Source(s) of the information:

Lawyers, other representatives, expert(s), tribunal’s secretary

Report of the Panel

I. PROCEDURAL BACKGROUND

1.1.
This proceeding has been initiated by two complaining parties, the European Communities and the United States.
1.2.
On 2 April 1997, the European Communities requested consultations with Korea under Article XXII:1 of GATT and Article 4 of the Understanding on Rules and Procedures Governing the Settlement of Disputes ("DSU") (WT/DS75/1). The United States (WT/DS 75/2) and Canada 6(WT/DS75/3) requested to be joined in those consultations, pursuant to Article 4.11 of the DSU on 17 and 21 April 1997, respectively. Korea agreed to those requests (WT/DS75/4 and WT/DS75/5). Consultations between the European Communities and Korea were held in Geneva on 29 May 1997, in which the United States and Canada participated.
1.3.
On 23 May 1997, the United States requested consultations with Korea under Article XXII:1 of GATT and Article 4 of the DSU with respect to the same matter (WT/DS84/1). Canada (WT/DS84/2) and the European Communities (WT/DS84/3) requested to be joined in those consultations, pursuant to Article 4.11 of the DSU, on 29 May and 5 June 1997, respectively.
1.4.
Consultations were held in Geneva on 24 June 1997, between the United States and Korea, and the European Communities and Canada participated as third-parties. Another set of consultations were held on 8 August 1997, to address US requests for further clarifications, but the parties were unable to settle the dispute.
1.5.
On 10 September 1997, the European Communities (WT/DS75/6), and the United States (WT/DS84/4), each requested the establishment of a panel pursuant to Article 6.1 of the DSU.
1.6.
In its panel request, the European Communities claims that:

Korea, by according a preferential tax treatment, through the Liquor Tax Law and the Education Tax Law, to soju vis-a-vis certain alcoholic beverages falling within HS heading 2208, has acted inconsistently with Article III:2 of GATT 1994, therefore nullifying or impairing the benefits accruing to the European Communities under the GATT 1994.

1.7.
In its panel request the United States claims that:

Korea, under its general Liquor Tax Law, imposes a lower tax on the traditional Korean distilled spirit soju than the high taxes it applies to other distilled spirits such as whisky, brandy, vodka, rum, gin and "ad-mixtures". This difference in tax burden is made even more dramatic by the application of an Education Tax.

1.8.
The Dispute Settlement Body (DSB) agreed to these two requests for a panel at its meeting of 16 October 1997, establishing a single panel pursuant to Article 9.1 of the DSU with the following standard terms of reference:

"To examine, in light of the relevant provisions of the covered agreements cited by the European Communities in document WT/DS75/6 and the United States in document WT/DS84/4, the matter referred to the DSB by the European Communities and the United States in those documents and to make such findings as will assist the DSB in making the recommendations or in giving the rulings provided for in those agreements".

1.9.
Canada and Mexico reserved their rights to participate in the Panel proceedings as third-parties.
1.10.
On 26 November 1997, the United States and the European Communities jointly requested the Director-General to determine the composition of the panel, pursuant to paragraph 7 of Article 8 of the DSU. On 5 December 1997, the Director-General composed the Panel as follows:

Chairman: Mr. Åke Lindén

Panelists: Professor Frédéric Jenny

Mr. Carlos da Rocha Paranhos

1.11.
The Panel had substantive meetings with the parties on 5 and 6 March 1998, and on 21 and 22 April 1998.

II. MEASURES IN ISSUE

2.1.
Korea maintains a multi-tiered taxation regime on the sale of alcoholic beverages. Under the Liquor Tax Law of 1949, as amended, Korea creates various categories of distilled spirits, on which it imposes different ad valorem taxes. Under the Education Tax Law of 1982, as amended, Korea assesses a surtax on certain of these sales, determined as a percentage of the established liquor tax.
2.2.
Both the liquor tax and the education tax on alcoholic beverages are imposed at the wholesale level. The tax is payable by the manufacturer of the beverages or, in the case of imports, by the importer. Tax liability accrues at the time of shipment from the factory (in the case of alcoholic beverages made in Korea) or of withdrawal from the bonded warehouse (in the case of imported alcoholic beverages).

A. THE LIQUOR TAX LAW

2.3.
The Liquor Tax Law lays down a system of excise taxes applicable to all alcoholic beverages (whether manufactured in Korea or imported) intended for consumption in Korea. The taxes applied to the categories in dispute are in the form of ad valorem taxes.
2.4.
For the purposes of assessing the tax, the value of imported alcoholic beverages includes transport and insurance costs as well as the import duty imposed. In other words, the tax base for imports is the price noted on the import declaration when the goods are withdrawn from the bonded warehouse (i.e., the CIF import value plus duty).1
2.5.
Domestic alcoholic beverages are taxed on the value of production costs, sales costs (including advertising), extraordinary costs, and profits, i.e., the tax base is the price of the goods when they are shipped from the production site.2 The categories of distilled spirits established by the Liquor Tax Law, and the applicable tax rates, are described below.

1. Categories

2.6.
Liquor Tax Law divides alcoholic beverages into eleven categories, some of which are further divided into sub-categories, and assigns to each of them a different tax rate. These categories include "soju," "whisky," "brandy," "general distilled liquors" (which covers beverages such as vodka, gin, rum and tequila), "liqueurs," and "other liquors" (to the extent that liquors falling within this category may contain distilled spirits or liqueurs falling within any of the preceding categories). Article 3 of the Liquor Tax Law sets forth definitions of these categories.3

(a) Soju

2.7.
Article 3.6 has four sub-categories of soju. Sub-categories A and B apparently refer to "distilled soju," while sub-categories C and D apparently refer to "diluted soju."
2.8.
Article 3.6.A and 3.6.B states the legal definition of soju as:

(a) Soju may be produced from discontinuous distillation of a fermented mash developed from the basic constituents of a starch source, yeast and water.

(b) Soju may be produced from discontinuous distillation as in Paragraph A above, but during the fermentation and production process other ingredients may be added as determined by Presidential decree.

2.9.
Thus paragraphs (A) and (B) describe two "types" of soju: (i) soju created by fermentation and discontinuous distillation, but without additives; and (ii) soju created by fermentation and discontinuous distillation and containing additives.
2.10.
According to Article 3.6.A, distilled soju cannot

(a) be produced from sprouted grain;

(b) be filtered through charcoal of white birch; or

(c) be produced in a process whereby water is mixed with grain and the mash sealed for fermentation and subsequent distillations.

2.11.
The chapeau of Article 3.6 specifies that soju must have an extract content of 2% or less.
2.12.
The legal definition of diluted soju in Article 3.6.C and 3.6.D is as follows soju:

(a) Soju may be produced by diluting neutral spirits with water or by adding thereto those ingredients as determined by Presidential Decree;

(b) Soju may be produced by adding to the products produced in accord with paragraphs A through C immediately above the product of paragraph A, when determined by Presidential Decree, or other grain spirits as determined by Presidential Decree.

2.13.
The definition of diluted soju in 3.6.C and D relies on "neutral spirits," which is defined by Article 3.1 of the Liquor Tax Law as follows:

(a) Neutral spirits may be produced from the distillation of a fermented mash developed from the basic constituents of a starch source and a sugar source that results in a product that is 85 percent or more alcohol;

(b) Neutral spirits may be produced from the distillation of ingredients containing alcohol, resulting in a product that is 85 percent or more alcohol.

(b) Whisky, brandy, and "general distilled liquors"

2.14.
Whisky, brandy and "general distilled liquors" are defined in Articles 3.7, 3.8 and 3.9, respectively. The definitions include a 2% extract limitation that distinguishes them from liqueurs. All three include fermentation and distillation as the manufacturing process. However, unlike the definition for soju, they generally specify starch sources.
2.15.
Article 3.7 of the Liquor Tax Law, the "whisky" category, includes all types of whisky made totally or partly from sprouted grain and aged in wooden casks, as well as, under certain conditions, admixtures of whisky and other spirits or ingredients.4
2.16.
Article 3.8, the "brandy" category, includes all liquors distilled from a fermented mash of fruit or fruit wine and aged in wooden casks. Subject to certain conditions, it includes also ad-mixtures of those liquors with other spirits or ingredients.5
2.17.
The category of "General Distilled Liquors" is a miscellaneous category comprising several kinds of distilled spirits. It consists of six paragraphs.

-- Paragraph (A) specifies kaoliang-ju lees as a starch source, and the manufacturing process includes sealing prior to fermenting and distilling; it is designed to address kaoliang-ju, which can be imported from China.

-- Paragraph (B) specifies sugar cane, sugar beet, sugar, and/or molasses as a starch source; it addresses rum.

-- Paragraph (C) specifies "fruits of juniper tree" as an ingredient; it addresses gin.

-- Paragraph (D) specifies filtering of the alcohol; it addresses vodka.

-- Paragraph (E) merely concerns "materials mainly containing starch or sugar produced by fermentation and distillation." It covers tequila and any distilled spirit. Its wording is the same as that used in the first part of the definition of "neutral spirits".6

-- Paragraph (F) addresses mixed distilled drinks (e.g., gin and rum mixed drinks).

(c) Liqueurs

2.18.
Article 3.10, the "liqueurs" category, covers liquors with more than 2% extract content produced by distillation of a starch or sugar source to which ginseng juice, fruits or fruits extracts are added.7
2.19.
Article 3.11 sets forth the category of "other liquors," a residual category including all liquors (whether fermented or distilled) not falling within any of the other categories defined by the Liquor Tax Law.8 It includes inter alia admixtures of whisky and brandy.

2. Tax rates

2.20.
The Korean law imposes different ad valorem tax rates on the various categories and sub-categories of distilled spirits. Pursuant to the definitions, soju is given a tax rate of 35 to 50 percent, while other distilled alcoholic beverages are taxed at 80 to 100 percent. The applicable liquor tax rates are:9

Item Ad Valorem Tax Rate (%)
Diluted soju 35
Distilled soju 50
Whisky 100
Brandy 100
General distilled liquors (vodka, gin, rum) 80
General distilled liquors containing whisky or brandy 100
Liqueur 50
Other liquors: -With 25% or more alcohol -With less than 25% alcohol -Which contain 20% or more whisky or brandy 80 70 100

B. THE EDUCATION TAX LAW

2.21.
The Education Tax Law of 1990 is assessed as a surtax on the sale of a variety of items, including most alcoholic beverages. For alcoholic beverages, the applicable rate is determined by reference to another tax -- the applied liquor tax rate.10 For those assessed a liquor tax rate of 80% or greater, the law imposes an education surtax calculated as 30% of the liquor tax imposed.11 For alcoholic beverages assessed a liquor tax rate of less than 80%, the law imposes an education surtax calculated as 10% of the liquor tax imposed.
2.22.
This tax structure results in a 30% surtax for imported distilled alcoholic beverages, including whisky, brandy and general distilled liquors (vodka, rum, gin, tequila, shochu, etc.) except for imports of Japanese shochu, which are classified for tax purposes and taxed at 10%. Of all distilled alcoholic beverages, only soju and liqueurs are subject to the lesser 10% surtax. Prior to 1995, soju was exempted from the Education Tax. However, after negotiations between Korea and the European Communities that Korea agreed to subject soju to the Education Tax at a rate of 10%.
2.23.
The applicable rates on the categories concerned by this dispute, expressed as a percentage of the amount payable pursuant to the Liquor Tax, is as follows:

Tax rates applied pursuant to the Education Tax Law
Product As % Liquor Tax
Diluted soju 10
Distilled soju 10
Whisky 30
Brandy 30
General distilled liquors 30
General distilled liquors containing whisky or brandy 30
Liqueurs 10
Other Liquors: -more than 25% alcohol content 30
-less than 25% alcohol content 10
-containing whisky or brandy 30

III. FACTUAL ARGUMENTS

A. EUROPEAN COMMUNITIES

3.1.
The European Communities proceeds from the premise that in response to its reiterated requests, Korea has reluctantly acceded to make a number of changes to its liquor tax system which have reduced (but by no means eliminated) the difference between the internal taxes applied to soju and those applied to other categories of distilled liquors.
3.2.
The European Communities states that as of 1 January 1991, Korea abolished the Customs Defence Tax, which until then had been applied only to imported liquors. It further states that on the same date, Korea also abolished the Liquor Defence Tax, which had been levied at a lower rate on soju than on other distilled spirits and liqueurs. Further, the European Communities states that Korea eliminated an uplift ratio of 1.0:1.1 (the so-called "times 1.1 multiplier") which had been applied in order to inflate artificially the import duty paid value on which the Liquor Tax is assessed in the case of imported beverages.
3.3.
The European Communities adds that these amendments were followed by a reduction of the Liquor Tax rates on the category of "whisky" from 200% to 150%, and on the category of "general distilled liquors" from 100% to 80%, both effective from 1 July 1991. According to the European Communities, this decrease, however, was partially nullified by a simultaneous increase in the Education Tax rates, which were raised to 30% for most distilled liquors other than "soju". At the same time, the category of "soju" was divided into the sub-categories of "distilled soju" and "diluted soju" and the rate on "distilled soju" raised from 35% to 50%.
3.4.
According to the European Communities, in June 1993, it reached an agreement with Korea (the "1993 Agreement") whereby Korea undertook to reduce progressively over a period of two years the liquor tax rate applicable to the "whisky" and "brandy" categories from 150% to 100%. The European Communities asserts that Korea further agreed to levy the Education Tax on both sub-categories of soju (which had until then been exempt from such tax) at a rate of 10% as from 1 January 199412 and to increase the tax on admixtures containing whisky or brandy (which are mainly bottled in Korea) from 80% to 100%.
3.5.
The European Communities further asserts that the 1993 Agreement envisaged that a new round of consultations would take place in 1996 in order to discuss further reductions of the remaining tax differences. According to the European Communities, as compensation for the continued application in the meantime of much lower taxes to soju, Korea agreed to further reduce the effectively applied import duties on whisky, brandy other than wine brandy (which already benefited from a 15% applied rate), rum, gin, vodka and liqueurs (but not on soju) from 30% to 20%.
3.6.
The European Communities allege that the consultations provided for by the 1993 Agreement eventually took place in January 1997. Nevertheless, according to the European Communities, Korea did not meet the EC's request to eliminate the remaining tax differentials so as to bring its liquor tax system in conformity with the GATT.

The Korean market for distilled liquors

3.7.
The European Communities states that the Korean market for distilled spirits and liqueurs was virtually closed to imports until the late eighties. According to the EC's argument, until 1 January 1989, imports of distilled spirits in bulk were subject to quotas, whereas imports of distilled spirits in bottles were prohibited until 1 July 1989, and thereafter subject to quantitative restrictions until 1 January 1990.
3.8.
The European Communities further argues that, Korea applied prohibitively high import duties: 150% until 1984; 100% until 1988; and 50 % until 1991. According to the European Communities, until March 1990 Korea applied an import deposit requirement. The EC's position is that, currently the applied import duty rate 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).13
3.9.
The European Communities further argues that, following the elimination of the import quotas and a substantial reduction of import duties and internal taxes, imports of distilled spirits and liqueurs have grown steadily but still represent only around 3.5% of the market. According to the European Communities, this share is unusually low. The European Communities is of the view that in most other OECD countries the share of imported sprits is between 30% and 40% of the market for distilled liquor. By comparison, the European Communities states that in Japan the share of imported spirits was 8% in 1995, despite the fact that at that time Japan applied a system of discriminatory internal taxes similar to the one in dispute.
3.10.
According to the European Communities, the Korean spirits market is overwhelmingly dominated by soju. In 1996 sales of soju amounted to 90 million 9L cases (810 million litres), which represents as much as 94% of the distilled spirits market.14 Soju's position, however, is allegedly being eroded by growing sales of imported spirits and liqueurs, and in particular of whisky. Over the past few years, sales of soju have allegedly increased at a lower pace than the total spirits market (between 1993 and 1994 sales of soju even decreased in absolute terms). As a result, the market share of soju fell from 96.37 % in 1992 to 94.39 % in 1996.15
3.11.
The European Communities states that imports of soju are insignificant. In 1997, Korea allegedly imported just 1,625 litres.16 In contrast, argues the European Communities, Korea exports large quantities of soju. The European Communities further asserts that during the first eleven months of 1996, exports of soju totalled 43 million litres of soju, which represents about 5% of the Korean soju production. According to the European Communities, the main export market is Japan, where soju is considered for customs and tax purposes as being the same product as local "shochu".
3.12.
The European Communities further asserts that almost all soju sold in Korea is diluted soju. Distilled soju is estimated to account for just over 1% of the total sales of soju. While diluted soju is generally an inexpensive liquor, distilled soju may fetch very high prices, similar to those paid for imported premium brands of whisky.
3.13.
The European Communities argues that, confronted with growing sales of western-style liquors, the manufacturers of diluted soju have been forced to address what are generally perceived by Korean consumers as negative attributes of that liquor as compared with the "western style" distilled liquors: inferior quality, harsh taste, hangover effects.
3.14.
According to the European Communities, this has led to the emergence of new 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 packaging. The European Communities asserts that the prices for premium soju brands are between two and three times higher than those for standard diluted soju. According to the European Communities, in spite of that, sales of premium soju are growing very rapidly. By EC estimates, in 1996 they represented 6% of soju sales and reached 10% in 1997.
3.15.
The European Communities points out that whisky is the largest category of distilled spirits after soju. Sales of whisky allegedly increased from 11 million litres in 1992 to 27 millions in 1996, i.e. by almost 140%. As a result, the European Communities argues that the share of whisky rose from 1.53% in 1992 to 3.14% in 1996. According to the European Communities, one of the main reasons for this increase is the progressive reduction in the applicable liquor tax rate from 200% in 1990 to 100% in 1996. The European Communities further argues that Scotch whisky imported from the European Communities, whether in bottles or in bulk, accounts for virtually all of the sales within this tax category.
3.16.
The European Communities further argues that the category of brandy is still very small but growing rapidly. The increase has allegedly been particularly remarkable in the case of cognac, which went up from just 13,000 litres in 1992 to 193,000 litres in 1996. As in the case of whisky, the argument goes, this increase is in part due to the progressive reduction of the Liquor Tax rate from 150% in 1990 to 100% in 1996. Almost all brandy sold in Korea is imported, whether in bottles or in bulk.
3.17.
According to the European Communities, the category of "General Distilled Liquors" is also very small. In the EC view, unlike sales of whisky and brandy, sales of liquors falling within this category have stagnated and in some cases even declined. One of the reasons for this, according to the European Communities is that, unlike whisky and brandy, this category has benefited only from a marginal reduction of taxes. The European Communitiesalleges that. Although the liquor tax rate on this category was lowered from 100% to 80% as from 1 July 1991, this reduction was almost totally offset by a simultaneous increase of the applicable Education tax rate from 10% to 30%.17 A significant proportion of sales within this category is imported. According to estimates of the EC industry, imports would represent approximately 20% of the sales of gin, 50% of the sales of rum and 70% of the sales of vodka.
3.18.
The European Communities further alleges that pre-mixes of distilled liquors and non-alcoholic beverages account for a major portion of sales (95% according to the estimates of the EC industry) within the category of "liqueurs". According to this argument, soju-based cocktails (e.g. lemon flavoured soju, cherry flavoured soju) account for the vast majority of the sales of pre-mixes. The EC view is that soju cocktails are a relatively new product targeted at the young generation and enjoy considerable success. According to the European Communities, during 1995 alone, sales of soju cocktails increased by 1250%. There are no imports of soju cocktails.
3.19.
In contrast, the European Communities argues that it may be estimated that as much as 90% of the sales of "authentic" or "single item" liqueurs are imported. Sales of this type of "liqueurs" have been growing off a small base at 15-20% every year and are currently estimated to represent 300,000 litres out of total market for liqueurs of 13.5 million litres.
3.20.
The European Communities further argues that although no official sales figures have been made available by the Korean Government, the EC industry estimates that while sales of whisky and other imported liquors declined during 1997, sales of soju would have increased. As a result, the European Communities argues, soju may have regained its lost share of the market. This new development is the result of extraordinary circumstances.
3.21.
According to the European Communities, in the first place, the depreciation of the Korean won, which has made imported liquors more expensive18. To this, states the European Communities, it must be added the effects of the boycotts against imported products orchestrated by civic groups and by business associations such as the Central Council of Korean Night-spots' Operators during the first months of 1997. Finally, according to the European Communities, the financial crisis which broke in October of last year, and the ensuing slow down in the Korean economy has made consumers much more price conscious and further depressed the sales of imported liquors to the benefit of the less taxed and less expensive soju.
3.22.
The European Communities argues that western-style liquors used to be perceived by Korean consumers as "luxury" items. According to the European Communities, at present the prices for western-style liquors remain much higher than the prices for diluted soju. Nevertheless, according to the European Communities, following the lifting of the import quotas and the lowering of import duties and liquor taxes, there has been a clear trend towards lower consumer prices, broader availability in all sales channels and consumption patterns which are more similar to those of soju.
3.23.
The European Communities concludes that the remaining tax differentials stand as an obstacle to that trend and hinder further competition between soju and imported western-style distilled spirits and liqueurs.

B. UNITED STATES

3.24.
From the US perspective, the products concerned by this dispute are soju, a locally produced distilled liquor, on the one hand, and imported distilled spirits classified under the Harmonized System (HS) heading 2208, on the other hand,19 including spirits such as vodka, whisky, gin, rum, brandy and liqueurs. Exports in 1996 of U.S. distilled spirits to Korea were allegedly only $1.8 million compared to an average export level in recent years of $90 million to Japan.
3.25.
The United States alleges that the current tax system and the state of the Korean market grows out of many years of protecting soju. It claims that although Korea has dismantled some of its trade barriers to imports over the last ten years (an effort that has produced inroads for imported spirits in the Korean market), Korea retains two tax laws that categorises liquor products arbitrarily, and imposes corresponding discriminatory tax rates.
3.26.
The United States further alleges that Korea’s current tariff and tax regime governing the sale of alcoholic beverages has grown out of a historically restrictive market for alcoholic beverages that has shaped the Korean market as it stands today.
3.27.
The United States asserts that after 1949, high tariffs, quotas and other measures were used by the Korean government to discourage the importation of distilled alcoholic beverages and conserve the country’s foreign exchange reserves. It cites, for example, that in the 1970's Korea assessed a duty of 150% C.I.F. on whisky imports. Until January 1989, Korea maintained quota restrictions on bulk imports of whisky, and it prohibited the importation of bottled whisky until July 1989. Importers were required to pay a deposit on the value of their imports, and the government permitted only twelve licensed importers until 1989.
3.28.
The United States further alleges that in the 1980's, Korea began to liberalize these barriers to distilled spirits imports by reducing applied rates on whisky. In 1982, the government reduced the rate of duty imposed on whisky from 150% to 100% for products certified for use in tourist hotels. In 1984, the government extended this rate reduction to all whisky imports regardless of destination. In 1988 the customs duty was further cut to 50%, where it remained until a reduction to 40% in 1991, followed by 30% in 1993. In 1996, Korea applied a tariff rate of 20% on whisky. Korea’s WTO bound rate, as a result of negotiations during the Uruguay Round, descends from a base of 100% in 1995 to a final rate of 30% in 2004 in equal annual instalments.
3.29.
The United States also alleges that, following pressure from the European Communities, Korea has also recently dismantled a number of its non-tariff barriers against distilled alcoholic beverages. In 1988, Korea eliminated the import deposit requirements for small and medium sized importers. In 1989, it reduced this deposit for large importers from 10% to 5%; increased the number of licensed importers from 12 to 25; lifted quota restrictions on the import of bulk whisky; and permitted the import of whisky bottled abroad for the first time, albeit subject to a quota. In 1990, the government removed this quota, abolished the import deposit requirement for large importers, and removed government limitations on the number of licensed importers. In 1991, Korea allowed foreign investment in the importation and distribution of spirits.
3.30.
The thrust of the US case is that concurrent with these tariff and non-tariff measures, Korea maintained a discriminatory system of internal taxes weighted against imported alcoholic beverages. According to the United States, after World War II, taxes on whisky and beer provided the government with a steady and easily collected form of revenue. However, in the face of increasing pressure, especially from the EC, Korea enacted a series of tax reductions on some imported distilled alcoholic beverages. Korea allegedly decreased the liquor tax rate on whisky and brandy from 200% to 150% in July 1991, 120% in January 1994, and 100% in January 1996.

The current Korean market for distilled liquors

3.31.
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).
3.32.
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.
3.33.
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.
3.34.
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.
3.35.
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.
3.36.
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.
3.37.
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.
3.38.
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.
3.39.
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

3.40.
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.
3.41.
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.
3.42.
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.
3.43.
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.
3.44.
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.
3.45.
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.
3.46.
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

3.47.
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.
3.48.
Korea further states that distilled liquors can be derived from materials as varied asgrain, 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.
3.49.
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

3.50.
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.
3.51.
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.
3.52.
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.
3.53.
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

3.54.
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

3.55.
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
3.56.
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%.
3.57.
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
3.58.
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.
3.59.
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.
3.60.
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.
3.61.
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

3.62.
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.
3.63.
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.
3.64.
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.
3.65.
Korea presents the following table that purports to show the reduced tax burden on whisky since 1991:

(in %) Whisky liquor taxEducation taxDefence taxCombined surtax burdenCombined 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

IV. CLAIMS OF THE PARTIES

4.1.
TheEuropean Communities claims that:

(i) Korea is in breach of its obligations under GATT Article III:2, first sentence, by applying internal taxes on imported vodka pursuant to the Liquor Tax Law and the Education Tax which are in excess of those applied on soju; and

(ii) Korea is in breach of its obligations under Article III:2, second sentence, by applying higher internal taxes pursuant to the Liquor Tax Law and the Education Tax Law on imported liquors falling within the categories of 'whisky', 'brandy', 'general distilled liquors, 'liqueurs', and 'other liquors' (to the extent that they contain other distilled spirits or liqueurs) than on soju, so as to afford protection to its domestic production of soju.

4.2.
The United States claims that the Korean laws outlined above differentiate among distilled spirits on the basis of arbitrary characteristics, resulting in great disparities in the treatment of soju and imported distilled spirits. According to the United States, at the very minimum:

(i) Korea’s application of internal taxes on vodka that exceed taxes applied to soju is inconsistent with the first sentence of GATT Article III:2; and

(ii) Korea's application of higher internal taxes to imported distilled spirits classified under HS heading 2208 falling within its legal categories of "whisky," "brandy," "general distilled liquors," "liqueurs" and "other liquors" (to the extent that they contain other distilled spirits) afford protection to its domestic production of soju, inconsistent with the second sentence of Article III:2.

V. LEGAL ARGUMENTS

A. PRELIMINARY ISSUES

1. General

5.1.
The complainants argue that Korea's request for preliminary rulings was not properly formulated and it was unclear what provisions of the WTO Agreement, if any, Korea considers to have been violated by the complainants, and that it was also unclear what precisely is the issue being addressed by Korea to the Panel.
5.2.
According to the European Communities, it is unclear whether Korea is asking the Panel to find that the European Communities has violated ceratin procedural provisions of the DSU, or whether it is asking the Panel to dismiss the complaint because certain procedural pre-requisites were not fulfilled, or whether it is asking the Panel to discharge itself.
5.3.
The United States was of the view was that given the scarce information provided by Korea in Korea’s oral statement (which formed the basis of its request for preliminary rulings) it considers that any preliminary ruling by the Panel would not be warranted. The United States adds that to the extent the request for a preliminary ruling warrants any attention, it may be addressed in the Final Panel report.

2. Specificity of the panel requests

5.4.
Korea takes issue with the specificity of the requests for a panel made by both the European Communities and the Unites States.
5.5.
Korea notes that the European Communities, in its request for a panel, has referred to a preferential tax rate on 'soju' vis-a-vis 'certain' alcoholic beverages falling within HS heading 2208. Korea states that the European Communities has not clarified its position even in its written submission. Korea further notes that the European Communities claim that 'all other distilled spirits and liqueurs' other than 'soju' falling within HS 2208 are within the purview of this dispute.
5.6.
Korea states that the US' request for a panel lacks specificity as well. Korea notes that the United States, in its request for a panel, refers to higher tax rates on 'other distilled spirits', while specifically mentioning 'whisky, brandy, vodka, rum, gin, and ad mixtures'. Korea further notes that the United States, in its first submission, seeks to broaden the dispute to all distilled spirits, other than soju, that are classified under HS 2208.
5.7.
Korea argues that such vaguely worded complaints violate its rights of defence. According to Korea, HS 2208 is a very broad tariff classification, which covers a wide variety of alcoholic beverages, including non-western liquors such as koryangu, Korean soju, Insam ju, Ogapiju, and Japanese shochu. Korea notes that it is surprising that both complainants refer to 'western-style liquors', yet HS 2208 also includes non-'western-style liquors'.
5.8.
Korea argues that this lack of specificity of the complainants' claims is improper for two reasons -

(i) it frustrates Korea's right of defense, which is a general principle of due process implicit in the DSU; and

(ii) it violates a clear obligation of the DSU, which is that such a request should 'identify' the specific measures at issue, and 'present the problem clearly', as stipulated in Article 6.

5.9.
Korea, therefore, requests the panel to issue a preliminary ruling, limiting the products at issue in this dispute. Korea submits that the only imported liquors whose tax rates are to be compared with the tax rate on the domestic soju products are: whisky, brandy, vodka, gin, and rum. According to Korea, these are the liquors identified specifically by the United States in its request for a panel In Korea's view, parties to a dispute cannot unilaterally alter the terms of reference by expanding, in their first submission, on issues not previously raised.
5.10.
Korea also submits that it is unable to identify which items the United States is referring to by its reference to 'ad mixtures' in its request for a panel.
5.11.
Korea also claims that the complainants have not clearly distinguished the domestic liquors that are supposed to be more favourably taxed in Korea. Korea states, in particular, that the complainants have not distinguished between Korea's distilled soju, an artisanal product sold at very high prices in tiny quantities, and subject to a 50% tax rate, on the one hand, and, on the other hand, diluted or standard soju, which is a large volume, inexpensive drink, consumed with meals and taxed at a rate of 35%.
5.12.
Korea argues that both complainants, in their requests for a panel, have referred to one 'soju' product, without acknowledging that there are, in reality, two different products, with two different tax rates. Korea also states that the complainants have not recognized that one group of western-style spirits ('liqueurs'), which they have mentioned in passing, is taxed at the same rate as distilled soju (50%).
5.13.
The European Communities argues that its panel request is more than sufficiently specific to meet the minimum requirements of Article 6.2 of the DSU. According to the European Communities, the mere fact that HS 22.08 covers many different types of liquors is no basis to consider that it lacks specificity.
5.14.
The European Communities also rejects Korea's assertion that it has, through its first submission, broadened the scope of its complaint as contained in the request for a panel. According to the European Communities, its request for a panel refers to '.. certain alcoholic beverages falling within HS 22.08'. In the EC's view, that HS position does not cover only 'spirits' but also 'undentured ethyl alcohol of an alcoholic strength by volume of less than 80% 'liqueurs' and 'other spirituos beverages' not falling within any other position of chapter 22 of the HS.
5.15.
The European Communities notes that its first submission refers to 'soju and all other distilled spirits and liqueurs falling within HS 22.08. In the EC's view, therefore, its first submission if anything narrows rather than broadens the scope of its complaint.
5.16.
The United States argues that Article 6.2 of the DSU requires, inter alia, that the request for a panel "identify the specific measures at issue and provide a brief summary of the legal basis of the complaint sufficient to present the problem clearly." According to the United States, its panel request satisfied both these requirements, and it also clearly includes all distilled spirits within HS heading 2208, as maintained in the first US submission.
5.17.
The United States argues that in accordance with Article 6.2 of the DSU, its request for the establishment of a panel defined the Korean measures at issue: the general liquor tax law and the Education Tax; and provided a brief summary of the legal basis of the complaint. The United States refers to Bananas III, where the Appellate Body allegedly noted that this provision concerning the legal basis requires that the request for a panel must be sufficiently specific with respect to the claims being advanced, but need not lay out all the arguments34 that will subsequently be made in the party’s submission. The United States argues that with respect to its request in this dispute, the legal claim is clear: that Korea’s taxes are higher on imported distilled spirits than on its domestic product "soju," in violation of Article III:2 of the GATT.
5.18.
The United States argues that Korea’s request that the Panel limit the proceeding to five specific products -- whisky, brandy, vodka, rum, and gin, is equally without basis. According to the United States, the panel request, which defines the terms of reference of the panel, refers to taxation of "other distilled spirits" -- i.e., distilled spirits other than soju. By using the term "such as," it sets forth the five products and "ad mixtures"35as examples, and not as an exclusive list. According to the United States, the extent to which the United States and European Communities establish to the Panel that all such products are "like" or "directly competitive or substitutable" is a matter to be determined through the course of these proceedings, beginning with the first submission. The United States notes that, under Article 7 of the DSU, the Panel may notdecline to address products that are clearly within its terms of reference, but must base its findings on the entirety of the proceeding.36
5.19.
As regards the challenge of defining which soju is referred to, the European Communities states that it regards all the varieties of soju as one product, with the necessary result that 'liqueurs' are more heavily taxed than some soju. According to the European Communities, the question of whether soju is or is not a single product is a substantive issue which cannot be decided by the panel in a preliminary ruling.
5.20.
The United States also argues that with respect to the use of the word "soju," its panel request made it clear that the tax preference for all soju was covered, giving Korea ample objective notice that the entire category was to be challenged. According to the United States, given the major emphasis in Korea's first submission concerning the differences between diluted and distilled soju, it is evident that Korea in fact did have ample notice -- sufficient to structure its entire first submission on the basis of alleged differences in the two kinds of soju.

3. Adequacy of consultations

5.21.
Korea also submits that explicit obligations of the DSU - namely 3.3, 3.7 and 4.5 - have been violated. Korea in effect alleges that the complainants did not engage in consultations in good faith with a view to reaching a mutual solution as envisaged by the DSU.
5.22.
Korea alleges that there was no meaningful exchange of facts because the complainants treated the consultations as a one-sided question and answer session, and therefore, frustrated any reasonable chance for a settlement.
5.23.
Korea considers this non-observance of specific provisions of the DSU as a "violation of the tenets of the WTO dispute settlement system" and requests the Panel for a ruling (no indication is made as to what relief Korea is seeking on this point).
5.24.
Both complainants assert that Korea's claim would appear to be that they have infringed Articles 3.3, 3.7 and 4.5 of the DSU because they did not attempt to reach a mutually acceptable solution to the dispute in the course of the consultations that preceded the establishment of this Panel. They note that at the first meeting with the Panel, Korea asserted that the United States and the European Communities have "ignored":

(i) Article 3.3 of the DSU, which provides that the "prompt settlement of disputes is essential to the effective functioning of the WTO";

(ii) Article 3.7 of the DSU, to the extent it calls for a "mutually acceptable" and "positive" solution; and

(iii) Article 4.5 of the DSU, which states that in the course of consultations, Members should attempt to "obtain satisfactory adjustment" of the matter.

5.25.
The complainants refer to the panel decision in Bananas III in which it was stated

[....] Consultations are, however, a matter reserved for the parties. The DSB is not involved; no panel is involved; and the consultations are held in the absence of the Secretariat. In these circumstances, we are not in a position to evaluate the consultation process in order to determine if it functioned in a particular way. While a mutually agreed solution is to be preferred, in some cases it is not possible for the parties to agree upon one. In those cases, it is our view that the function of the panel is only to ascertain that consultations, if required, were in fact held or, at least, requested.

As to the EC argument that consultations must lead to an adequate explanation of the complainants' case, we cannot agree. Consultations are the first step in the dispute settlement process. While one function of the consultations may be to clarify what the case is about, there is nothing in the DSU that provides that a complainant cannot request a panel unless its case is adequately explained in the consultations. The fulfilment of such a requirement would be difficult, if not impossible for the complainant to demonstrate if a respondent chose to claim a lack of understanding of the case, a result which would undermine the automatic nature of the panel establishment under the DSU. The only per-requisite for requesting a panel is that consultations have 'failed to settle a dispute within 60 days of receipt of the request for consultations... Ultimately, the function of providing notice to a respondent of a complainant's claims and arguments is served by the request for the establishment of a panel and by the complainants' submissions to that panel.37

The complainants point out that Korea cannot dispute the fact that consultations were in fact held on three separate occasions between itself and both the United States and the European Communities.

5.26.
The complainants state that, in any event it is not true that they refused to engage in a 'meaningful exchange of facts' during the GATT Article XXII consultations. They allege that it was Korea's attitude during the consultations which prevented such exchange from taking place.
5.27.
The United States further argues that Korea’s complaints about the alleged inadequacy of the complainants’ attempts to settle the dispute or engage in good faith consultations have no bearing on the authority of the Panel or the progress of this proceeding.
5.28.
The United States asserts that Korea’s assertion that the United States and the European Communities failed to engage in good faith consultations is belied by the record. According to the United States, the three parties to this dispute (Korea, the United States and the European Communities) held consultations on three separate occasions over a six-week period, in which numerous factual and legal issues were discussed, including the fact that the Korean Liquor Law applies to all types of distilled spirits covered by HS 2208. The United States asserts that it presented detailed factual questions to Korea and requested that the answers be provided in writing. According to the United States, Korea refused to reply in writing but did agree to provide oral answers. The United States also states that Korea acknowledged that it was in possession of a market study commissioned by Korean producers of distilled spirits, but declined to provide a copy.
5.29.
The United States asserts that with the European Communities, it requested Korean data for 1990-1996 on all distilled spirits under HS heading 2208, by both volume and value, Korea initially stated at the 24 June consultation that it would try to provide this information. According to the United States, however, during the consultations held on 8 August 1997, the Korean delegation refused to provide copies of this information, stating that it was only for the use of its private lawyers for defensive purposes in the event a panel proceeding was initiated.
5.30.
The United States, therefore, believes that these events make all the more baffling Korea’s request for a procedural ruling, given that the United States failed to obtain sufficient factual information from Korea.

4. Confidentiality

5.31.
Korea alleges that both complainants breach the confidentiality requirement of Article 4.6 of the DSU by making reference, in their submissions, to information supplied by Korea during consultations.
5.32.
The European Communities argues that Korea's interpretation of Article 4.6 of the DSU is wrong. According to the European Communities, the confidentiality requirement of Article 4.6 of the DSU concerns parties not involved in the dispute and the public in general. The European Communities stresses that the requirement cannot in any way be read as referring to the panel itself. In the EC view, Article 4.6 cannot be interpreted as a limitation on the rights of parties at the panel stage.
5.33.
It is also the EC view that, if the interpretation by Korea of Article 4.6 were correct, it is Korea which has violated Article 4.6 of the DSU by making extensive reference to the consultations in support of its claim under Article 3.3, 3.7, and 4.5 of the DSU.
5.34.
The European Communities concludes that it is not the purpose of Article 4.6 of the DSU to limit the possibilities available to a panel to be apprised of information on the dispute before it. In the EC's view, there can be no 'artificial wall' between the consultation and the panel proceeding through which the transfer of information is blocked.
5.35.
The United States considers that Korea's claim concerning a breach of confidentiality in the U.S. and EC submission is unclear concerning the relief it requests. to the extent it alleges a violation of the DSU, such a claim is not within the panel's terms of reference. Moreover, according to the Untied States, the citation in a footnote in the first U.S. submission cited by Korea attempted to highlight a factual issue concerning which there was confusion in the Korean law, a point that was rectified by the first submission and is of no consequence as a factual or legal matter.

B. PANEL AND APPELLATE BODY REPORTS ON JAPAN - TAXES ON ALCOHOLIC BEVERAGES

1. Complainants

5.36.
According to the European Communities, the Korean liquor tax system at issue in this dispute is very similar to the system in place in Japan until very recently. The European Communities argues that, like Korea in the instant situation, Japan applied a much lower rate to shochu (a local distilled liquor which, the European Communities consider is "like" Korean soju) than to "western-style" distilled spirits and liqueurs which are "like" or "directly competitive or substitutable" with shochu.
5.37.
The European Communities notes that the Japanese liquor tax system was found to violate Article III:2 of GATT by the 1987 Panel Report on Japan - Customs Duties, Taxes and Labelling Practices on Imported Wines and Alcoholic Beverages38(Japan - Taxes on Alcoholic Beverages I) and again by the 1996 Panel and Appellate Body Reports on Japan - Taxes on Alcoholic Beverages39 (Japan - Taxes on Alcoholic Beverages II).
5.38.
The European Communities concedes that, in accordance with the Panels' terms of reference, that finding was limited to the Japanese market. In the EC view, however, this does not mean that it is irrelevant to the present dispute. The EC view is that although there may still subsist superficial differences between the Japanese and the Korean market, the underlying dynamics of both markets are very similar. According to the European Communities, there is no good reason why the findings made by prior Panels with respect to the Japanese market should not be considered as pertinent in the present dispute.
5.39.
The United States argues that the Korean liquor tax system at issue in this dispute is very similar to the system in place in Japan until very recently. The United States further argues that like Korea, Japan has long protected shochu, a local distilled liquor which, in its pure form, is identical to Korean soju. According to the United States, until recently, Japan applied a much lower tax rate to shochu than to other categories of Western distilled spirits that ‑are "like" or "directly competitive or substitutable with" shochu. The United States alleges that the structure of its law is remarkably similar to the Korea tax law, including a broad definition for shochu from which beverages such as those using a birch filter (i.e., vodka) are arbitrarily excepted.
5.40.
According to the complainants, the main difference between the Korean liquor tax system and the Japanese system is that in the Korean system the taxes take the form of an ad valorem duty whereas Japan applied specific taxes. In the complainants view, for the purposes of this dispute, however, this has the consequence only of rendering even more transparent the protective effects of the Korean system as compared to those of the Japanese system. According to the complainants, in Japan - Taxes on Alcoholic Beverages II,40 Japan's main line of defence was that while the rates on shochu were lower, the "tax/price ratios" (i.e. the tax burden expressed as a percentage of the retail price) for all categories were "roughly the same". In the complainants view, in the present case, since the taxes are ad valorem, Japan's attempted defence is not available to Korea.
5.41.
The European Communities states that during the consultations Korea claimed, although without providing any supporting evidence, that current consumption patterns in Korea differ from consumption patterns in Japan. According to the European Communities, even if the alleged differences were proved to be significant, they would merely reflect the fact that western-style liquors became a mass product in Japan earlier than in Korea, to a large extent as a result of an earlier liberalisation of imports.
5.42.
The European Communities further argues that the Korean market has no inherent or permanent characteristic which makes it so different from the Japanese market as to warrant the conclusion that the very same liquors which were found to be "substitutable and competitive" on the Japanese market in 1987 and 1996 cannot be regarded as such in Korea. To the contrary, the EC argument goes, the current Korean market for distilled sprits and liqueurs is in many ways reminiscent of the Japanese market in the early eighties.
5.43.
The European Communities argues that, as in Japan one decade before, since the early nineties an increase in the levels of disposable income, coupled with the lifting of import quotas and a reduction in the applicable tariffs and internal taxes, have led to a spectacular increase in sales of western-style liquors on the Korean market, and in particular of whisky.
5.44.
According to the European Communities, Korean consumers, like their Japanese neighbours, at first perceived western-style liquors as "luxury" items to be offered as gifts or to be consumed only on special occasions and at special places. Over time, however, the argument goes, there has been, both in Japan and in Korea, a clear trend towards lower prices, greater availability in all sales channels, and consumption patterns which are more similar to those of the "traditional" local liquor.
5.45.
The European Communities further states that there has also been a trend towards the "internationalisation" of the local liquors, which in Korea is illustrated by the recent emergence of the premium soju segment and in Japan by the proliferation of whisky-like and vodka-like shochus. The result of these two converging trends is an ever increasing degree of competition between shochu/soju and western-style liquors.
5.46.
The European Communities concludes, that given the close resemblance between the Korean liquor tax system and the Japanese measures at issue in Japan - Taxes on Alcoholic Beverages I and II, the Panel and Appellate Body reports adopted in those disputes are particularly relevant and should provide decisive guidance to this Panel. It is submitted by the European Communities, in particular, that the findings of those two Panels and of the Appellate Body to the effect that vodka and shochu/soju are "like" products and that shochu/soju and all other distilled spirits and liqueurs are "substitutable" and "competitive" products, are equally relevant for this dispute.
5.47.
The United States also takes the position that the development of the distilled spirits markets in Japan and Korea are very similar. According to the United States, since the early 1990's an increase in the levels of disposable income, coupled with the lifting of the import restrictions and a reduction in the applicable tariffs and internal taxes, have led to a spectacular increase in sales of Western-style spirits on the Korean market, in particular whisky.
5.48.
The United States further asserts that, like their Japanese neighbours, Korean consumers at first perceived Western-style liquors as "luxury" items to be offered as gifts or to be consumed only on special occasions and at special places. Over time, however, there has been, both in Japan and in Korea, a clear trend towards consumption of all types of distilled spirits on more and varied occasions, and in different methods of consumption, i.e. in mixed drinks, warm, cold, etc. According to the United States, the expanding methods and venues of consumption have also been aided by greater availability of all types of spirits in all sales channels.
5.49.
According to the United States, the result of expanded purposes for spirits, and the burgeoning styles of soju is an ever increasing degree of competition between soju and Western-style liquors. Those trends are converging in Korea, as in Japan.
5.50.
The United States also concludes that the close similarity between the Korean liquor tax system and the Japanese measures at issue in the recent WTO/GATT disputes make the Panel and Appellate Body findings in that case very pertinent to this Panel’s examination of Korean tax measures. In particular, the United States argues that the findings of those two panels and of the Appellate Body to the effect that vodka and shochu/soju are "like" products and that shochu/soju and all other distilled spirits are directly competitive or substitutable products are especially relevant for this dispute.

2. Korea

5.51.
Korea notes that both the United States and the European Communities demonstrate the desire simply to superimpose the results of the 1996 Japan ‑ Taxes on Alcoholic Beverages Panel on this case. In Korea's view, the complainants attempt to equate Japan and Korea, their markets, and the products at issue. According to Korea, they do so by asserting that soju and shochu are 'identical’, and that the 'underlying dynamics of both [the Japanese and Korean] markets are very similar’, save some 'superficial differences’. Korea argues that this approach is not compatible with Article III:2 GATT.
5.52.
Korea argues that Korean soju is not identical to Japanese shochu, irrespective of statements made in the context of the Japan case, to which Korea was not a party. Korea cites the example from the complainants to say that Korean companies are exporting soju to Japan. According to Korea, when Korean soju is exported to Japan, it is destined for the Korean community in Japan,41 and sold in Korean stores and restaurants. However, argues Korea, Korean producers exporting to Japan are primarily aiming to capture Japanese consumers. For this purpose, they export a different product, a sort of 'Korean shochu’. These two products are taxed differently under the Japanese liquor tax law. Korea adds that 'Korean shochu’ is not sold in Korea.
5.53.
Korea further argues that despite the complainants’ contentions, the Korean case is not a 'mirror image’ of the Japanese case, and Korea will not entertain arguments in that vein. Korea argues that it need only point to the Japan - Taxes on Alcoholic BeveragesII Panel report itself, which repeatedly stresses that an Article III examination must be carried out on a 'case‑by‑case basis’,42 noting in particular that 'consumers’ tastes and habits... change from country to country’.43
5.54.
Korea acknowledges that the Japan - Taxes on Alcoholic BeveragesII case sets forth the legal framework for the application and interpretation of Article III of GATT. Korea accepts that it will follow that framework in its analysis, but adds that when these legal rules are applied to the facts of this case, the result is completely different than under the dissimilar set of facts of the Japanese case.

Korea and Japan: differences between their products and markets

5.55.
According to Korea, the first noticeable difference between soju and shochu is taste. Korea argues that Japanese shochu has a neutral taste compared to Korean soju, which is sweeter.44 Consumers easily recognise that taste difference; Koreans prefer soju and will not accept shochu as a substitute; the Japanese feel the same way about shochu.
5.56.
Secondly, according to Korea, soju is allegedly only drunk straight at a cold temperature. In Japan, on the other hand, different consumption patterns exist for the consumption of shochu: one can drink it straight or mixed with warm or cold water.45
5.57.
Korea argues that these differences are so important that Korean companies attempting to sell Korean soju in Japan have had to make a special product to appeal to the Japanese consumer. As an example Korea refers to the Korean company Jinro, which sells two products on the Japanese market, Jinro Gold and Jinro Export. According to Korea, the first product is exported to Japan in very small quantities (32 kl in 1997) with the primary purpose of targeting the Korean residents in Japan. This brand is only distributed to Korean restaurants and Korean supermarkets in Japan. The second brand, Jinro Export, targets Japanese consumers and represents the bulk of Jinro's exports to Japan (27 182 kl in 1997).46 Korea argues that it is made to suit the Japanese taste,47 sold in differently shaped bottles,48 at much higher prices,49 and is not available on the Korean market.
5.58.
Korea also alludes to the EC contention that in Japan, soju is considered for tax purposes as being the same product as local 'shochu’, which Korea argues is incorrect. According to Korea, when Korean standard soju (such as Jinro Gold) is exported to Japan, it is treated as a 'spirit’ for tax purposes. Only the specially‑produced 'Korean shochu’, such as Jinro Export, is treated like Japanese shochu by the Japanese tax authorities. The tax rate for Korean standard soju exports is higher than for 'Korean shochu' exports.50
5.59.
Korea also argues that there are notable differences in the way shochu is marketed in Japan and the way that standard soju and distilled soju are marketed in Korea. Shochu is marketed more like western‑type liquors that can be drunk as cocktails.
5.60.
Korea further argues that Japanese shochu producers even make a shochu A (the standard version) that is aged and is brown in colour, and they make an effort to convince consumers that there are a plethora of similarities between brown shochu and whisky. Korea states for example, that the leading brand of brown shochu A in Japan, Takara Legend, closely resembles whisky in colour and packaging. Korea also asserts that in Korea, it is legally prohibited to add colour to standard soju.51
5.61.
Korea contends that another important difference is the pricing structure of the Japanese market. Shochu B (the distilled version) and shochu A are similarly priced, and are selling in comparable volumes. This contrasts to the Korean soju market in which distilled soju is selling in much smaller volumes and at much higher prices than standard soju. According to Korea, in the Japanese shochu market, shochu A and shochu B have comparable market shares, whereas in the Korean market distilled soju takes up 0.2% of the soju market and standard soju takes up 99.8% of the market.
5.62.
Korea notes that as the European Communities argued in the Japan - Taxes on Alcoholic Beverages II case, the prices of imported liquors and Japanese shochu were within a relatively short range, with the tax removed.52 Korea further notes that in contrast, as the EC experts have recognised in this case, the pre‑tax prices for imported liquors in Korea are much higher than the prices for standard soju.53
5.63.
In its rebuttal submissions, the European Communities argues that Korea is understandably anxious to escape the clear implications for this dispute of the Panel Report on Japan ‑ Taxes on Alcoholic Beverages I,54 and the Panel and Appellate Body Reports on Japan ‑ Taxes on Alcoholic Beverages II.55 The EC view is that Korea unjustly accuses it of trying to apply mechanically the conclusions of those reports to the present case. According to the European Communities, that is an obvious misrepresentation of its position.
5.64.
According to the European Communities, the present dispute must be determined on its own merits. The EC view, however, is that this Panel must take into account any adopted Panel and Appellate Body reports which are relevant to this dispute. The European Communities refers to the Appellate Body decision in Japan ‑ Taxes on Alcoholic Beverages II, wherein it was stated:

Adopted Panel reports are an important part of the GATT acquis. They are often considered by subsequent Panels. They create legitimate expectations among members, and, therefore should be taken into account where they are relevant to any dispute.56

5.65.
The EC position is that it has demonstrated that the two Panel reports and the Appellate Body report on Japan ‑ Taxes on Alcoholic BeveragesII are particularly relevant for the present dispute because:

(a) the tax measures are very similar;

(b) the products concerned are the same; and

(c) there is no fundamental difference between the Japanese market and the Korean market.

The European Communities argues that Korea fails to refute any of those similarities.

5.66.
In its rebuttal submission, the United States recalls that its first submission cited the reports of the WTO panel and Appellate Body in the Japan- Alcoholic BeveragesII case as setting forth the applicable legal standards and factual findings concerning a market, tax measures and products that are identical or analogous to those presented in this dispute. The United States argues that it has not called for a "mechanical" application of the analysis of the Japanese market to the Korean market, as suggested by Korea.57
5.67.
According to the United States, it is well established that the issue of what is a "like" or "directly competitive or substitutable" product for purposes of Article III:2 must be determined on a case-by-case basis on its own merits. However, in the US view, given the similarities of the tax measures and products involved in the Japanese and Korean markets, this Panel should consider that the conclusions of the panel concerning the products, measures, and extent of competition in the Japanese market can also be reasonably drawn with respect to the facts presented here.
5.68.
The United States notes that Korea has contested any similarities between soju and shochu, and between the Korean and Japanese markets and disputes the US point that soju and shochu are "identical." According to the United States, while Korea understandably is entitled to dispute the point, the source for the point made by the United States was the government of Japan, which in Japan - Taxes on Alcoholic BeveragesII stated that, "Essentially shochu and soju are identical products."58 With respect to the fundamental similar qualities of the product, Japan noted that:

These [shochu/soju] products have the following common three features: First, they use grains or potatoes as the base material, which is readily available at low cost in this part of the world. Second, they have a relatively low alcoholic strength.... Third, they are consumed directly after distillation. They do not normally undergo further post-distillation processing.59

5.69.
According to the United States, as the largest importer of Korean soju (Korean imports account for 8 percent of Japan’s shochu A market), Japan would appear to be reasonably authoritative regarding the objective characteristics of the products.
5.70.
The United States further argues that, even using the marketplace approach, the similarities between the present Korean market and the Japanese market make the Japan panel’s findings analogous for purposes of this proceeding. In the US view, in both markets, Western distilled spirits are more expensive and considered premium types of spirits compared to local shochu/soju, and in both markets Western spirits are used for gift-giving more frequently than the local product, although in this dispute, Korea has characterized distilled soju as uniquely suited to gift-giving. The marketplace reacted similarly in Japan and Korea, as consumption of Western spirits increased with the lifting of trade barriers and the narrowing of tax disparities. The United States notes for instance, that US exports of Bourbon to Japan have increased from 6.3 million litres in 1987 to 12.2 million litres in 1997 due to 1989 reforms in the Japanese liquor tax, and US exports of distilled spirits to Korea increased from 170,000 litres in 1990 to 644,000 litres in 1996 following the removal of quota restrictions on bottled imported spirits.
5.71.
The United States also notes that the evolution of the marketplace in Korea and Japan also bears great similarity. Only a decade ago, Japanese "izakayas" (the Japanese equivalent of traditional Korean restaurants) used to serve only shochu, sake and beer, whereas western style "snack bars" would serve western distilled spirits, but not shochu. Today, shochu and western distilled spirits are usually available at both the "izakayas" and "snack bars." Korea is beginning to resemble the Japanese market of today, with increasing availability of western spirits in traditional, casual Korean restaurants and bars. According to the United States, Korea’s greater constraint of choice of distilled spirits availability in various bar and restaurant venues bears a closer resemblance to Japan before its last round of market liberalization in 1989.
5.72.
The United states notes that the marketplace does reveal some differences between Korea and Japan. The market for Western spirits in Korea is predominantly served by one type of imported spirit (whisky), while Japan has matured into a market for many types of imported spirits, with the most recent spirit to become popular being tequila. According to the United States, Korean consumption patterns are much more fixed in traditional, family-type restaurants than in Japan, where a wider range of distilled spirits is consumed. However, most of these differences between shochu/soju consumption in Korea and Japan are a function of market maturity and evolution of drinking tastes and styles.
5.73.
The United States further states that Korea has conceded that it classifies both soju and shochu in the same HS classification at the eight-digit level -- item 2208.90.40. The fact that Korean manufacturers may export two kinds of soju to Japan (namely, Jinro Gold and Jinro Export) does not make these products any less similar. It is common for companies to modestly differentiate their products in order to meet the needs of different sets of consumers -- one version for expatriates and another, seasoned differently, to meet local tastes and customs. Korean manufacturers do the same when they market two versions of soju in Japan. In fact the differences in the two kinds of soju exports probably reflect Japanese laws and cost considerations more than anything else. Most of the additives in Korean soju are sweeteners with varying thickening qualities (fructose, oligosaccharide and stevioside) -- functions served by sugar in the version for Japanese consumers. Most importantly though, these are clearly additives, as opposed to ingredients. Liquor laws around the world, including Korea’s, recognize the distinction by placing a limit on the percentage of sugar that may be added to a distilled spirit (on the order of 2 percent), after which it becomes yet another competitive product, a liqueur. At the same time, there is no requirement in Korean law to use any sweetener at all in soju, thus making it possible for soju to contain no additives at all. Korea also classifies soju and shochu identically for both tax and tariff purposes.
5.74.
Furthermore, according to the United States, Korea’s reliance on differences in the additives between shochu and soju as establishing that they are fundamentally different is contradicted by its description of premium soju. Even though premium soju differs from standard soju by its additives, such as honey, Korea states that premium soju is "only an upgraded version of standard soju." Why are differences in additives critical in the context of vodka and shochu, but irrelevant with respect to premium and standard soju? Clearly, Korea’s conclusion concerning premium soju is the legally correct one: such additives should not be decisive in examining these products under Article III.

C. THE BURDEN OF PROOF

1. Korea

5.75.
Korea proceeds from the premise that to prove a violation of the first sentence of Article III:2, the Appellate Body in the Japanese Liquor Taxes case clearly stated that there are two limbs that must be proved by the complainant. First the complainants must prove that the products concerned are in fact 'like’. Secondly, the complainants must prove that the imported product was taxed in excess of the domestic 'like’ product.
5.76.
According to Korea, regarding Article III:2 second sentence, the complainants must prove three things: first, that the imported and domestic products are directly competitive and substitutable products, second, that foreign products are subject to tax differentials that are more than 'de minimis', and third that tax was applied 'so as to afford protection’ to domestic production.
5.77.
Korea further argues that under both the first sentence and second sentence, the obligation rests on the complainant to prove all the requirements of the respective sentences. In Korea's view, this burden cannot be discharged by making inadmissible analogies to another case and another set of facts. Korea emphasizes that the burden must be discharged with regard to the facts of the case at hand.
5.78.
According to Korea, the Panel can make no ruling about the tax rates of all products falling under HS 2208 in the abstract. Therefore, the complainants must prove, on a product‑by‑product basis, that the products at issue are directly competitive or substitutable, or even 'like’, products.
5.79.
Korea points out that the complainants have only submitted evidence regarding a limited number of imported alcoholic drinks falling under HS 2208: whisky, brandy, vodka, gin, and rum. They have also mentioned by name a few other, though by no means all, alcoholic beverages (liqueurs, tequila, ad mixtures, koryangju, Japanese shochu) covered by HS 2208, without providing an intelligible argument or evidence in their regard.60 In Korea's view, the complainants have not met their burden of proving that these are 'like', or directly competitive or substitutable products with the Korean sojus.
5.80.
Korea submits that the complainants' principal and theoretical argument that all distilled spirits necessarily compete everywhere in the world, because of some similarities in physical characteristics and end use, runs counter to the controlling precedent. This precedent, Japan – Taxes on Alcoholic Beverages II, clearly requires a concrete market analysis. Furthermore, to the extent the complainants have analysed the Korean market, this analysis is demonstrably poor. Accordingly, the complainants have not met their burden of proof; and they cannot meet their burden by quibbling with Korea's positions.
5.81.
Korea submits that it is not up to Korea to prove that the western-style liquors are not DCSP or 'like' any of the Korean sojus. It is up to the complainants to show that they are. Korea does not need to prove that there is no cross-elasticity of demand. In Korea's view, the complainants brought this case; they ought to carry their burden of proving that such cross-elasticities exist. All Korea has to do is rebut the proof brought by the complainants.61
5.82.
Korea further argues that there is not much evidence in the complainants’ documents. According to Korea, the complainants make many assertions without any attempt at evidence. Korea further argues that, absent an intelligible argument and supporting evidence, Korea has had no way to defend itself so that this part of the complaint also infringes a fundamental principle of due process.62
5.83.
Korea therefore submits that the Panel should reject any such broad‑ranging complaints out of hand.

2. Complainants

5.84.
The European communities notes that Korea alleges that it has only submitted evidence regarding a limited number of imported alcoholic beverages (namely whisky, brandy, vodka, gin and rum) and claims that the Panel should reject the EC complaint as far as other distilled spirits falling within HS 2280 are concerned.
5.85.
According to the European Communities, Korea’s claim is factually wrong. In the EC view, Korea appears to have derived its list of products from Annex 9 of the EC submission, yet that Annex is by no means the only piece of evidence submitted by the EC in this case. Other pieces of evidence submitted by the European Communities allegedly do cover specifically other types of distilled spirits.
5.86.
In particular, the European Communities takes issue with the proposition that, in order to meet its burden of proof in this case, it is required to provide specific evidence with respect to each and every single type of distilled liquor falling within HS 2208.
5.87.
The European Communities refers to Korea's assertion that, "if one travels around the world, one will encounter a seemingly infinite variety of alcoholic beverages." In the EC view, even a much shorter trip within the borders of the EC would suffice to convince the Panel of the large variety of distilled spirits produced in the EC.
5.88.
According to the European Communities, had the EC submitted specific evidence with regard to each and every known type of distilled spirit manufactured in the European Communities, the Panel would have been unnecessarily overburdened. Further, the EC view is also that in some cases it would have been materially impossible to gather such evidence. The European Communities refers to one of the criticisms levelled by Korea against the Dodwell study, that the respondents may have been confused by an allegedly too complex set of questions. What, asks the European Communities, if the respondents had been asked to look at the prices of forty or fifty different types of western distilled spirits instead of just seven?
5.89.
The European Communities reiterates that all distilled spirits are produced according to the same method and, as a result, share the same basic physical characteristics. The European Communities states that the distilled spirits for which it has submitted specific evidence are those traded in largest volumes, both between the European Communities and Korea, and globally. They are allegedly representative of the full spectrum of distilled spirits. According to the European Communities, there is virtually no distilled spirit whose production process and physical characteristics do not resemble closely those of at least one of the spirits for which the EC has provided specific evidence.
5.90.
The European Communities concludes, therefore, that if the Panel found, as it should, that those spirits for which specific evidence has been submitted are "directly competitive and substitutable" with soju, it should infer that all other distilled spirits falling within HS 2208 also are "directly competitive and substitutable" with soju.
5.91.
According to the European Communities, this approach has been endorsed by the Appellate Body in Japan ‑ Taxes on Alcoholic Beverages II. In that case, the complainants claimed that shochu was "directly competitive or substitutable" with all other distilled spirits falling within HS 2208. Nevertheless, like the complainants in this case, they submitted specific evidence only with respect to a limited number of representative spirits. The Panel concluded that only certain spirits falling within HS 2208 were "directly competitive or substitutable" with shochu.63 According to the European Communities, on appeal, this finding was reversed by the Appellate Body which ruled that the Panel’s failure to incorporate in its conclusions all the liquors falling within its terms of reference (i.e. all distilled spirits falling within 2208) was an error of law.64
5.92.
The United States noted Korea’s claim that product-specific evidence must be submitted for every conceivable type of distilled spirit classified under Heading 2208. The United States clarified that the Dodwell study covered the full spectrum of distilled spirits in this dispute and those currently being exported by the United States. While there may be other products of importance, such as pre-mixed cocktails and admixtures, these are only variations of the products employed in the Dodwell study. There is no distilled spirit produced in the United States that is not akin to those employed in the Dodwell study.
5.93.
More importantly, argues the United States, given the fundamental similarities between all distilled spirits, it is not necessary to provide specific evidence, even less a market study, for every conceivable product that might fall within HS heading 2208. The products are all fairly highly concentrated forms of distilled alcohol consumed for socialization and relaxation, and all markets recognize them as being in competition. The Korean measures themselves group these products together in the same law, mostly as exceptions to soju. In the Korean tax law, to the extent the Western spirits are not designated in specific categories such as whiskey and brandy, most are lumped in the general category of "general distilled spirits,"65 with the same tax rate. Given Korea’s own recognition of the similarities of the products, and the other evidence presented in this dispute that the products in the Dodwell study are directly competitive or substitutable with soju, it is reasonable to conclude that all imported distilled spirits are equally so. The Appellate Body in the Japan case took precisely this approach. In the Japan case, the panel had not included all products within HS heading 2208 in its findings under Article III:2, second sentence, having specified only whisky, brandy, rum, gin and liqueurs.66 The Appellate Body found the limited finding was in error and modified it to include all distilled spirits in HS 2208.67

D. ARTICLE III ARGUMENTS

1. Complainants

5.94.
In this sub-section, the arguments of the European Communities and the United states are combined as the arguments of the "complainants".

(a) GATT Article III:2, first sentence

i) General

5.95.
The complainants draw the attention of the Panel to GATT Article III:2, first sentence, which provides that:

"The products of the territory of any contracting party imported into the territory of any other contracting party shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly to like domestic products"

5.96.
The complainants state that as confirmed by the Appellate Body in Japan - Taxes on Alcoholic Beverages II,68 in order to establish whether an internal tax is applied in violation of Article III:2, first sentence, it is necessary to make two determinations:

(i) whether the taxed imported and domestic products are "like"; and

(ii) whether the taxes applied to the imported products are "in excess of" those applied to the like domestic products.

5.97.
According to the complainants, before making those two determinations, it must be ascertained whether the taxes in question constitute an "internal tax".
5.98.
The complainants refer to the decision by the Appellate Body in Japan - Taxes on Alcoholic Beverages II, wherein the Appellate Body stated that the general principle contained in Article III:1 informs also the first sentence of Article III:2. Nevertheless, in order to establish a violation of Article III:2, first sentence, it is not necessary to show that the measure at issue is applied "so as to afford protection to domestic production" separately from the above requirements.69

ii) The Liquor Tax and the Education Tax are "internal taxes"

5.99.
The complainants state that the Liquor Tax and the Education Tax are levied on all distilled spirits and liqueurs intended for consumption in Korea, whether locally manufactured or imported, and not just "on" or "in connection" with the importation of distilled spirits and liqueurs. Accordingly, in the EC view, they constitute "internal taxes" in terms of GATT Article III:2, and not "import charges" within the purview of GATT Articles II and VIII.

iii) Vodka is "like" soju

5.100.
The complainants state that GATT does not define the notion of "like product". According to the complainants, the approach followed by previous Panels has been to examine whether products are "like" on a case-by-case basis in light of factors such as the physical characteristics of the products concerned, their end uses and their customs classification. This approach was endorsed expressly by the Appellate Body in Japan - Taxes on Alcoholic Beverages II70 and in Canada - Certain Measures Concerning Periodicals.71
5.101.
The complainants note that in the same reports the Appellate Body held that the terms "like products" should be construed "narrowly" for the purposes of Article III:2, first sentence72. The complainants further notes that "like" products need not be identical in all respects73. Thus, it has been established by a previous Panel that in the case of alcoholic beverages:

[m]inor differences in taste, colour and other properties (including different alcohol contents) do not prevent products from qualifying as like products.74

5.102.
The complainants take the position that in this instance, vodka and soju are "like" products because they have the same physical characteristics and, consequently, are objectively apt to serve identical end uses. Furthermore, according to the complainants, Korean soju is the same liquor as Japanese shochu, which has already been found by the two Panels on Japan - Taxes on Alcoholic Beverages to be "like" vodka.

(a)Soju and vodka have virtually the same physical characteristics and, therefore, serve for the same end uses

5.103.
According to the complainants, the essential characteristics of vodka and soju can be summarised as follows:

Table 3

VodkaDistilled sojuDiluted soju

Raw materials Potatoes, grains Potatoes, grains Neutral spirits

Neutral spirits

Process Continuous Pot Still Continuous

Distillation distillation distillation Charcoal filtration excluded

Usual bottling strength 37.5-40% ABV 40-45% ABV 20-30% ABV

Appearance Clear Clear Clear

5.104.
According to the complainants, from the above table, it emerges that the main differences between soju and vodka are confined to the following:

(i) diluted soju is usually bottled at an alcoholic strength of 25 % ABV whereas vodka is sold at 37.5%-40% ABV

(ii) unlike vodka, distilled soju is obtained by non-continuous distillation and cannot be filtered through white birch charcoal, although it can be filtered through any other materials.

5.105.
At the request of the EC industry, the Scotch Whisky Research Institute has conducted a series of analyses on a sample of well known brands of soju and vodka, which prove that the manufacturing processes and the physical characteristics of the two liquors are nearly identical75 According to the European Communities the analyses indicate that:

(i) all the sampled brands had been fermented from similar carbohydrate sources;

(ii) all of them had been distilled to concentrate alcohols;

(iii) none had been matured in wood post-distillation;

(iv) none contained significant levels of residue;

(v) none had significant levels of obscuration;

(vi) the major volatile congeners were at similar levels in vodka and diluted soju. They are only marginally higher in distilled soju; and

(vii) all contained similar levels of methanol.

(b) The differences between vodka and soju are the same as between vodka and Japanese shochu

5.106.
According to the complainants, the differences between vodka and soju are clearly minor and do not prevent soju and vodka from being "like" products. In the EC view, the existence of the very same differences between vodka and Japanese shochu did not prevent the two Panels on Japan - Taxes on Alcoholic Beverages from reaching the conclusion that those two liquors were "like" in the sense of Article III:2, first sentence.
5.107.
The complainants state that the average alcoholic strength of shochu A is, as that of Korean diluted soju, around 25%. In spite of that, notes the complainants, the two Panel Reports on Japan - Taxes on Alcoholic Beverages concluded that shochu A was like vodka. The Panel Report on Japan - Taxes on Alcoholic Beverages II noted in this regard that:

"... a difference in the physical characteristics of alcoholic strength of two products did not preclude a finding of likeness especially since alcoholic beverages are often drunk in the diluted form..."76

5.108.
The complainants further note that like distilled soju, both shochu B and shochu A may not, by law, be filtered through white birch charcoal. In addition, the complainants note that the Japanese Liquor Tax Law requires that shochu B must be obtained through discontinuous distillation. In the EC view, however, these differences were not an obstacle for the Panel Report on Japan - Taxes on Alcoholic Beverages II to conclude that both types of shochu were like vodka.

(c) Korean soju is treated as shochu in Japan

5.109.
As mentioned above, Korean soju is exported in large quantities to Japan, where it is treated for all purposes as being the same product as shochu. Diluted soju corresponds to Japanese shochu A, whereas distilled soju is the equivalent to Japanese shochu B.
5.110.
The complainants note that in Japan - Taxes on Alcoholic Beverages II, the Japanese Government stated that:

"... the largest producer of shochu is either the Republic of Korea or the People's Republic of China... the liquor tax legislation of the Republic of Korea defines soju in two sub-categories of 'diluted soju', which is equivalent to shochu A, and 'distilled soju', which is equivalent to shochu B, in a manner similar to Japan's definition. Essentially, shochu and soju are identical products77."

5.111.
The complainants further note that in response to these claims, the Panel "accepted the evidence submitted by Japan according to which a shochu-like product is produced in various countries outside Japan, including the Republic of Korea..."78 In the US view, the similarities in the way Japanese shochu and Korean soju are advertised further confirm the "equivalence" of these products.
5.112.
The complainants conclude that the "likeness" of soju and shochu is further confirmed by the results of the analytical tests conducted by the Scotch Whisky Research Institute.79

iv) Imported vodka is taxed "in excess of" soju

5.113.
The complainants argue that the prohibition of discriminatory taxes in Article III:2, first sentence, is not conditional on a trade effects test nor is it qualified by a de minimis standard80. The complainants refer to the Appellate Body in Japan -Taxes on Alcoholic Beverages II, which stated that "even the smallest amount of 'excess' is too much"81.
5.114.
The Table below is presented by the complainants purportedly to summarise the differences in taxation between vodka and soju. It purportedly indicates that both the Liquor Tax and the Education Tax are applied to vodka at a much higher rate than to diluted soju and distilled soju. In all, the combined tax rate applied on vodka is 1.9 times higher than the combined rate on distilled soju and 2.7 times higher than the combined tax rate on diluted soju.

Table 4

Comparison of the tax rates on soju and vodka

Liquor TaxEducation TaxCombined Tax RateDiscrimination Index

(As % of Liquor

Tax Base)

Diluted soju 35 % 3.5 % 38.5 % 1.00

Distilled soju 50 % 5 % 55 % 1.43/1.00

Vodka 80 % 24 % 104 % 2.70/1.89

5.115.
The complainants conclude that it is indisputable that the taxes applied to imported vodka pursuant to both the Liquor Tax Law and the Education Tax Law are "in excess of" those applied to soju.

(b) GATT Article III:2, second sentence

i) General

5.116.
The complainants note that GATT Article III:2, second sentence, reads as follows:

[M]oreover, no contracting party shall otherwise apply internal taxes or other internal charges to imported or domestic products in a manner contrary to the principles set forth in paragraph I.

5.117.
The complainants further note that GATT Article III:1 provides in relevant part that:

The contracting parties recognise that internal taxes.... should not be applied to imported or domestic products so as to afford protection to domestic production.

5.118.
The complainants further note that the Interpretative Note to Article III:2 states that:

A tax conforming to the requirements of the first sentence of paragraph 2 would be considered to be inconsistent with the provisions of the second sentence only in cases where competition was involved between, on the one hand, the taxed product and, on the other hand, a directly competitive or substitutable product which was not similarly taxed.

5.119.
According to the complainants, in Japan - Taxes on Alcoholic Beverages II,82 the Appellate Body confirmed that in order to determine whether an internal tax measure is inconsistent with Article III:2, second sentence it is necessary to address the following three issues:

(i) whether the imported products and the domestic products are "directly competitive or substitutable products" which are in competition with each other;

(ii) whether the directly competitive or substitutable imported and domestic products are "not similarly taxed"; and

(iii) whether the dissimilar taxation of the directly competitive or substitutable imported products is "applied... so as to afford protection to domestic production".

5.120.
The European Communities in particular note that, in addition, it must be determined whether the measures at issue are "internal taxes". As already discussed above in connection with the application of Article III:2, first sentence, both the Liquor Tax and the Education Tax are internal taxes within the meaning of Article III:2, rather than import charges within the purview of GATT Articles II and VIII. That conclusion, in the complainants' view, is equally valid for the purposes of applying Article III:2, second sentence.

ii) Soju and all other distilled spirits and liqueurs are competitive and substitutable products

5.121.
According to the complainants, in Japan - Taxes on Alcoholic Beverages II, the Appellate Body stated that a determination whether two products are "competitive or substitutable" must be made on a case-by-case basis and in light of "all the relevant facts in that case".83
5.122.
The complainants further argue that in the same report, the Appellate Body found that in deciding whether two products are directly competitive or substitutable, it may be appropriate to look not only at such matters as physical characteristics, end uses and customs classification but also "at competition in the relevant markets".84 In doing so, it is appropriate, according to the Appellate Body, to examine the "elasticity of substitution".85
5.123.
The complainants argue that it is important to note that Article III:2, second sentence is concerned not only with differences in taxation between products which are actually competitive on a given relevant market but also with differences in taxation between products which are potentially competitive. Indeed, according to the complainants, whereas consumer tastes and habits may differ from one market to another, tax measures should not be used to "freeze" consumers' preference for a domestic product. For that reason, the complainants argue, evidence that two products are not competing actually in a market at a given point in time is not a defense if the absence of actual competition is due, at least in part, to the tax measures in dispute.86

(a) Soju and all other distilled spirits and liqueurs have the same basic physical characteristics and are apt for the same end uses

5.124.
The complainants argue that the notion of "directly competitive and substitutable" products is broader in scope than that of "like" products. According to the complainants, two products which are too "different" in terms of physical properties or of end uses to qualify as "like" for the purposes of Article III:2, first sentence, may still be "competitive or substitutable" in the sense of Article III:2, second sentence. The complainants note that as recently recalled by the Appellate Body in Canada - Certain Measures Concerning Periodicals87, a case of "perfect substitutability" would no longer fall within the second sentence of Article III:2, but within the first sentence.
5.125.
The complainants further note that the Panel Report on Japan - Taxes on Alcoholic Beverages I indicated that:

[t]he flexibility in the use of alcoholic drinks and their common characteristics often offered an alternative choice for consumers leading to a competitive relationship. In the view of the Panel there existed - even if not necessarily in respect of all the economic uses to which the product may be put - direct competition or substitutability among the various distilled liquors.88

5.126.
According to the complainants, the basic physical properties of soju and the other categories of liquors concerned in this dispute are essentially the same. All distilled spirits are concentrated forms of alcohol produced by the process of distillation. In the complainants' view, at the point of distillation, all spirits are nearly identical, which means that raw materials and method of distillation have almost no impact on the final product. Post-distillation processes such as ageing, dilution with water or addition of flavourings, do not change the basic fact that the product sold is still a concentrated form of alcohol.
5.127.
The complainants present a table below which compares the key characteristics of soju and the main types of distilled sprits at issue in this dispute. This table purports to show that all of them have essentially the same physical characteristics. For instance, according to the complainants, the main differences between soju and whisky, the largest category after soju, are limited to the following:

(i) whisky must be made, at least in part, from sprouted grain;

(ii) whisky has an average alcoholic strength of 37-40% ABV, whereas diluted soju is generally sold at 25%ABV (in contrast, the alcoholic strength of distilled soju is similar to that of whisky); and

(iii) whisky must be aged in wooden casks.

DISTILLED SPIRITS – COMPARISON OF PHYSICAL CHARACTERISTICS AND MANUFACTURING PROCESSES

WHISKYBRANDYGINRUMVODKASOJUSHOCHU
Raw Material Grain Grapes Grain; neutral spirits* Sugar Cane; Molasses Grain; Potatoes; neutral spirits* Grain; Potatoes; neutral spirits* Grain; Potatoes; neutral spirits*
% of Alcohol at Distillation †Less than 95% †Less than 95% †At or above 95% †Less than 95% At or above 95% Not less than 85% Not less than 85%
% of Alcohol at Bottling †Not less than 40% †Not less than 40% †Not less than 40% †Not less than 40% Not less than 40% Not less than 20% Not less than 20%
Method of Distillation Continuous or Pot Still Continuous or Pot Still Continuous Continuous Continuous Continuous or Pot Still Continuous or Pot Still
Aged in Wooden Casks Yes Yes Yes/no Yes/no No Yes/no Yes/no
Color Amber Amber, Clear1 Clear to Amber Clear to Amber Clear2 Clear Clear to Amber
% of Alcohol 37-50 36-50 37-50 37-50 37-50 20-45 20-45
Added Flavorings Variety3 Peach, Blackberry, Cherry, Apricot, Coffee Spice, Lemon Spice, Lemon Currant, Lemon, Orange Lemon, Honey Lemon, Variety of Fruit Flavors
Body/Taste Intensity Medium Medium Light to Medium Light to Medium Light Light to medium Light to Medium

1 Examples of clear brandies include grappa, pisco

2 Addition of flavoring adds color, e.g. red/purple

3US and Canadian regulations permit the addition of flavorings; EU regulations do not

*Vodka, gin, soju and shochu may be produced from neutral spirits, which is an alcoholic spirit distilled at not less than 95% alcohol by volume from any material of agricultural origin.

†Based on U.S. standards of identity (Title 27 Code of Federal Regulations, part 5); EU and other countries allow bottling of brandy at 36% and vodka, gin and rum at 37.5%, Australia allows whisky to be bottled at 37 per cent. Japan maintains no minimum alcohol requirements for these products.

5.128.
The complainants argue that in practice, the above differences are even less important than they might appear at first sight:

(i) soju can be made and is often made from the same type of cereal grains as whisky, even if they are not sprouted;

(ii) whisky is often served on the rocks or mixed with water or other non-alcoholic beverages and is therefore consumed at a similar strength as diluted soju;

(iii) distilled soju can and is sometimes aged for up to two years in wooden casks. Some brands of diluted premium soju claim to be aged in oak barrels.

5.129.
The complainants argue that the above differences are clearly not sufficient to prevent soju and whisky from being directly "substitutable" or "competitive" products in the sense of Article III:2, second sentence. According to the complainants, the existence of similar differences between whisky and Japanese shochu did not preclude the 1987 and 1996 Panels on Japan - Taxes on Alcoholic Beverages from finding that those liquors were in competition on the Japanese market.89
5.130.
The complainants further argue that having essentially the same basic physical properties, soju and all the other distilled spirits and liqueurs are objectively apt to serve the same end-uses:

(i) all of them are drunk with the same purposes: thirst quenching, socialisation, relaxation, etc.

(ii) all of them may be drunk in similar ways: "straight", diluted with water or other non-alcoholic beverages or mixed with other alcoholic beverages;

(iii) all of them may be consumed before, after or during meals; and

(iv) all of them may be consumed at home or in public places such as restaurants, bars, etc.

5.131.
In the complainants' view, the above reasons alone are more than sufficient to conclude that soju and all other distilled spirits and liqueurs are objectively "substitutable" and potentially "competitive" in the Korean market. In addition, the complainants argue that there is conclusive evidence that, despite the distortions introduced by the Korean liquor tax system, competition between soju and other distilled liquors on the Korean market is not just potential but, to a significant degree, also actual.

(b) Soju and the other distilled spirits and liqueurs are sold in the same sales channels and are promoted and advertised in a similar way

5.132.
The complainants assert that the consumption of western-style liquors used to be confined to upmarket restaurants and entertainment establishments. However, the argument goes, over the past few years western-style liquors have gained considerable distribution penetration. According to the complainants, with the main exception of traditional Korean-style restaurants, where soju and other traditional local liquors continue to predominate, western-style liquors are now widely available alongside soju in most sales channels, both for on-premise and off-premise consumption.
5.133.
As evidence of the increasing availability of western-style liquors, the complainants point to a recent survey completed by Hankook Research in May 1997 and covering more than 700 sales outlets, which allegedly found that the leading brands of whisky were sold in a majority of outlets within each relevant category. More specifically, the survey established that 'Imperial', 'Passport' and 'Dimple', the "three big" brands of whisky, were sold in 76%, 81% and 61%, respectively, of the surveyed on-premise outlets and in 64%, 98 % and 85%, respectively, of the surveyed off-premise outlets.90
5.134.
The complainants further purport to show by the photographs included in their exhibits91 that off-premise outlets often display soju and other distilled sprits and liqueurs side-by-side on the same shelves, thus providing evidence in their view, that both the retailers and the public regard them as being in competition.
5.135.
According to the complainants, the advertising of soju, and especially of premium soju, is very similar to the advertising of western-style liquors and tends to emphasise precisely those characteristics which are generally attributed by Korean consumers to western-style liquors, such as pureness, mild taste, maturity, no-hangover effects, etc.92
5.136.
The complainants assert that likewise, the packaging of soju, and in particular of premium soju, is similar to the packaging of western-style spirits and liqueurs.
5.137.
The complainants state that, like their Japanese neighbours, Korean consumers at first perceived Western-style liquors as "luxury" items to be offered as gifts or to be consumed only on special occasions and at special places. Over time, however, there has been, both in Japan and in Korea, a clear trend towards consumption of all types of distilled spirits on more and varied occasions, and in different methods of consumption, i.e. in mixed drinks, warm, cold, etc. According to the United States, the expanding methods and venues of consumption have also been aided by greater availability of all types of spirits in all sales channels.
5.138.
The complainants further state that, to capitalize on Korean consumer's expanded awareness, the soju market has been creating new categories and brands of soju at a fast pace. Most of the activity has been in the recently established premium soju segment. For example, in Korea, Bohae Brewery first successfully used the strategy of incorporating flavoured additives such as honey to soju in its Kim Sat Gat brand soju. Kim Sat Gat was quickly followed by other premium sojus that also contained honey, or were flavoured by aging in wood.

(c) Consumers' demand for soju has been responsive to the changes in the price of whisky

5.139.
The complainants argue that there is statistical evidence indicating that, despite the competitive distortions created by Korea's liquor tax system, demand for soju has been responsive in the past to changes in the prices of the other categories of distilled liquors, and in particular to changes in the price of whisky.
5.140.
The complainants further argue that the applicable liquor tax rate on whisky has been progressively lowered from 200% in 1990 to 100% in 1996. According to the complainants, during the same period, the applicable import customs duties were lowered from 70% to 20%. These tax and tariff changes were followed by a reduction of the prices for whisky and a spectacular increase in sales from 11 million litres in 1992 to 27 million litres in 1996.
5.141.
The complainants argue that, the increase in sales of whisky took place, to a significant extent, at the expense of soju. According to the complainants, until last year sales of soju have grown at a lower pace than overall demand for distilled spirits and liqueurs. As a result, the complainants argue, soju lost market share, mainly to the benefit of whisky. Thus, the argument goes, whereas the market share of soju fell from 96.37% in 1992 to 94.39% in 1996, during the same period the share of whisky increased by a similar percentage from 1.53% to 3.14%. The complainants conclude that this transfer of market share from soju to whisky shows that the two liquors are in competition with each other on the Korean market.
5.142.
The complainants further explain that this trend may have reversed itself during 1997 as a result of the depreciation of the Korean won, the campaign of boycotts against imported products and the financial crisis of last autumn. According to the complainants, this reversal of market trends constitutes an additional proof of the substitutability between soju and imported western-style liquors.

(d) The Dodwell study shows that there is a significant degree of cross-price elasticity between soju and all other distilled spirits and liqueurs

5.143.
The complainants presented a document,93 which purports to contain a copy of a study completed on 17 July 1997 for the Confederation of European Producers Spirits by Dodwell Marketing Consultants Ltd in co-operation with Frank Small and Associates, Korea ("the Dodwell study").
5.144.
The complainants argue that the purpose of the Dodwell study was to test the hypothesis that a reduction in the prices of western-style spirits and liqueurs and/or an increase in the prices of soju following a change in the applicable liquor tax rates will lead to a relative increase in the consumption of western-style liquors at the expense of soju.
5.145.
According to the complainants, the research method used in the Dodwell study is the same as that followed in the ASI study, which was cited by the Panel on Japan - Taxes on Alcoholic Beverages II as one of the reasons for its conclusion that shochu and all other spirits and liqueurs were competitive in the Japanese market.94
5.146.
The complainants further state that the Dodwell study is based on the responses to questions from a representative sample of 500 Korean spirits drinkers. The complainants also state that the survey-takers showed to each respondent pictures of representative brands of soju, premium soju and three brown spirits (standard scotch, premium scotch and cognac) and a list of prices for each, and asked which type of beverage the respondent would most like to buy given the prices specified.
5.147.
The complainants argue that initially, both the proposed price for standard soju and the proposed prices for the other beverages were based on current representative prices on the Korean market ("Level 1" prices). The prices for soju were then successively increased to "Level 2" and to "Level 3". At each of the three price levels for soju, the prices for the other beverages were reduced in two steps ("Level 2" and "Level 3"). Thus, the complainants argue that the respondents were confronted with nine different price combinations. All the prices proposed to the respondents were within the range of the price levels which could reasonably result from the elimination of the existing differences in tax rates. The same research was carried out also with respect to the main types of white spirits (gin, vodka, rum and tequila) and liqueurs.
5.148.
The complainants argue that the Dodwell study confirms that there is a significant degree of cross-price elasticity between soju and brown spirits, as allegedly evidenced by the following findings:

(i) even very small price movements gave raise to significant changes in the preferences of the respondents. For example, if the current representative price of standard soju was increased by just 100 won (10% of the Level 1 price) and the prices for brown liquors remained the same, the share of respondents who would buy brown liquors instead of soju would increase by 8% from 15.2% to 16.4%;

(ii) the respondents were even more sensitive to an equivalent decrease in the price of the brown sprits. For instance, if the price for a bottle of standard Scotch whisky fell from 11,500 won (Level 1) to 10,150 won (Level 2) and the price of standard soju remained unchanged, the share of standard Scotch whisky would increase from 7.4% to 10% (i.e. by 35%);

(iii) the switch is most marked when the price for soju increases and, simultaneously, the prices for brown liquors decline. At current representative prices (Level 1), the share of consumers who prefer brown spirits to soju (including premium soju) is 15.2%. If the price of standard soju was increased by 200 won to Level 3 and, at the same time, the prices for brown liquors fell to Level 3, the share of brown spirits would increase to 28.4%, i.e. by as much as 87%.

5.149.
The complainants also argue that the Dodwell study shows that cross-price elasticity between soju and white sprits and liqueurs is also significant. Thus, it is alleged that according to the study, if the price of soju was increased by 200 won to Level 3 and, simultaneously, the price for white sprits and liqueurs was reduced to Level 3, the share of consumers who would prefer white spirits and liqueurs to soju (including premium soju) would increase from 13.8% to 23.8% (i.e. by 72 %).

iii) Soju and other distilled spirits and liqueurs are "not similarly taxed"

5.150.
The complainants note that, as confirmed by the Appellate Body in Japan - Taxes on Alcoholic Beverages, for two competitive or substitutable products to be deemed as "not similarly taxed", the difference in taxation must be more than de minimis95. The complainants further notes that in the same report, the Appellate Body held that whether any particular tax differential is or is not de minimis must be determined on a case-by-case basis96.
5.151.
The complainants presented the following table which purports to show the differences in taxation between each of the sub-categories of soju and the other categories concerned in this dispute. According to the complainants, the table evidences that diluted soju is taxed at the lowest combined rate, whereas distilled soju is taxed at a lower combined rate than any other category with the only exception of "liqueurs".

Table 5

Comparison of the tax rates applied to soju

and other distilled spirits and liqueurs

Liquor TaxEducationCombinedDiscrimination

rate (%)tax rate tax rate (%)Index

(% Liquor

Tax Base)

Diluted soju 35 3.5 38.5 1.00

Distilled Soju 50 5 55 1.43/1.00

Whisky 100 30 130 3.38/2.36

Brandy 100 30 130 3.38/2.36

General distilled spirits 80 24 104 2.70/1.89

- (containing whisky or brandy) 100 30 130 3.38/2.36

Liqueurs 50 5 55 1.43/1.00

Other Liquors

-more than 25% alcohol content 80 24 104 2.70/2.36

-less than 25% alcohol content 70 7 77 2.00/1.40

-containing whisky or brandy 100 30 130 3.38/2.36

5.152.
The complainants conclude that table 5 provides evidence that the differences in taxation are in all cases far from being "de minimis" and, therefore, that soju is not "similarly taxed". According to the complainants, the combined tax rate on whisky and brandy, for instance, is 2.36 times higher than the rate on distilled soju and 3.38 times higher than the rate on diluted soju.

iv) The differences in taxation are applied so as to afford protection to the domestic production of soju

5.153.
The complainants note that in Japan - Taxes on Alcoholic Beverages II, the Appellate Body laid down the following approach for establishing whether dissimilar taxation of directly competitive or substitutable products is applied "so as to afford protection to domestic production":

we believe that an examination in any case of whether dissimilar taxation has been applied so as to afford protection requires a comprehensive and objective analysis of the structure and application of the measure in question on domestic as compared to imported products. We believe it is possible to examine objectively the underlying criteria used in a particular measure, its structure, and its overall application to ascertain whether it is applied in a way that affords protection to domestic products.

Although it is true that the aim of a measure may not be easily ascertained, nevertheless its protective application can most often be discerned from the design, architecture and revealing structure of a measure. The very magnitude of the dissimilar taxation in a particular case may be evidence of such protective application,... Most often, there will other factors to be considered as well. In conducting this inquiry, panels should give full consideration to all the relevant facts and all the circumstances in any given case.97

5.154.
The complainants argue that in the present case, the following facts and circumstances regarding the "structure of the measures" as well as its "overall application on domestic as compared to imported products" constitute irrefutable evidence that the Liquor Tax Law and the Education Tax Law are applied "so as to afford protection" to Korea's domestic production of soju. For this proposition, the complainants gives the following factors:

(i) the very magnitude of the tax differentials;

(ii) the lack of rationality of the product categorisation;

(iii) the fact that there are virtually no imports of soju;

(iv) the fact that soju accounts for the vast majority of the Korean production of distilled spirits and liqueurs;

(v) the fact that almost all whisky and brandy, as well as a significant proportion of the liquors falling within the categories of General Distilled Liquors and Liqueurs are imported; and

(vi) the existence of a long history of tax discrimination and protectionism.

(a) The magnitude of the tax differentials

5.155.
The complainants argue that in Japan - Taxes on Alcoholic Beverages II, the Appellate Body found that the very magnitude of the difference in taxation between shochu and other distilled spirits and liqueurs was sufficient evidence to conclude that the Japanese Liquor Tax Law was applied so as to afford protection to the domestic production of shochu.98
5.156.
According to the complainants, the situation is similar in the present dispute. It argues that the tax differentials between soju and other distilled spirits and liqueurs are so large that they constitute sufficient evidence in themselves that the Liquor Tax Law and the Education Tax Law are applied so as to afford protection to the domestic production of soju.
5.157.
The complainants state that the tax differentials at issue in this dispute appear to be even bigger than those taken into consideration by the Panel and the Appellate Body in Japan - Taxes on Alcoholic Beverages II.99 They add that, it must be recalled that the tax differentials between soju and other distilled spirits and liqueurs would be much larger but for the successive changes introduced by Korea since 1990 in response to pressure from the Community.

(b) The product categorisation is arbitrary

5.158.
The complainants are of the view that the Liquor Tax Law defines soju almost exclusively in negative terms, by excluding from a very broad, catch-all formula any type of distilled spirits which happen to be imported in significant quantities. According to the complainants, the lack of specificity of the legal definition of soju is further attested by the overlap between that definition and the legal definitions of other residual categories (e.g. the sub-category defined in Article 3.9 E of the Liquor Tax Law). In the complainants' view, this clearly shows that the application of a lower rate of tax to soju does not correspond to any distinguishing characteristic of soju, but is merely aimed to afford protection to Korea's domestic production of distilled spirits.
5.159.
For instance, the complainants argue that according to their respective legal definitions, the only difference between diluted soju and gin is that the latter has juniper berries and plant flavourings added before distillation100. However, according to the complainants, this obviously minor difference entails a tax differential equivalent to more than 90% of the import CIF value of a bottle of imported gin. In the complainants' view, this huge tax differential is clearly disproportionate and can only be explained as being aimed at affording protection to the domestic production of soju.

(c) Domestic soju is "isolated" from imports of soju

5.160.
The complainants further note that in Japan - Taxes on Alcoholic Beverages II, both the Panel and the Appellate Body noted that:

"... the combination of customs duties and internal taxation in Japan has the following impact: on the one hand, it makes it difficult for foreign-produced shochu to penetrate the Japanese market and, on the other, it does not guarantee equality of competitive conditions between shochu and the rest of 'white' and 'brown' spirits. Thus, through a combination of high import duties and differentiated internal taxes, Japan manages to 'isolate' domestically produced shochu from foreign competition, be it foreign produced shochu or any other of the mentioned white and brown spirits".101

5.161.
According to the complainants, the situation is similar in the present case. The complainants argue that Korean soju is effectively "isolated" from competition from foreign soju. It is alleged that imports of soju into Korea have always been negligible. It is argued that in 1997 for instance, the imported volume of soju was just 1,625 litres, which allegedly represents barely 0.0002% of the total soju sales in Korea. According to the complainants, therefore, it is indisputable that by favouring soju vis-a-vis other liquors, Korea protects a "domestic production".
5.162.
The complainants further argue that Korean soju is even more "isolated" from imports of foreign soju than Japanese shochu was from foreign shochu in Japan - Taxes on Alcoholic Beverages. It is argued that in that case, Japan could point to the existence of a significant, even if small in relative terms, flow of shochu imports (between 1-2%). In contrast, it is argued that imports of soju into Korea are virtually non-existent.
5.163.
The complainants assert that as in the case of shochu in Japan - Taxes on Alcoholic Beverages II, one of the reasons why Korean soju is "isolated" from imports of foreign soju is the high level of the import duties on that product. It is argued that currently, the bound rate on soju is 79% and the applied rate 30%. In comparison, it is alleged that in Japan - Taxes on Alcoholic Beverages II, the bound and applied rates on shochu were 26.7% and 17.9%, respectively. It is further argued that the applied import duty rate on soju (30%) is higher than the applied rate on any other category of distilled spirits and liqueurs (15%-20%).

(d) Soju accounts for the vast majority of the Korean production of distilled spirits and liqueurs

5.164.
According to the complainants, it may be estimated that soju accounts for more than 95 % of the Korean production of distilled spirits and liqueurs. Thus, by applying a lower tax rate to soju, Korea is affording protection not just to its domestic production of soju but more generally to its entire domestic industry of distilled spirits and liqueurs.

(e)Almost all whisky and brandy sold in Korea is imported

5.165.
The complainants argue that whereas imports of soju are almost non-existent, virtually all the sales of whisky and brandy, as well as a significant proportion of the sales of white spirits and liqueurs are imported. In the complainants' view, this makes the Korean liquor tax system even more protective in effect than the tax measures at issue in Japan - Taxes on Alcoholic Beverages I and II, where a majority of sales within the more taxed category of "whisky/brandy" was domestically produced.

(f)There is a long history of tax discrimination and protectionism

5.166.
The complainants further argue that the Korean soju industry has traditionally benefited from a very high degree of protection against imports. According to this view, until 1989 the Korean market for distilled spirits and liqueurs was almost closed to imports through the combined application of quantitative restrictions and dissuasive import duties. Since then, the argument continues, Korea has been forced to lift the import quotas and to negotiate with the complainants a reduction of the applied customs duties as part of the 1993 Agreement. The complainants assert that in light of Korea's past record of protectionism in this sector, it becomes evident that the measures at issue are but a last ditch attempt by Korea to continue to afford protection to its domestic soju industry against imports of western-style liquors.
5.167.
The complainants respectfully request the Panel to find that:

(i) Korea is in breach of its obligations under GATT Article III:2, first sentence, by applying internal taxes on imported vodka pursuant to the Liquor Tax Law and the Education Tax Law which are in excess of those applied on soju; and

(ii) Korea is in breach of its obligations under GATT Article III:2, second sentence, by applying higher internal taxes pursuant to the Liquor Tax Law and the Education Tax Law on imported liquors, classified under HS heading 2208, currently falling within the categories of "whisky", "brandy", "general distilled liquors", "liqueurs" and "other liquors" (to the extent that they contain distilled spirits or liqueurs) than on soju, so as to afford protection to its domestic production of soju.

2. Korea

(a) General

5.168.
Korea notes that in bringing this case before the Panel, the United States and the European Communities have called into question the validity of the Korean tax regime on alcoholic beverages, claiming that this regime discriminates against some imported spirits, to the benefit of a Korean distilled alcoholic beverage called 'soju’, and in violation of Article III:2 of the GATT. Korea concedes, as the complainants point out, that it imposes a different rate of tax on soju than it imposes on certain imported alcoholic beverages. However, in Korea's view, not every difference in rates of tax amounts to a violation of Article III:2.
5.169.
Korea asserts that Article III:2 is perhaps the provision of the GATT that treads most heavily upon national sovereignty. In Korea's view, a nation’s taxation system is the product of a long and intricate domestic political process. Korea argues that taxes are built up over years, and reflect different and evolving policy goals. No country imposes a single rate of tax on all products. Korea also notes that the GATT contains no requirement that countries harmonise their tax systems. Korea asserts that the fundamental purpose of Art. III:2 is to avoid protectionism.
5.170.
Korea further argues that the prohibitions of Art. III:2, while honouring their anti-protectionist purpose, must be strictly interpreted. In Korea's view, before the tax rates of imported and domestic products can be compared, the competitive relationship between these two products must be strong, if not very strong indeed.
5.171.
Korea's position is that according to Article III:2, imported products ought not be taxed less favourably than competing domestic products. Korea further argues that where products are perfect substitutes, or 'like', no difference in tax treatment can be tolerated. Where products are not 'like', but are still 'directly competitive or substitutable', the argument continues, there is more room for tax differences, as long as they do not have a protectionist effect.

(b) The Korean Tax System

5.172.
Korea proceeds to give an explanation of its internal tax system. It states that it has 32 different types of taxes, which are largely divided into national and local taxes. Korea further states that like other countries, it distinguishes between direct taxes and taxes on goods and services. Unlike some other countries in Korea the share in total tax receipts of indirect taxes is much higher than direct taxes.102
5.173.
Korea notes that all alcoholic beverages are subject to severaltaxes, such as value added tax, liquor tax and education tax. The latter two taxes, as applied to certain imported alcoholic beverages, are disputed in this case.

i) The Liquor Tax

5.174.
Korea notes that the Liquor Tax Law was enacted in 1949, and has been amended more than twenty times since. An important step in the development of the Liquor Tax Law was the change from a specific tax system to an ad valorem tax system in 1968.103 According to Korea, the reason for this alteration was mainly that the Korean legislature wanted to raise taxes in proportion to the prices of products. It is of some significance, notes Korea, in view of the allegations that Korea's taxes are protectionist, that at the time of enactment of the Liquor Tax Law, and at the time of the change to an ad valorem system, Korea had very little imports of liquor.
5.175.
Korea notes that the parts of its Liquor Tax Law that are relevant to this case are contained in the general provisions and in the chapter dealing with imposition. In the general provisions, a description is given for each drink in such way that it sets the requirements as to the content of each of the liquors in order to fit into the classification of the Liquor Tax. The section of the law dealing with imposition fixes the rates which apply to each particular group of liquors. The descriptions in the law determine the different applicable rates, thus, Korea concedes imposing a different tax rate on standard soju and whisky.
5.176.
However, Korea argues that the complainants attempt to create the mistaken impression that the law's very structure reveals a protectionist intent.104 According to Korea, the reality is different. For a long time, soju was the only spirit subject to liquor taxes. Korea notes that though the law's definition was broad, it covered only what was known. Over time, other spirits were marketed, and as they appeared, new tax categories were created.
5.177.
Korea notes that the Liquor Tax relates to spirits and beverages containing at least 1% of alcohol. The persons falling under the Liquor Tax are either manufacturers of alcoholic beverages supplying from their factory, or importers. These persons pay taxes on the basis of the price at the time of delivery, when the beverages are delivered from a factory, or, when the liquors are imported, on the basis of the CIF plus duty price.
5.178.
Korea further notes that the applicable tax rates on the alcoholic beverages are described in the Liquor Tax Law.105 The tax system and the applicable rates have evolved over time. The applicable rate does not depend on the origin of the liquor. Korea presents the following rates that purportedly apply to the distilled beverages in dispute:

DrinksAd valorem%
Soju: a) standard (or 'diluted') soju b) distilled soju 35% 50%
Liqueurs106 50%
General distilled spirits107 80%
Whiskies, brandies 100%

5.179.
Korea states that being a high‑volume, common drink that Koreans usually consume with meals, standard soju is in a class of its own, and so is distilled soju, being an artisanal drink, that is unique to Korea.
5.180.
Korea notes that there is also a substantial domestic production of liqueurs, general distilled spirits and, particularly, of whisky, that fall under the higher tax rates.
5.181.
According to Korea, the liquor taxes are an important tool for the government of Korea to raise revenue. According to the most recently available figures, liquor taxes amounted to 3.52% of national tax revenues.108 Their share in indirect taxes represented 9.08%. The largest contributor to the liquor taxes traditionally has been beer, which is mostly domestically produced, which accounts for 69% of the Liquor Tax revenues in 1996.

ii) The Education Tax

5.182.
Korea states that in addition to the Liquor Tax, an education tax is levied. According to Korea, Education Tax is an earmarked tax, meaning that the revenues collected through the Education Tax can only be used for the specific purpose of improving the educational system. The Liquor Tax regime is not the only regime that has an Education Tax. Korea asserts that there are ten other regimes to which the Education Tax is attached, such as tobacco consumption tax, property tax and transportation tax. Likewise, taxpayers liable for the payment of liquor taxes are also subject to the education tax. In Korea's calculation, the revenues generated by liquors in the education tax proceeds amount to 12.5%.
5.183.
Korea states that the tax basis for the Education Tax, as levied on payers of the liquor tax, is the Liquor Tax corresponding to each kind of drink. The Education Tax applies as follows: alcoholic beverages whose ad valorem tax rate is higher than 80% are subject to 30% education tax on the amount of the Liquor Tax, and alcoholic beverages with an ad valorem tax below 80% are subject to 10% Education Tax.
5.184.
Korea notes that the Education Tax is levied irrespective of the origin of the products. The proceeds of the Education Tax are allocated exclusively to the improvement of Korea's educational system, notably at the mandatory education level from primary to middle school.

(c) Legal Analysis

5.185.
Korea notes that the complainants argue that because Korea imposes a different rate of tax on 'soju’ than the rate which is imposed upon a number of alcoholic beverages, its tax system unfairly burdens imported spirits, to the benefit of the domestic spirit 'soju’.

i) The purpose of Article III of the GATT is to prevent protectionism, not to harmonise taxes

5.186.
According to Korea, Article III, perhaps more than any other provision of the GATT, steps into a realm which is traditionally the province of national sovereignty ‑‑ the domestic tax system.
5.187.
Korea notes that as each Member joins the WTO, it brings with it its individual tax system, an intricate web of rules built up over many years reflecting a mixture of government objectives (ranging from social policies to the need to raise revenues).
5.188.
Korea further states that no Member of the WTO has the same rate of internal taxation for all products, and the tax differences that have built up throughout the years may not always seem completely coherent. However, the argument continues, it is not the role of the GATT to attempt to render each tax system internally coherent, and nor is it the province of GATT to harmonise the tax systems of its many Members.
5.189.
Korea takes note of the 1992 Panel report in United StatesMeasures Affecting Alcoholic and Malt Beverages in which it was stated:

The purpose of Article III is not to harmonise the internal taxes and regulations of contracting parties, which differ from country to country.109

In Korea's view, tax harmonisation is a sensitive matter even between countries that have achieved a high level of integration, such as the member states of the European Communities.

5.190.
Korea further argues that it should be noted that Article III is not intended to encroach upon the powers of WTO Members to pursue their legitimate objectives through their tax systems. In this regard Korea draws attention to a statement by the Appellate Body put in Japan -Taxes on Alcoholic Beverages, in which it said:

Members of the WTO are free to pursue their own domestic goals through internal taxation or regulation so long as they do not do so in a way that violates Article III or any of the other commitments they have made in the WTO Agreement.110

5.191.
Korea, therefore asserts that Article III of the GATT is only meant to step into this sensitive realm of taxation in certain narrowly circumscribed circumstances, in order to pursue a specific objective. According to Korea, the fundamental purpose of Article III is to avoid protectionism and to oblige the WTO members to provide for equality of competitive conditions for imported products in relation to domestic products. As the Appellate Body put it in Japan - Taxes on Alcoholic Beverages II:

The broad and fundamental purpose of Article III is to avoid protectionism in the application of internal tax and regulatory measures. Toward this end, Article III obliges Members of the WTO to provide equality of competitive conditions for imported products in relation to domestic products.111

ii) The analysis required under Article III:2

5.192.
Korea states that reconciling the anti-protectionist purpose of Article III:2 with the need to recognise each WTO Member's discretion to maintain and develop its own tax policy has not been an easy exercise.
5.193.
Korea further states that the Malt Beverages panel construed the so‑called 'aims and effects' test. Under that test, as long as the tax system introduced product distinctions for policy purposes that were unrelated to the protection of domestic production, the resulting tax differences could not violate Article III:2.112 According to Korea, this approach did not find favour with the Appellate Body in Japan - Taxes on Alcoholic BeveragesII. In Korea's view, the Appellate Body (as well as the Panel in the first instance) ruled that the aims and effects test strayed too far from the text of Article III:2, ignoring the distinction made between the two prohibitions contained, respectively, in the first and the second sentence of this provision. The first sentence tolerates no differentiation whatsoever between tax rates that apply to 'like' products. The second sentence imposes constraints on tax differentials that apply to 'directly competitive and substitutable products'.
5.194.
Korea further argues that according to the Appellate Body, the wording of the first sentence leaves no room to inquire whether a tax rate differential, which applies to 'like' products, was really introduced with protectionist 'aims and effects'. By this argument, differential tax rates applying to 'like' products violate Article III:2.
5.195.
Korea argues, however, that this does not mean that the Appellate Body was insensitive to the concerns of the WTO membership about preserving discretion to develop individual tax policies. Korea notes that in its report, the Appellate Body took great pains to underline 'how narrow the range of "like" products is meant to be'.113 Korea further notes that the Appellate Body, affirming the Panel,114 also clarified that 'like' products are a subset of directly competitive and substitutable. In Korea's view, this indicates that Article III:2 only comes into play when the products at issue are in a particularly close relationship (they should be at least "directly competitive or substitutable"). Where there is no relationship, or an insufficiently close relationship between two products, argues Korea, the WTO Members retain the sovereignty to impose taxes according to their own discretion.
5.196.
Korea argues that the determination of whether two products are 'like’ or directly competitive and substitutable products is based upon an overall appreciation, on a case‑by‑case basis, of their qualities and their relationship. Korea refers to one general remark regarding both the determination of 'like’ products and of directly competitive and substitutable products which was made in Japan - Taxes on Alcoholic Beverages II, which allegedly emphasised that a particularly appropriate test to define whether two products are 'like’ or 'directly competitive or substitutable products’ is the 'marketplace’.115 Korea notes that while noting that there might be other means to identify the broader category of directly competitive and substitutable products, the Appellate Body upheld this reasoning, stating that the: 'GATT 1994 is a commercial agreement, and the WTO is concerned, after all, with markets.'116
5.197.
Korea also states that it is useful to make some preliminary comments about the threshold condition of Article III:2: i.e. how does one analyse whether there is a sufficiently close competitive relationship between the Korean sojus and the remaining imported liquors? Korea poses the question, when are products sufficiently competitive for the purposes of comparing their tax rates under Article III.2?
5.198.
Korea argues that to answer this threshold question, it is useful to recall first the factors that are relevant to establish a competitive relationship between two products and then analyse the degree of competition that will trigger the application of Article III.2, first and second sentences.

iii) Relevant factors

5.199.
According to Korea, first, one must determine whether the products at issue are at least roughly comparable. Where potable liquids are concerned, it makes little sense to compare soft drinks with alcoholic beverages for example. Consumers who want a soft drink will not consider alcohol a suitable alternative.
5.200.
Korea further states that within the broad category of alcoholic beverages, a further distinction can be made according to product characteristics, such as:

Raw materials - Are products rice‑based, grain‑based, potato‑based, tapioca‑based, etc? Which additives are used? In Korea's view, these elements may influence the taste of the beverage, and the consumer's perception in general.

Production process - Are the alcoholic drinks based on fermentation only, or on distillation? Are they aged, and if so how, before being sold? According to Korea, these are factors that may influence the final appearance and taste of the drink, but also its image in the marketplace. Ageing in wooden casks, for instance, gives a drink an 'artisanal' image, that may make quite a difference to consumers, even though objectively it is debatable whether more industrial production processes (e.g., mere storage in metal containers) result in inferior products.

Physical characteristics - of the finished products. Are the products similar in terms of their appearance, the degree of alcoholic strength?Other notable factors determining whether two products compete revolve around price and end use.

Price - Are the products at issue in the same price range? According to Korea, if prices differ greatly, two seemingly similar products cannot be considered directly competitive. Korea notes that in Japan - Taxes on Alcoholic Beverages II, the complainants argued that Japanese shochu and the imported liquors were in the same price range before tax.117 Korea further notes that Japan does not appear to have contested this. Korea asserts that the price differences in Korea between standard soju and the disputed imported liquors are very considerable.

End uses - Do consumers use these products in the same way? Do they drink a particular drink straight or mixed; with meals, or on other occasions? Korea states that these elements were highlighted in Japan - Taxes on Alcoholic Beverages I.118 Korea argues for instance, that depending on the food they usually eat, consumers will show a preference for different alcoholic drinks during meals. In countries with a spicy food tradition, consumers may favour strong alcohol that cleans the palate, when eating meals. In countries where spicy food is not a tradition, consumers will by definition have a different preference for an alcoholic drink that goes best with their national cuisine.

5.201.
Korea argues that the existence, or absence, of a competitive relationship can also be gleaned from other factors, such as the places of sale and consumption. According to Korea, one relevant question in this connection is whether the disputed liquors are sold through the same outlets, so that consumers are actually offered a choice between them. If not, this is an indication that they are not, in fact, competing.

iv) The degree of competition or substitutability

5.202.
Korea poses the question, how strong must competition between two products be, before one can speak of a directly competitive and substitutable, or even a 'like' product relationship within the meaning of Article III:2?
5.203.
Korea argues that it is good policy to give a strict reading to the terms of Article III:2. In Korea's view, given that the WTO is an organisation which brings together a large number of diverse countries, and that it has no mandate to harmonise tax policies, the threshold to review taxes under Article III:2 GATT (i.e., the competitive relationship between differently taxed products) is both important and substantial.
5.204.
According to Korea, for 'like' products, the competitive relationship must be very strong indeed. Korea cites the Appellate Body report on Canada - Certain Measures Concerning Periodicals, in which it was stated that 'like' products are 'perfect substitutes'.119
5.205.
Korea argues that in relation to the examination of the legal obligation under Article III:2 second sentence, the existence of competitive relationship is also an essential requirement for the determination of whether products can be determined to be directly competitive and substitutable. In Korea's view, unlike 'like’ products, substitution does not have to be perfect between the products. Korea asserts that the texts of Article III:2 second sentence and its Interpretative Note require that the competitive relationship must still be strong before the products can be considered directly competitive and substitutable. This is why the text refers to "directly competing or substitutable products".
5.206.
In Korea's view, the complainants have not shown that there is any close relationship between the imported products and soju. Korea therefore, is of the view that they have been unable to show actual competition on the market between the products and are now trying to introduce the argument that the absence of actual competition was due, at least in part, to the tax measures.
5.207.
According to Korea, such a loose interpretation of Article III.2 runs counter to the text of the Interpretative Note to Article III.2. This Note adds that 'only where competition was involved' between two 'directly competitive or substitutable' products could a tax differential conceivably amount to a violation of the second sentence of Article III:2. In Korea's view, this language strongly suggests that there must be actual competition between the directly competitive or substitutable products before their tax rates are to be compared.
5.208.
Korea further argues that it is clear that in the present case the complainants have neither shown that imported liquors actually compete with the Korean sojus, nor have they shown that these liquors would directly compete with each other in the absence of the tax differential. Korea refers to the argument by the complainants that there is a substantial measure of price elasticity between the Korean sojus and imported liquors. According to Korea, the complainants seek to argue that various product combinations are in competition with each other, on the grounds that relatively small changes in the price of soju will persuade Korean consumers to switch to imported liquors such as whisky. Korea notes that in support of this argument the European Communities submitted a market survey,120 which has been endorsed by the United States.
5.209.
Korea points out that given the considerable price differences (even pre-tax) and different end uses between these liquors, the complainants' conclusion flies in the face of common sense. Korea adds that another study funded by the European Communities, and conducted by the same organization but not for legal proceedings, found that "soju in particular remains unaffecetd by imported drinks".121
5.210.
Korea submits that this particular study (the 'Dodwell' study) constitutes poor evidence. Korea puts forward the following reasons for its assertion that the Dodwell study cannot be relied upon as constituting evidence of product substitutability:

v) Problems in the Dodwell Report

Internally inconsistent results
5.211.
Korea expounds upon the peculiarity and problems, namely flaws in design or oddities in the reported results. Korea mentions as an example that in chart 2, the percentage choosing soju rises when price of soju increases from 1,100 to 1,200 won, even though all other prices are held constant. Korea argues that this seems to imply a positively‑sloped demand curve, which is, as the United States noted before the Japan – Taxes on Alcoholic Beverage II case, "contrary to one of the fundamental tenets of micro‑economic theory.122 Moreover, Korea observes, the percentage choosing premium and standard scotch rises as the price of soju rises from 1,000 to 1,100 won but falls as the price of soju rises from 1,100 to 1,200 won. Korea notes that such odd findings are frequent: indeed, they appear in every chart.123
5.212.
Korea argues that there is no theoretical reason why the quantity demanded of one good should not fall as the price of a related good rises, although the implication that soju and whisky, for example, are complements in consumption, so that a fall in the price of whisky would increase consumption of soju, might seem to many economists implausible. Korea notes that the difficulty with the Dodwell report is that it sometimes shows the quantity of scotch demanded rising as the price of soju rises, and sometimes falling. Korea finds the facts reported, though curious, are less troubling than their lack of internal consistency.
5.213.
Korea suggests that consumers in actual markets are unlikely to be so random in their responses to price changes. Korea concludes that the members of the Dodwell sample may have treated the Dodwell question with less gravity than the reports authors might like to believe.

Standard and premium soju

5.214.
Korea points to another peculiarity in the treatment of standard and premium soju. Korea observes that in the Dodwell report, the premium soju is offered as a choice side‑by‑side with western‑style spirits in the pairwise choice between white spirits and standard soju and in the pairwise choice between brown spirits and standard soju. Thus, Korea notes, in the Dodwell "brown spirits" test, respondents are offered a choice between scotch, cognac and premium soju on the one hand, and standard soju on the other; and in the white spirits test they are offered a choice between vodka, gin, rum, tequila, liqueur, and premium soju on the one hand, and standard soju on the other.
5.215.
Korea argues that grouping soju with western‑type spirits rather than with standard soju is eccentric, and suggests a lack of familiarity with these two soju products. According to Korea, standard and premium soju are regarded as close substitutes in Korea. Korea states that premium soju is more expensive than standard sojuthe "current price" of premium soju in the Dodwell report is 2,400 won as compared to 1,000 won for standard soju. Korea notes, however, that is hardly a compelling case for putting premium soju in the same group as 20,000 won scotch or 32,000won cognac.124

Problems

5.216.
Korea states that studies of the Dodwell type must be carefully designed if they are not to fall foul of bias. Korea points out that the Dodwell report clearly has not managed this. Korea discusses two sources of bias and claims that either is sufficient to eliminate the credibility of the Dodwell Report.

Choice of respondents

5.217.
Korea points out that no reason is given for the exclusion of males above the age of 49 or of the rural population when the Dodwell report states "It was decided to select as respondents for the research 500 Korean men in 3 Korean cities aged between 20 and 49 who have purchased soju in the last month."125
5.218.
Korea states that no information is provided on how and where the same was selected, or on how its members were induced to spend their time answering the survey questions. Korea notes that no information is given on the drinking habits of respondentsfor example, where they typically purchase alcohol, or how much they consume(although questions 5‑13 deal with these matters). Korea further notes that no information is provided on the actual characteristics of the samplefor example, average age, occupation, incomethat would permit a check on whether the sample is even representative of "Korean males aged between 20 and 49 who have purchased soju in the last month."
5.219.
Korea argues that the restriction and exclusion of the rural population are not the only ones placed on the sample. Korea indicates that p. 3 of the report announces that "additional criteria for the respondents were whisky purchase in the last 3 months." Korea notes that no reason is given for rejecting persons who have not purchased whisky in the last three months. Korea conjectures that, possibly, the results of the study in the absence of this condition were disappointing. Korea notes that it is certainly true that a good way to obtain a strong response to a fall in the price of whisky and a rise in the price of soju is to select a sample of persons that drink both soju and whisky(and, of course, a whisky purchase in the last three months and a soju purchase in the last month is consistent with a purchase of both in the last week, day or hour).
5.220.
Korea states that the effects of selection bias are evident, regardless of the motivation for the additional restriction,. Korea points out that in the Dodwell sample, at current prices, 72 per cent of respondents select soju when asked to choose between brown spirits and soju; and 72 per cent select soju when asked to choose between white spirits and soju (Korea refers to the Dodwell study, p. 6). Korea notes, however, that the actual share of soju in consumption of distilled spirits in Korea, however, is about 95 per cent.
5.221.
Korea asserts that the discrepancy between those who prefer soju at current prices in the Dodwell study and the true figure is very large126 Korea nevertheless states that the difference between 72 per cent of the sample and 95 per cent that choose soju in reality is likely to seriously understate how unrepresentative the sample is. Korea attributes the discrepancy to the fact that respondents were given a pairwise choice between soju and brown spirits, and then a pairwise choice between soju and white spirits. They were not offered a three‑way choice between soju or brown spirits or white spirits.
5.222.
Korea acknowledges that some respondents may choose brown spirits rather than soju from that pair, but soju rather than white spirits when offered that pair; while others might select white spirits rather than soju in that pairwise offering, but soju rather than brown spirits. Offered a three‑way choice, all of those who reject soju in the pairwise choice will continue to reject soju. Korea, however, emphasizes that those who chose white spirits when offered a choice between soju and white spirits need not be the same as those who choice brown spirits when offered a choice between soju and brown spirits. Korea states that it follows that the figure of 72 per cent choosing soju rather than brown spirits in the Dodwell sample, and the similar percentage selecting soju rather than white spirits, gives the highest possible percentage of those in the sample who would have chosen soju had they been offered a three‑way choice.
5.223.
Korea points out that the actual percentage choosing soju in a three‑way choice would be 72 per cent only if all those who prefer white spirits to soju also prefer brown spirits to soju and vice versa. Korea notes that at the opposite extreme, though, if all of those choosing whisky over soju prefer soju to white spirits; and if all of those choosing white spirits rather than soju prefer brown spirits, the percentage opting for soju in a three‑way choice would be 44 per cent28 per cent would reject soju in favour of brown spirits, and 28 per cent would reject soju for white spirits. Korea states that only 72 per cent of Dodwell respondents choose soju at current prices indicates the unrepresentative nature of the Dodwell sample: that a lower figure is avoided only by the failure to offer a three‑way choice; and that in such a choice, the number choosing soju might fall as low as 44 per cent, puts the Dodwell report into a world entirely different from that of Korean reality.
5.224.
Korea argues that the Dodwell study is based upon a sample of persons who are strongly biased towards western‑type spirits, relative to the Korean population as a whole. Korea asserts that the Dodwell sample is not a credible sample. Korea states that, even leaving aside other grounds for doubt, the response to hypothetical price changes of a group so unrepresentative cannot be taken to reflect anything of the responses of the Korean population as a whole to real price changes.

The single choice drink

5.225.
Korea indicates that the Dodwell study respondents are confronted with an either‑or choice. Korea notes that according to the Dodwell script, interviewers say: "As you can see, there are five types of spirits and photos of typical brands of these types. Which spirit would you choose at these prices?"
5.226.
Korea states that reliable information about how different prices might change drinking habitsthat is, whether a person who is a regular soju drinker might switch to becoming a regular whisky drinker were the price of soju higher and the price of whisky lowermight be relevant in this case. However, Korea argues, that is not what the Dodwell interviewers ask about. Korea notes that they ask which bottle a respondent would choose at the different prices. Korea points out in the Lexecon/Hindley Report that respondents might perfectly naturally interpret the Dodwell questions asking: "If you saw these prices the next time you bought a bottle of spirits, which bottle would you choose?" Korea notes that such questions opens the possibility that some respondents interpreted the hypothetical prices as a one‑time offer: "If you saw these prices the next time you bought a bottle of spirits, but knew that usual prices would be back in force the time after that, which bottle would you buy?" Korea emphasizes that some Dodwell respondents may simply be saying that they would try a bottle of high‑price cognac were it temporarily on offer at such a low price.
5.227.
Korea argues that respondents interpreting the question as asking "would you try a bottle of cognac if it was offered at this price?" are almost certainly more likely to answer affirmatively than those interpreting the question as asking "would these prices cause you to change your drinking habits?". Accordingly, Korea concludes, the ambiguity in the question almost certainly increases the number saying they would buy a bottle of brown or white spirits at a lower price.
5.228.
Korea emphasizes that there is absolutely no reason to suppose that respondents are speaking about a change in their drinking habitsthat their answers imply that if soju rose in price from 1,000 won to 1,200 won, they would switch their regular drink, during meals for instance, from soju to cognac at 32,000 won or scotch at 20,000 won.
5.229.
Korea argues that market surveys, carried out specifically for the purposes of legal proceedings at the request of an interested party, are, of course, to be treated with caution. The analysis must be rigorous, and bias must be avoided at all cost. According to Korea, the Dodwell study does not meet these standards. Korea sums up what it perceives to be the most glaring defects of this study:

(i) It is not at all clear whether the sample of Korean consumers used for the analysis was representative.

(ii) The questions posed were, in Korea's view, ambiguous. Korea argues that the question 'which spirit would you choose at this different price?’ for example, might have been interpreted by respondents as asking whether they would change their habit of drinking soju with meals and switch instead to a western‑type spirit; or as the different question of whether, at the hypothetical lower price, they would buy an experimental bottle of a western‑type drink.

(iii) Korea argues that the conclusions drawn from this study by the complainants are fanciful. According to Korea, it does not rebut the common sense presumption that, given the enormous price differences (even before tax) between standard soju and western‑type liquors and their different end uses, no appreciable number of Korean consumers consider them to be substitutes.127

5.230.
Korea further argues that in contrast, more credence can be given to a study, which was not prepared specifically for regulatory purposes, but which tries to explain in objective terms to exporters the situation on the Korean market. Korea refers to a recent report initiated by the European Commission recently, which stated:

Soju is consumed widely, from the young to the old, and is the most popular traditional drink in Korea. Soju in particular remains unaffected by imported alcoholic drinks. Furthermore Soju, is insulated from economic downturns and maintains a loyal following of steady consumers.128

5.231.
Korea asserts that the constant and independent demand for soju is not the result of any protective government policies. Korea refers to the same EC study which notes that:

"The Korean alcohol market is no longer a market protected by the government with market shares contested by local producers. In fact, it is becoming a truly global market where multinational companies convene to compete with one another for the lucrative and promising Korean market".129

(d) Product-by Product Analysis

5.232.
Korea submits that as competitive relationships differ from product to product and from market to market, the United States and the European Communities bear the burden of proving for each individual product combination that a 'like’ or 'directly competitive and substitutable’ relationship exists in the Korean market before they can put the applicable tax rates into question.
5.233.
Korea states that, without assuming the complainants' burden of proof, it will demonstrate the failure of the complainants to discharge this burden in the following way:

(i) that the complainants have confused various products that are called soju.

(ii) Korean soju is a different product from Japanese shochu.

(iii) Korean standard soju is unlike distilled soju. Korea argues that these are different products in terms of inter alia their raw materials, production process, taste, price, place of consumption, end use, and their marketing. Korea also submits that they are subject to different tax rates: 35% for standard soju and 50% for distilled soju.

5.234.
Korea, therefore argues that both diluted soju and distilled soju must be compared individually to each of the imported liquors in question. Further, it states that although premium soju is a variation of diluted soju, Premium's price is somewhat higher, though still far below the price of the imported liquors. Premium soju represents only a small volume of diluted soju sales (currently, around 5%). In the discussion below of diluted soju due account is taken, where necessary, of any of premium's special features.130
5.235.
Korea notes that the only products that the United States and the European Communities have alleged are 'like’ are standard soju and distilled soju and vodka. Korea states that it will therefore only make representations about the lack of a 'like product’ relationship as far as vodka is concerned. In its view, it goes without saying that Korea does not accept that any 'like product’ relationships exist in this case.131
5.236.
Korea also seeks to point out the very considerable price differences that exist between the imported liquors and diluted soju. According to Korea, the complainants recognize these differences at actual market prices.132 However, Korea argues that these price differences remain considerable, even when the disputed taxes are eliminated. Korea points out that this is shown by the complainants’ own expert study, the Dodwell Study.133 Korea's position is that although it contests the results of the Dodwell Study, the raw price data provided in that study appear to be generally correct. Korea feels that these data are so compelling that it has not felt it necessary to go beyond the data set forth by the complainants. In its view, the one exception is whisky, where, given its importance to this case, Korea has supplemented the Dodwell data with its own figures.
5.237.
In short, Korea is seeking to show that an inexpensive local meal drink such as diluted soju is not in direct competition with expensive western‑type liquors. In the alternative, Korea is seeking to show why the complainants have not shown that Korea's tax system meets the other criteria of Article III:2, assuming that the Panel would still find a competitive relationship between some products,
5.238.
Korea states that contrary to what the complainants are alleging, the so‑called soju based cocktails are not soju. According to Korea, these are sweetened mixtures, with a low alcohol percentage (10‑15%), that were introduced in 1994. They are not comparable to either standard or distilled soju. Korea adds that to make the distinction, manufacturers never use the word 'soju’ in the brand names for these products. They are classified differently, like liqueurs, according to the liquor tax law. Korea points out this classification also covers such imported liqueurs as Bailey’s, Grand Marnier, Kahlua, etc. Liqueurs are subject to a tax rate of 50%. It is unclear to Korea what, if any, complaint the European Communities and the United States are formulating in this respect.
5.239.
Korea also argues that contrary to EC assertions, sales of soju-based cocktails did not increase by 1250% in 1995. According to Korea, the taxed volume of soju-based cocktails increased by 419% in 1995, from 1,583 kl (1994) to 8,218 kl (1995), and that in 1996 sales decreased by 8% (to 7,562); in 1997 by 22% (to 5,893) kl).134

i) Diluted soju

Diluted soju and Whisky
5.240.
Korea argues that diluted soju and whisky are entirely different products, regardless of the perspective from which one looks at them. Korea points out that, firstly, the physical difference between these two products is immediately obvious to the eye and to the palate. Even more striking, according to Korea, are the market differences between the way that diluted soju and whisky are sold and consumed in Korea. Korea states that the primary differences boil down to this: in Korea, diluted soju is the drink one finds on the dinner table, the drink that is consumed with meals. As such, it is an inexpensive beverage. According to Korea, diluted soju is not drunk in bars or clubs. Whisky, by contrast, is an expensive drink that is primarily consumed in high‑class bars and clubs ‑‑ hardly ever with meals.
5.241.
According to Korea, these factorsshow that there is no actual competitive relationship between diluted soju and whisky, and a removal of the tax differential would not create direct competition between those two drinks either.
5.242.
Korea argues that at first glance, one can see that diluted soju is a 'white’ spirit, transparent and colourless, while whisky is a 'brown’ spirit, of a translucent golden‑brown colour (an element much prized by consumers). Korea adds that, diluted soju has an alcoholic strength of 25% by volume, while the alcoholic strength of whisky is at least 40% by volume.
5.243.
As to their organoleptic qualities, Korea states that the most important types of whisky - Scotch, Irish, Bourbon and Canadian - have in common a very typical flavour and smell. It states that the elements that are often mentioned in connection with whisky are that it has a warm, smooth and smoky flavour. According to Korea, one of the objectives in the production process is, as with wine, to develop the taste and aroma imparted to the beverage as a result of the raw materials used for its production (maize, barley, rye or malt) and its ageing in wooden casks.
5.244.
Korea further argues that, on the other hand, diluted soju has quite a 'rough’ flavour and tends to leave a stinging sensation in the mouth and throat. Korea submits that this is a function of the raw materials of which standard soju is made and its production process. In Korea's view, the emphasis in the production process of diluted soju is on making the product as cheaply as possible, not, as with whisky, on ageing and adding value and subtle flavours. That is why, according to Korea, standard soju tends to have a 'cold’ mouth feel that makes the drink suitable for consumption with the typically spicy Korean cuisine for which whisky is not suited. Hence, Korea concludes, as a matter of taste, Korean consumers do not consider whisky and diluted soju as substitutes for each other.
5.245.
Korea further states that diluted soju is the alcoholic beverage that Koreans prefer with their meals. It is an effective foil for the hot and spicy food Koreans prefer, and Koreans consider that it is important to have some food when consuming diluted soju, in order to protect the stomach from the drink’s harshness.
5.246.
Korea concedes that it may seem unusual that Koreans prefer a distilled alcoholic beverage with their meals. Korea points out that in many cultures, particularly western ones, the alcoholic beverage found at the table is usually a fermented beverage with a lower alcohol content, such as wine or beer. It is in fact a western notion that distilled alcoholic beverages are not drunk with meals, but as straight drinks or cocktails. However, Korea points out that not all cultures share this trait, and gives as an example the Chinese, who allegedly also enjoy distilled alcoholic beverages with their meals. Finally, Korea notes that as in most countries, whisky is not consumed with meals in Korea.
5.247.
Korea argues that these differences have follow‑on effects. In conjunction with meals, standard soju is often consumed at home, while whisky is not. Whisky is instead consumed primarily in high‑class hotel bars, night clubs, room saloons, and karaoke bars. Diluted soju not only not consumed in those places, it is not even on offer. Korea adds that when diluted soju is drunk away from home, it is mainly in Korean restaurants (including barbecue houses), mobile street vendors and inexpensive Chinese restaurants, where whisky is not normally available.
5.248.
Korea therefore states that the Hankook Study introduced by the European Communities135 begs the question. It allegedly shows that whisky is available in shops, hotels, danlanjujum (karaoke bars), Japanese restaurants, cafés, bars, night‑clubs and discos. According to Korea, however, it does not show that soju is available in all of these outlets. Furthermore, argues Korea, it omits to mention the outlets in which diluted soju is drunk, but whisky is not available, such as the outlets where Koreans typically eat (Korean restaurants, including barbecue houses, mobile street vendors and inexpensive Chinese restaurants).
5.249.
Korea states that in addition to the fact that diluted soju is a 'meal drink’ while whisky is not, another element which shows in a most definitive way that diluted soju and whisky are not directly competitive and substitutable is their large difference in price. According to Korea, whisky is not nearly in the same price range as standard soju.
5.250.
Korea asserts that in order to exclude any possible distortive effect from the disputed taxes, it will only compare pre‑tax prices.136 At this level, in Korea's analysis, striking price differences emerge from the Dodwell Study. According to Korea, Premium Scotch whisky is 12 times the price of diluted soju. North American whiskies are 10.8 times the price of diluted soju, and standard Scotch whisky is 7.2 times the price of diluted soju. Even the cheapest whisky, bottled in Korea, is cited as 6.3 times the price of standard soju.137 In Korea's view, these figures show that diluted soju and whisky are far from being in the same price range.
5.251.
To further support that point already made through the Dodwell data, Korea provides in the following table, average pre‑tax prices for the past three years using its own figures. Korea explains that because these figures are calculated by dividing the total taxed value by the total taxed volume, they show the weighted average (pre‑tax) prices of whisky and diluted soju (including premium soju) in Korea. In Korea's view, the results138 show more pronounced price differences:

(in Korean won, pre‑tax) 1995 1996 1997
Standard soju (360 ml) 289.94 305.11 322.46
Whisky (360 ml) 3401.27 3582.09 4111.50
Factor of: 11.73 11.74 12.75

5.252.
Korea submits that these price differences are maintained even if taxes are harmonised, either down to the diluted soju level, or up to the whisky level. According to Korea, this is a compelling indication that whisky and diluted soju would not be in direct competition, even if the tax differential were eliminated.
5.253.
Korea points out that this is not to say that whisky sales would not rise if the tax on whisky were reduced. It concedes that this might well be the case, just as in the past tax rate reductions on whisky have led to increased whisky sales. Korea points out, however, that whisky would still not be in direct competition with diluted soju. According to Korea, their price and other differences would remain too important and diluted soju sales would continue to develop largely independently.139
5.254.
Korea states that this observation was also made by the recent European Commission study already cited:

Soju in particular remains unaffected by imported alcoholic drinks. Furthermore Soju, is insulated from economic downturns and maintains a loyal following of steady consumers.140

5.255.
Korea also notes that the complainants have also not taken into account external factors such as currency fluctuations that also have an impact on sales of imported whisky.
5.256.
Accordingly, Korea concludes that it is not under any legal obligation, by virtue of Article III.2 GATT, to reduce taxes on whisky to diluted soju levels (or, for that matter, to increase taxes on standard soju to whisky levels). In Korea's view, these two products are simply not sufficiently related on the Korean market for a tax differential to raise GATT concerns.
5.257.
Korea submits that there are also other factors that contribute to the conclusion that diluted soju and whisky are not directly competitive and substitutable. Korea cites for instance, the marketing strategies for both drinks follow from the distinct consumption patterns and the price aspects described above. According to Korea, the target consumer is clearly different for both drinks and the producers and importers market the drinks accordingly. According to Korea, diluted soju is marketed as an everyday drink, consumed during meals, barbecues ‑‑ not in luxurious surroundings. It is contended that these advertisements typically show Korean citizens in day‑to‑day clothes having diluted soju while eating. In contrast, according to Korea, whisky is positioned as a high class luxury drink that is meant for special occasions. The advertising is allegedly meant to appeal to consumers who are prepared to pay a considerable price for this privilege.141
5.258.
Korea also argues that each product has its own branding strategy. Korea contends that no trademark for whisky is used for sales of diluted soju, neither is a soju trademark used for sales of whisky. Korea states for example, that the Jinro company sells its domestic whisky under the 'Imperial Classic' brand, whereas its diluted soju is sold as 'Jinro Gold'. In Korea's view, this is yet another indication demonstrating that both products do not compete, and are not substitutable on the Korean market.

Diluted soju and Brandy/Cognac

5.259.
Korea argues that there are a myriad of differences between diluted soju and brandy/cognac. Some of these differences are apparent at first glance. Korea contends that in their packaging, brandies/cognacs are presented in an elegant fashion in keeping with their distinguished character. This makes these drinks very suitable for gifts. The same cannot be said about diluted soju, bottled in common plastic or glass bottles and geared toward frequent consumption, rather than to occasional consumption.
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Korea further argues that another striking difference is in the appearance of the alcohol itself: brandy/cognac is generally a deep golden brown colour and has substantial body, while standard soju is a white clear spirit, with little body. Brandies/cognacs have an alcohol content of at least 40%, as opposed to diluted soju’s 25%. Further, the flavour and aroma of brandy has been much celebrated, and described as 'velvety’ and full‑bodied, with a powerful and pleasant bouquet. Part of the typical flavour of brandies/cognacs can be attributed to the fact that they are derived from fermented fruit. Korea also points out that in addition, brandies/cognacs undergo an important ageing process in oak casks (e.g., in order to bear the name 'cognac’, this special brandy must be aged for at least 6 years in wooden casks). It is contended that diluted soju on the other hand is most often made of tapioca, and has a much more industrial production process with no ageing. Suffice it to say that the resulting diluted soju has none of the refined characteristics of brandies/cognacs.
5.261.
Korea further states that the price of brandy/cognac compared to diluted soju clearly spells out that competition between these products is improbable: pre‑tax, brandy is 19.2 times as expensive as diluted soju.142 In Korea's view, this is certainly not 'within a relatively short range’ of prices.
5.262.
Korea submits that consumers perceive brandies/cognac and diluted soju as completely different products and use them in completely different ways. According to Korea, brandies are very expensive luxury drinks, and are consumed in places in keeping with their stature: room saloons, clubs, hotel bars, and other luxurious premises where standard soju is not on offer. Korea adds that brandy/cognac would not be consumed with a meal while diluted soju is the traditional cheap Korean drink essentially drunk during meals. It is contended that it is drunk (often in rather large quantities) by ordinary folks in less illustrious settings than brandy, such as with a meal at home or in a family restaurant. Korea states that a request for a glass of cognac such as Rémy Martin in these settings would likely be met with incredulity.
5.263.
According to Korea, these differences are further reflected in the fact that the marketing strategies of diluted soju and brandies are essentially different. Korea states that of all the drinks concerned by this dispute, brandy probably has the most luxurious image, and is marketed as such, in its packaging, advertising, the target consumer class, and of course, its price range. The marketing of diluted soju, is, as stated before, concentrated on meal consumption and is the 'common’ man’s drink.

Diluted Soju and Vodka

5.264.
Korea states that vodka is the only product for which the United States and the European Communities have claimed a 'like’ relationship with diluted soju. Korea raises doubts as to the evidence brought by the complainants for alleging 'likeness’ of diluted soju and vodka. According to Korea, out of six physical characteristics of vodka and diluted soju which the United States compared, only two corroborate their point of view. Korea notes that the Panel in the Japan - Taxes on Alcoholic Beverages II stated that "'like products’ need not be identical in all respects". However, Korea further notes that this statement was immediately followed by an insistence that "the term 'like product’ should be construed narrowly…."143
5.265.
Korea states that as far as the alleged 'likeness' is concerned, it should be noted that vodka and diluted soju do not fall under the same tariff classification. Vodka is allegedly classified under HS Classification 2208.60.00, while diluted soju falls under HS Classification 2208.90.40. Korea also mentions that there are other differences that suggest that there is no direct competitive relationship between these two products. Korea states that even though the difference between standard soju and vodka is not as striking as the differences between diluted soju and whisky, brandy, and cognac, described above, diluted soju and vodka are not like. However, Korea points out that both diluted soju and vodka also resemble tap water and paint thinner‑‑ a sign, according to Korea, that appearances can be deceptive.
5.266.
Firstly, Korea states that consumers are unlikely to treat vodka and diluted soju as substitutes for each other in light of the price differences between them. Even the comparison of the pre‑tax prices of diluted soju and vodka shows that vodka is 5.7 times the price of diluted soju.144 According to Korea, if these products were truly as 'like’, in competition, or substitutable for each other, it would be difficult to understand how such a vast price discrepancy could exist.
5.267.
Korea further argues that vodka and diluted soju are not consumed in the same ways or in the same places. In Korea's view, this follows, not only from the price difference, but also from the difference in alcohol percentage (vodka: 40%; standard soju: 25%). Korea contends that vodka is primarily a 'mixing’ drink, and that there are even recipe books dedicated to cocktails one can make with vodka. According to Korea vodka is mostly consumed, though at considerably lower volumes than whisky, in room saloons, hotel bars, night clubs, karaoke bars, in short, places where meals, and standard soju, are not offered.
5.268.
Korea also states that diluted soju is drunk straight in a typical small glass and is decidedly not a mixer. Korea contends that the outlets for diluted soju are generally eating establishments, and they are more 'ordinary’ than those at which vodka is offered. It is contended that one can buy soju in places like barbecue houses, restaurants, mobile street vendors and Chinese restaurants, while one cannot generally buy vodka there.
5.269.
Korea further states that diluted soju is a volume drink, which vodka is not. According to Korea, the small volumes of vodka sold in Korea are not attributable to the tax differential. Whisky, with a higher tax than vodka, sells at considerably larger volumes in Korea. In Korea's view, the more likely explanation for vodka’s small sales volume is simply that Korean consumers have no particular taste for it.
5.270.
According to Korea, in light of all these differences, vodka and diluted soju are certainly not 'like' products, and they are also not directly competitive and substitutable.

Diluted Soju and Gin

5.271.
Korea states that even though diluted soju and gin look alike, there is more to these products than meets the eye. Firstly, Korea states that gin is usually 40% alcohol while diluted soju is only 25% alcohol. Secondly, gin is derived from maize and flavoured with certain aromatics and spices, in particular juniper berries, which impart to gin a unique flavour and aroma, reminiscent of spices ‑‑ a taste which is not comparable to any other liquor. By contrast, diluted soju is made with tapioca or potatoes, and has a more harsh and neutral flavour. Korea argues that, accordingly, a consumer desiring the specific taste of gin will not settle for soju. Conversely, a Korean consumer interested in soju will not turn to gin with its typical, even overbearing, taste.
5.272.
Korea further states that another reason why consumers would not substitute gin for diluted soju is the fact that gin is a product which is significantly more expensive than diluted soju. According to Korea, even without taking into account the disputed taxes levied on both drinks, the price differential between the average price of diluted soju and gin amounts to a factor of five.145 Korea maintains that at harmonised tax rates this large price difference would remain.
5.273.
Korea argues that the fact that consumers do not consider gin and diluted soju to be substitutable for each other is borne out in the patterns of consumption and places of sale. According to Korea, the vast majority of diluted soju is drunk straight, with meals. Gin on the other hand is served as a long drink, not straight, and is not drunk during meals. Korea contends that gin is an 'occasional’ drink in Korea, only rarely purchased on the Korean market even compared to whisky. Compared to diluted soju consumption volumes, gin is a mere drop in the bucket, showing that in terms of demand, gin is not a substitute for diluted soju.

Diluted Soju and Rum

5.274.
Korea states that rum comes in two varieties, light and dark, and while light rum looks like diluted soju, dark rum does not. However, Korea states that both varieties of rum are very different from standard soju. Firstly, Korea argues that diluted soju has an alcoholic strength of 25% by volume, while rum is at least 38% alcohol by volume. Secondly, Korea argues that rum is distilled at less than 96% by volume from the juice of cane sugar or molasses, specifically so that the distillate retains the specific organoleptic characteristics imparted to it from those raw materials. Thirdly, rum is aged. According to Korea, the result is a sweetness and a caramel flavour and smell that is smooth and appealing. Korea notes that, on the other hand, diluted soju is made from more neutral raw materials (tapioca, potatoes, corn), and is not aged. It has a 'rough’ flavour and tends to leave a burning sensation in the mouth and throat. According to Korea, therefore, due to this difference in taste, a consumer would not be willing to accept rum when he wants diluted soju, or vice versa.
5.275.
Korea further argues that like with the other liquors, consumers are even less likely to consider these two products as substitutes for each other in light of the difference in price between them. Korea states that pre‑tax, rum is already 6.2 times more expensive than diluted soju.146
5.276.
Korea states that in addition to, and likely because of, the physical and price differences, diluted soju and rum are consumed in very different fashions. Rum is allegedly usually mixed as a cocktail and sold at bars and night clubs, where diluted soju is not even available while diluted soju is almost exclusively drunk neat and is normally served as an accompaniment to food.
5.277.
Korea argues that these differences are borne out in the marketing of both products: rum is presented as a special and exotic beverage, intended for consumption in elegant establishments such as those mentioned above. Diluted soju on the other hand, is the commoner’s drink, and is marketed as such.
5.278.
Korea therefore concludes that, as with gin, the disparity in the volumes of rum sold and the volumes of diluted soju sold should be kept in mind. In other words, diluted soju is a commodity, while rum is a special, 'niche’ drink.
5.279.
Korea submits that it has presented a product‑by‑product analysis of the relationship of diluted soju and the imported liquors at issue. Korea considers that the conclusion of this analysis is that none of these products is in a directly competitive and substitutable relationship with any other (and, of course, that vodka, and for that matter, none, of the imported beverages is 'like’ diluted soju).
5.280.
Korea further submits that even if the Panel considers that any one of the imported products is directly competitive and substitutable for standard soju, there is still no violation of Article III. That is because the complainants have failed to prove, as is required under Article III:1, that the tax differential at issue in this case is 'so as to afford protection to domestic production.’
5.281.
Korea argues that, firstly, it should be recalled that in Japan - Taxes on Alcoholic Beverages II, a protectionist effect was found in the combination of customs duties and the tax differentials, which 'isolated’ Japanese shochu from competition. Korea contends that this combination does not exist in Korea. Korea submits that although it levies a (GATT‑compatible) customs duty, its market for soju is not 'isolated’ at all. Korea recalls once more the recent report published by the European Commission:

The Korean alcohol market is no longer a market protected by the government with market shares contested by local producers. In fact, it is becoming a truly global market where multinational companies convene to compete with one another for the lucrative and promising Korean market.147

5.282.
Korea further argues that making diluted soju basically involves mixing joojung with water, and in Korea the vast majority (approximately 70%) of the joojung used to make diluted soju is imported in a semi‑finished state. Korea adds that when joojung is locally produced it is primarily made from imported ingredients (notably tapioca). According to Korea, therefore, even if the Panel concludes that standard soju is 'protected’ by the difference in tax, one could only say that Korea protects one imported product at the expense of another.
5.283.
Korea argues that on the other hand, if Korea’s diluted soju production is nevertheless considered substantial enough to amount to domestic production, then it must also be considered that Korea has a domestic whisky industry as well. According to Korea, the production of whisky in Korea is in fact similar to the production of diluted soju, in that concentrated whisky is imported, then mixed with water and caramel, and then bottled. Korea states that this process, though it can be described in these simple terms, does add a substantial amount in value.148 From this perspective, therefore, by imposing a higher tax on whisky, Korea has in fact been penalising its own domestic whisky industry.
5.284.
Korea also argues that the fact that there are few imports of soju (e.g., from Japan) can be explained by commercial realities, rather than regulation: Japanese shochu sells at prices that are much closer to western‑type liquors in Japan.

ii) Distilled Soju

5.285.
Korea argues that if one could speak of a ‘soju market’, diluted soju would represent more than 99.8% of that market, and distilled soju, 0.2%.
5.286.
Korea points out that the small volume of sales of distilled soju is indicative of the fact that distilled soju is a special artisanal product. Korea states that it is in fact difficult to compare a product that is mass‑marketed around the world such as the imported liquors at issue in this case to such a tiny niche product, sold only in Korea. According to Korea, distilled soju is not in the same league as these world‑wide players.
5.287.
Korea further states that because distilled soju is prepared with great care and in small quantities, it is an expensive product in the price range of top‑range whiskies and brandy/cognac. This is in contrast to diluted soju which is far less expensive than the imported products, and falls completely on the other end of the scale.
5.288.
Korea also states that distilled soju comes in an expensive ceramic bottle and is most often offered as a gift to friends or colleagues, to be taken home and consumed there. It is marketed as such.

Distilled Soju and Whisky

5.289.
Korea argues that the differences in the appearance of distilled soju and whisky are obvious. Distilled soju is a ‘white’ spirit, while whisky is a brown spirit. As regards taste, whisky has a typical flavour, described as smooth, smoky and warm. Korea adds that one can detect the taste and aroma imparted to the beverage as a result of its raw materials (maize, barley, rye) and its mandatory ageing in wooden casks for at least 3 years. Distilled soju has a full‑bodied liquor with a clean aftertaste. This flavour is achieved by using mainly rice or grain as a raw material. Korea states that distilled soju can be, but need not be, aged (for a maximum of 2 years) in order to refine its flavour.
5.290.
Korea also argues that distilled soju and whisky are used for very different consumer needs. Korea states that the most common way to drink whisky in Korea is as a cocktail, on the rocks, diluted with water or another mixer while distilled soju is almost exclusively drunk neat, that is, not diluted or mixed.
5.291.
Korea states that most whisky is sold in Korea through channels as bars, hotels, room saloons, night clubs, karaoke bars and restaurants while distilled soju is a typical artisanal ‘gift’ item and as such is mostly sold through retail shops (and, recall, in very small quantities). Korea further states that distilled soju offered as a gift is then consumed at home, rather than in trendy bars like whisky.
5.292.
Korea argues that consistent with these different patterns of consumption is a different type of marketing: whisky, a chic drink to be sipped in swanky venues; distilled soju, a traditional product to be offered as a gift.

Distilled Soju and Brandy/Cognac

5.293.
Korea argues that as with whisky, the differences between distilled soju and brandy/cognac are apparent at first glance. Brandies/cognacs are brown spirits, contrary to distilled soju which is a clear white spirit. In addition, Korea states that brandies have more body as they are aged for a longer period than distilled soju. As to their taste, brandies/cognacs have a warm and fruity taste, while the taste of distilled soju is full‑bodied with a clean aftertaste.
5.294.
According to Korea, the difference in raw materials and production processes is the origin of this difference in taste and appearance. Brandies/cognacs are derived from fermented grapes, then aged in wooden casks, generally from 3 to 12 years. Distilled soju is usually made with rice and grain, and can only be aged for 2 years.
5.295.
Korea argues that brandy/cognac is usually consumed neat in a high‑brow restaurant as a digestif. Distilled soju, as mentioned above, is generally received as a gift, and therefore is consumed at home. Further, the marketing of distilled soju is specifically geared at offering the product as a gift, whereas brandy/cognac is more often consumed by the glass in restaurants or high class drinking establishments.

Distilled Soju and Vodka

5.296.
Korea states that there are similarities between distilled soju and vodka. They are both white spirits, and they have similar degrees of alcoholic strength. However, Korea argues that, in light of other, more important differences in price, places of sale and consumption, end uses and marketing, distilled soju and vodka cannot be considered as ‘like products’ or as directly competitive or substitutable products.
5.297.
Korea argues that distilled soju is a very special product that has a different flavour from vodka. Vodka approaches ‘flavourlessness’, while the taste of distilled soju is linked to its raw material. Vodka and distilled soju are also not consumed in the same fashion or in the same places. Due to its absence of flavour, vodka is particularly suitable for use in mixed drinks and is most often consumed as long drink in Korea. In so far as vodka is consumed in Korea, it is mostly sold through bars, discos, and room saloons. By contrast, distilled soju is only consumed straight. In general, distilled soju is sold through shops as it is a typical artisanal gift item. When received as a gift, distilled soju is subsequently consumed by the recipient at his home.
5.298.
According to Korea, the above differen