the rate for pisco (25%). The EC argues that this is more than de minimis. The European Communities also argues that pisco will be taxed at a lower rate than the category of "other spirits". The European Communities states that, while the differential is lower than with respect to whisky, it is still large enough to be capable of affecting the competitive relationship between the products, citing the 1998 SM survey.
95. Chile does not contest the EC's arguments with respect to the Transitional System, relying instead on its arguments that the domestic and imported products are not directly competitive or substitutable.
96. It is obvious that the level of difference in taxation between the imported and domestic products is greater than de minimis. We note that there is Chilean production of both whisky and other spirits, but by definition there are no imports of pisco. Whisky (imported and domestic) currently is taxed at more than twice the rate of pisco. While this difference will narrow somewhat next year, it clearly will remain more than de minimis. With respect to other spirits (again, including both domestic and imported) the difference is five percentage points ad valorem. The 1998 SM Survey indicates that such a difference has an impact and is greater than de minimis. Chile does not contest the EC's arguments and evidence to the effect that this is greater than de minimis in the context of distilled alcoholic beverages in Chile.
97. We are of the view that under the Transitional System imported and domestic distilled alcoholic beverages are not similarly taxed. The fact that some of the domestic production (e.g., products such as Chilean whisky) is similarly taxed is irrelevant to this step of the analysis. That is, it is sufficient to find that certain of the imports are taxed dissimilarly compared to certain of the domestic substitutable products. It is not necessary to show that all of the imports are taxed dissimilarly to all of the domestic products. ⁴¹²

3. New Chilean System

98. The New Chilean system becomes effective on 1 December 2000. ⁴¹³ The distinction between types of distilled alcoholic beverages utilised in the Transitional System is eliminated. Instead, the New Chilean System assesses taxes on an ad valorem basis that varies according to alcohol content. All distilled alcoholic beverages of 35� of alcohol or less are taxed at the rate of 27% ad valorem. The rate increases by four percentage points ad valorem per degree of alcohol content through 39�, topping out at a rate of 47% ad valorem for alcoholic beverages of higher than 39�.
99. The European Communities argues that this system still taxes the domestic and imported products dissimilarly. They claim that 90% of pisco sales will be taxed at the lowest rate of 27% while imports such as whisky, vodka, rum, gin and tequila will be taxed at 47% while brandy will be taxed at no less than 39 %. The European Communities notes that under Chilean law, whisky, vodka, rum, gin and tequila must contain at least 40� of alcohol.
100. According to the European Communities, the New Chilean System cannot be considered as a tax on alcohol content, because it is applied on the value of the beverage as a whole and not on the value of the alcohol content. Moreover, the European Communities argues that the value of distilled spirits is not directly related to alcohol content. For those reasons the European Communities considers that, in order to determine whether pisco and the other spirtis are "similarly taxed", we should compare the rates per bottle of each spirit. Such ad valorem rates are manifestly different varying between 27% and 47% in steps of four percentage points and such differences are clearly not de minimis. In the alternative, the European Communities argues that, at any rate, pisco and the other spirits are also "not similarly" taxed when one compares the rates per degree of alcohol. The rates vary from 0.771% per degree of alcohol at the level of 35� of alcohol to 1.175% per degree of alcohol for beverages at 40�, which is a rate of taxation more than 50% higher per degree of alcohol. ⁴¹⁴ According to the European Communities, this difference also is more than de minimis.
101. Chile responds that the New Chilean System is based on objective and neutral factors. In Chile's view, the criterion of alcohol content was recognized by the panel in Japan � Taxes on Alcoholic Beverages I as a permissible objective means of taxation. Chile notes that that case involved non-taxable thresholds and taxes applied in a manner not directly proportional to alcohol content and that the panel did not object to either characteristic. In Chile's view, there is no requirement in GATT/WTO jurisprudence for the proposition that tax systems must be directly proportional.
102. Chile argued that it has many products in the higher tax ranges of the New Chilean System, including gran pisco and pisco reserve, as well as locally produced brandy, rum, gin, vodka and whisky. Chile also notes that the European Communities produces many spirits that contain 35� alcohol or less. Chile states that according to the EC's arguments, the EC tax structures would also produce dissimilar taxation. According to Chile, it all depends on how one looks at the issue. Specific tax systems are preferential to high priced products, while ad valorem tax systems are preferential to low priced products. Chile made extensive arguments with respect to the taxation system of EC member states to show that such systems were not proportional or could be considered discriminatory depending on how they were viewed.
103. In our view the question of dissimilar taxation is relatively straightforward. It does not involve judgements about the objectivity of the laws or regulations involved. It does not involve an assessment of who benefits from the tax system. It does not involve an examination of the design, structure or architecture of the law in question. Such inquiries are relevant only to the next step of our analysis; namely, whether any system of dissimilar taxation has been applied so as to afford protection to domestic production. All we are doing at this point is determining whether there is dissimilar taxation of directly competitive or substitutable imported and domestic products. Even if it were to turn out that the large majority of imported products benefited from a particular tax, that would be irrelevant to this stage of the analysis. Our only issue here is to identify whether there is dissimilar taxation.
104. We note Chile's references to the panel report in Japan �Taxes on Alcoholic Beverages I, but we also note that the method of analysis in that case, as well as in the panel finding in Japan � Taxes on Alcoholic Beverages II, was somewhat different from the test utilised now. In those panel reports there was not clear demarcation between the analysis of "dissimilar taxation" and "so as to afford protection". The Appellate Body in Japan � Taxes on Alcoholic Beverages II made it clear that panels should review the matter in two distinct steps. ⁴¹⁵ Some of the Chilean argumentation with respect to the question of dissimilar taxation is more appropriately considered in the next step of our analysis.
105. We do agree with the Chilean observation that tax systems can appear dissimilar depending on how one looks at them. However, we do not think that observation is relevant to our consideration. ⁴¹⁶ A tax system based on taxing value is generally considered not to be applying dissimilar taxation if done on a purely ad valorem basis (i.e., a single ad valorem rate applied uniformly to all products). The difficulty in evaluating the New Chilean System is that it is not strictly an ad valorem system. It applies ad valorem rates that vary not just by the value but qualifies the rate by alcohol content.
106. With respect to Chile's argument that it is permitted to choose any objective criteria it wishes in formulating its tax system, we make the following observations. First, we note that the justification of "objective criteria" is troublesome in this regard. Some of the arguments on objectivity are, as we stated, relevant to the third step of the analysis, if at all. Second, it is unclear whether any "objective criteria" would suffice even in Chile's proposal. Would it be permissible, for instance, to tax white spirits differently from brown spirits? The color of spirits is a major dividing line in consumer perception of distilled alcoholic beverages and is certainly "objective" in that it is fairly clear into which category a particular beverage would fall. However, use of such "objective criteria" could result in different taxation of, for example, white rum and dark rum, which would be completely arbitrary. Thus it is clear that Chile's reliance on the argument that its system is based on "objective criteria" is not sufficient.
107. To argue as Chile does that there is no rule requiring proportionality is rather beside the point. Even utilising the EC's system of expressing the difference of percentage points per degree of alcohol, an evaluation of the nature of the system still involves mixing together two types of criteria. It is not clear that, even if proportional with respect to some particular products, assessing an ad valorem tax qualified by the additional criterion of alcohol content would result in a system of taxation that would survive examination under this step of the analysis. In this case, a statement that the New Chilean System does not assess taxes in a proportional manner is merely another way of stating that it is not really an ad valorem system strictly speaking (and certainly is not a specific system). ⁴¹⁷
108. We reiterate our observation in the section above that a system of taxation which results in non-de minimis dissimilar taxation of directly competitive or substitutable products is not in itself inconsistent with Article III:2, second sentence. It is only inconsistent if such a dissimilar system of taxation is applied so as to afford protection to domestic production. We, in fact, agree that a system which mixes criteria, and possibly even one that explicitly treats imported and domestic directly competitive or substitutable (but not "like") products differently, is not necessarily GATT-inconsistent. However, such a system could be found to involve dissimilar taxation and, therefore, require further analysis under the third step.
109. Chile has suggested that saying that the New Chilean System involves dissimilar taxation would be condemning luxury tax systems. However, in the context of the products involved in this case, a luxury tax system would be an ad valorem tax system that increased rates as the value of the products increased, not as some specific characteristic changed. Thus, for example, a system that assessed taxes at a rate of 20% for products valued between 1000 and 5000 pesos, 30% for products valued between 5,000 and 10,000 pesos, and 40% for products valued above 10,000 pesos and so on might arguably constitute a luxury tax. However, varying the ad valorem rate based on alcohol content does not necessarily tax high priced goods at a higher rate because the additional criterion of alcohol content is not necessarily related to value. Therefore, we need not reach the issue of whether luxury tax systems are consistent with the requirements of Article III:2, second sentence. ⁴¹⁸
110. The difference in taxation between the top (47%) and bottom (27%) levels of ad valorem rates of taxation of distilled alcoholic beverages is clearly more than de minimis and is so by a very large margin. Indeed, it is obvious that the difference of four percentage points between the various levels of alcohol content also constitutes a greater than de minimis level of dissimilar taxation. ⁴¹⁹
111. Furthermore, if viewed from the perspective of specific taxation the difference of over 50% per degree of alcohol between pisco of 35� (0.771 percentage points per degree of alcohol) and whisky and other imports of 40� (1.175 percentage points per degree of alcohol) is much greater than de minimis. We also are of the view that the differential between the individual degrees of alcohol are more than de minimis. For instance, spirits of 35� are assessed taxes at 0.771 percentage points per degree of alcohol; spirits of 36� are assessed at 0.861 percentage points per degree of alcohol; and spirits of 37� are assessed at 0.946 percentage points per degree of alcohol. These are significant percentage differences. ⁴²⁰
112. We also wish to be clear that we are not concluding that any "hybrid" system must result in dissimilar taxation. For one thing, such a broad conclusion would require further examination of the definition of the term "hybrid." For another, it would be beyond our terms of reference. Rather, our finding is that this particular system utilised by Chile results in dissimilar taxation that is not de minimis.
113. As with our finding above with respect to the Transitional System, the fact that some imported and domestic distilled alcoholic beverages could in particular factual circumstances be assessed identical taxes, or different taxes at less than de minimis levels, does not change our conclusion. ⁴²¹ It is sufficient for this step of the analysis to find that some of the imports are being taxed dissimilarly from some of the domestic production and the difference is more than de minimis.

E. "so as to afford protection to domestic production"

1. General

114. In its report on Japan � Taxes on Alcoholic Beverages II, the Appellate Body stated that:

[The] third inquiry under Article III:2, second sentence, must determine whether "directly competitive or substitutable products" are "not similarly taxed" in a way that affords protection. This is not an issue of intent. It is not necessary for a panel to sort through the many reasons legislators and regulators often have for what they do and weigh the relative significance of those reasons to establish regulatory intent. ⁴²²

115. The Appellate Body further noted that rather than review the intent of legislators to see whether there was protectionist intent, the real issue was one of "how the measure in question is applied". ⁴²³ The Appellate Body went on to explain that the question of application of a measure can be discerned from an examination of the "design, architecture and revealing structure of a measure". ⁴²⁴ The Appellate Body further observed that the very magnitude of dissimilar taxation could be evidence of protective application, but there often will be other factors and that panels should give full consideration to all the relevant facts on a case-by-case basis.
116. In its report on Canada � Periodicals, the Appellate Body provided extensive quotations from a Canadian Minister Designate concerning a Task Force Report which preceded the legislation under examination. There was also a quotation from the Minister of Canadian Heritage during the debate on the legislation to the effect that:

[T]he reality of the situation is that we must protect ourselves against split-runs coming from foreign countries and, in particular, from the United States. ⁴²⁵

117. The Appellate Body also noted the effect in the market-place that one split-run magazine had pulled out of the Canadian market and that a Canadian-owned split-run magazine had ceased production of its US edition. In light of these various facts, as well as the magnitude of the dissimilar taxation, the Appellate Body concluded that the system of dissimilar taxation was applied in a way that afforded protection to domestic production.
118. To a certain extent, this may appear as a change by the Appellate Body in their approach to this part of the analysis of Article III:2, second sentence. However, in its report in Japan � Taxes on Alcoholic Beverages II, the Appellate Body stated that the central issue was the design, architecture and revealing structure of the measure. It goes without saying that the stated objectives by the government of the Member concerned may be relevant in evaluating the design of a measure. However, caution must be exercised in doing this for many views can be expressed in open parliamentary debates and this was why the Appellate Body stated that delving into individual legislators' intent is not a useful exercise. Thus, presumably, the Appellate Body was distinguishing between statements by a government and statements by individual legislators.
119. Also, it is worth noting the nature of the quotations used in Canada � Periodicals. The statements were supportive of a finding of a protective objective and structure of the provision. Statements by a government against WTO interests (e.g., indicating a protective purpose or design) are most probative. Correspondingly, it is less likely that self-serving comments by a government attempting to justify its measure would be particularly probative. To put it another way, dissimilar taxation applied so as to afford protection to domestic production cannot be justified as WTO-consistent because of good intentions. There is no basis for such a justification in the text of GATT 1994.
120. Finally in this regard, such statements as referred to by the Appellate Body in Canada � Periodicals are really only useful as a factor confirming other evidence. The Appellate Body did not rely just on the statements; rather, account also was taken of the results in the marketplace and the fact of the high level of differential in tax rates between the domestic and imported products.
121. The European Communities submitted evidence concerning the Chilean legislative process that led to the adoption of the Transitional System and the New Chilean System. Among other things, the European Communities has alleged that the taxation systems were arrived at as part of an agreement between the Chilean domestic industry and the government. As part of this, the European Communities argues that the pisco industry agreed to sacrifice the high alcohol content versions of pisco in order to preserve the preferential tax treatment of the large majority of pisco production under 35� alcohol content. According to the European Communities, there is no other logical reason why the pisco industry would agree to this increase in taxation of some of its products.
122. We do not think it fruitful or appropriate to try to evaluate the Chilean legislative process. As noted above, all sorts of agreements can be made in order to obtain support from a domestic constituent for changes in tax rates. Some may not even have anything to do with the legislation at hand. Furthermore, it is normal for one constituent to wish to push a tax burden onto another even if the products made by both constituents are not directly competitive. The competition in spreading tax burdens may be very different from the competition in the marketplace. We do not find the evidence of legislative purpose offered by the European Communities to be particularly probative in this instance.
123. In our view, an important question is who receives the benefit of the dissimilar taxation. This is implicit in the reference of the Appellate Body and previous panels to the magnitude of the tax differentials. For example, the magnitude of the differentials would not be particularly relevant if the products realizing the resulting benefits were imports. Furthermore, the Appellate Body's review of the results of the application of dissimilar taxation in the marketplace in Canada � Periodicals shows that the Appellate Body was reviewing who had benefitted from the tax rate differentials. This is only logical given the language of Article III itself.
124. We must consider in this regard that Article III is to protect competitive opportunities. If there have been significant governmental restrictions in the market-place (which can include completely WTO consistent measures such as tariffs) it may be that there are relatively few, if any, imports and the distribution of the current benefits of the dissimilar taxation may be reflective of this fact. In such a situation, it would be necessary to consider if the large differentials could be having the effect of inhibiting potential imports.

2. Transitional System

125. The European Communities has argued that there are a number of factors that support a conclusion that the dissimilar taxation under the Transitional System is applied in a way so as to afford protection to domestic production. The European Communities refers to the following factors:

• the magnitude of the tax differentials;
• the absence of legitimate policy purposes for applying a lower rate to pisco;
• the fact that the beneficiary of the differentials (pisco) is by Chilean law a domestic product;
• the fact that the vast majority of Chilean production of distilled spirits is pisco;
• the fact that the majority of whisky (the highest taxed product) is imported; and,
• the alleged admission by the Chilean government that the reason for enacting the New Chilean System is that the prior and existing systems were discriminatory.

126. Chile responds that the purpose of the Transitional System is to allow time for the domestic and foreign producers and distributors to prepare for the changes under the New Chilean System and also to begin phasing in immediate benefits for whisky producers. In effect, Chile argues that the Transitional System should not be condemned as being a measure applied so as to afford protection when the primary result is the lessening of taxes on importers.
127. We take note of this point made by Chile that the primary beneficiary of the changes under the Transitional System are some of the imported products, specifically whisky. However, it is not for the Panel to inquire into such issues as whether political deference should be accorded for these efforts. The fact that the Transitional System lessens the protective effect does not vitiate the conclusion that, even at its least discriminatory, it is a system that does and will afford protection to domestic production.
128. The Transitional System assesses tax rates by type of spirits. The lowest tax rate is on pisco which under Chilean law is exclusively a domestic product. There could be an import physically identical to pisco and it would be assessed a tax rate five percentage points higher. This illustrates the protective nature of the structure of the tax system.
129. The largest category of imports by far at the present time is whisky and that is presently taxed at a rate of 53% (at its least discriminatory level beginning 1 December 1999) compared to pisco's 25% and pisco accounts for almost 75% of domestic production of distilled spirits. It is clear that the beneficiary of this structure is the domestic industry.
130. In our view, the design, architecture and structure of the Transitional System is to apply dissimilar taxation in a manner so as to afford protection to domestic production. The fact that the level of protection is lessened during the period of applicability of the law does not obviate the fact that its objective is to maintain such protection during the period.

To continue with New Chilean System

⁴¹¹ Appellate Body Report on Japan � Taxes on Alcoholic Beverages II, supra., p. 27. See also Appellate Body Report on Canada � Periodicals, supra., at 29.

⁴¹² See Appellate Body Report on Canada � Periodicals, supra., p. 29; Panel Report on Korea � Taxes on Alcoholic Beverages, supra., para. 10.100 (fn. 412).

⁴¹³ The new Chilean System has been enacted but not implemented. There appears to be no discretion allowed in its enforcement. The law is certain and definitive. We consider it appropriate to examine the law to determine its consistency with Article III:2, second sentence. Neither party has argued to the contrary.

⁴¹⁴ The European Communities suggests that there is a third typical method of taxation which is based on volume without reference to value or alcohol content. However, this type of taxation is not used in whole or part in the New Chilean System.

⁴¹⁵ See also Appellate Body Report on Korea � Taxes on Alcoholic Beverages, supra., para. 107.

⁴¹⁶ If taken further, one could argue that an overall system of indirect taxation provides dissimilar taxation if viewed from the perspective of direct income taxation. Such an observation may not be inaccurate, but it also is largely devoid of meaning.

⁴¹⁷ Chile offered as an analogy the example of automobile taxation in Europe. According to Chile, such automobile taxes increase depending on the size or horsepower of the engines. Chile states that this could discriminate against high horsepower imports. Therefore, Chile concludes, the logic of the EC's argument implies that such a system would be inconsistent with the EC's WTO obligations if Chile's system is found to be so. Analogies can be useful analytical tools if they provide relatively simple illustrations of a problem. However, analogies lose their utility to the extent more and more facts need to be provided about the purportedly analogous situation to determine its relevance. With respect to engine power or size based systems of taxing automobiles, we would need to find out more about the competitive relationship of the products in question and structure of the tax system, as well as how it is applied. Again, we note, mere dissimilar taxation alone is not enough to render a tax system inconsistent with the obligations of Article III:2, second sentence. It is also necessary to determine if such a system of dissimilar taxation is applied in a manner so as to afford protection to domestic production. Even then, there may be questions regarding the potential applicability of exceptions pursuant to Article XX. Chile's analogy might or might not be correct, but it would require a whole new fact finding exercise to make such a determination and that clearly is beyond the scope of our terms of reference.

⁴¹⁸ We also note, that a luxury tax system could be found to result in dissimilar taxation, but still not result in a violation of Article III:2, second sentence, as long as such a system was not applied so as to afford protection to domestic production.

⁴¹⁹ See discussion with respect to Transitional System, above, and results of the 1998 SM Marketing Survey.

⁴²⁰ We also note because of the particular structure of the New Chilean System, the rates decrease from 15� to 35�, increase substantially from 35� to 39� and then begin to decrease above 40�.

⁴²¹ 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 of the Tariff Act of 1930, BISD 36S/345, para. 5.14.

⁴²² Appellate Body Report on Japan � Taxes on Alcoholic Beverages II, supra., p.27.

⁴²³ Ibid., p. 28 (emphasis in the original).

⁴²⁴ Ibid., p. 29.

⁴²⁵ Appellate Body Reports on Canada � Periodicals, supra., p. 31.