CHILE – TAXES ON ALCOHOLIC BEVERAGES
Document: Report of the Panel
Date: 15 June 1999
Document codes: WT/DS87/R; WT/DS110/R
Complainant: EU
Respondent: Chile
Third parties: Canada, Peru, U.S., Mexico
Dispute stage: Appellate Body
Agreements cited: Art. III:2  GATT 1994

CHILE – TAXES ON ALCOHOLIC BEVERAGES

Report of the Panel

The report of the Panel on is being circulated to all Members,
pursuant to the DSU. The report is being circulated as an unrestricted document from 15 June 1999
pursuant to the Procedures for the Circulation and Derestriction of WTO Documents
(WT/L/160/Rev.1). Members are reminded that in accordance with the DSU only parties to the
dispute may appeal a panel report. An appeal sha ll be limited to issues of law covered in the Panel
report and legal interpretations develope d by the Panel. There shall be no ex parte communications
with the Panel or Appellate Body concerning matte rs under consideration by the Panel or Appellate
Body.

Note by the Secretariat: This Panel Report shall be adopted by the Dispute Settlement Body (DSB) within 60 days after the date of its
circulation unless a party to the dispute decides to appeal or th e DSB decides by consensus not to adopt the report. If the Pa nel Report is
appealed to the Appellate Body, it shall not be considered for adoption by the DSB un til after the completion of the appeal. I nformation on
the current status of the Panel Report is available from the WTO Secretariat.

I. PROCEDURAL BACKGROUND
1.1 This proceeding has been initiated by a complaining party, the European Communities.
1.2 On 4 June 1997, the European Communities re quested consultations with Chile under
Article XXII:1 of the General Agreement on Tariffs and Trade 1994 ("GATT 1994") and Article 4 of
the Understanding on Rules and Procedures Governing the Settlement of Disputes ("DSU") with
regard to the Special Sales Tax on Spirits of Chile (). Chile agreed to the request. Peru,
the United States, and Mexico requested, in communications dated 19 June 1997 (WT/DS87/2),
23 June 1997 (WT/DS87/3) and 20 June 1997 (WT/ DS87/4) respectively, to be joined in those
consultations, pursuant to Article 4.11 of th e DSU. Consultations between the European
Communities and Chile were held on 3 July 1997 , in which Peru, the United States and Mexico
participated, but the parties were unable to settle the dispute.
1.3 On 3 October 1997, the European Communiti es requested the establishment of a panel
pursuant to Article 6 of the DSU (WT/DS87/5).
1.4 In its panel request, the European Communities claims that:
Chile, by according a preferential tax treat ment, through the Special Sales Tax on
Spirits, to pisco vis-à-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 GATT 1994.
1.5 The Dispute Settlement Body (DSB) agreed to this request for a panel at its meeting of
18 November 1997, establishing a panel pursuant to Ar ticle 6 of the DSU with standard terms of
reference.
1.6 Canada, Mexico, Peru and the United States reser ved their rights to participate in the Panel
proceedings as third-parties.
1.7 On 15 December 1997, the European Communities fu rther requested consultations with Chile
under Article XXII:1 of GATT 1994 and Article 4 of the DSU with regard to the Additional Tax on
Alcoholic Beverages ("Impuesto Adicional a l as Behidas Alcoholicas"), as modified by Law
No. 19,534 (WT/DS110/1). The United States and Mexico requested, in communications dated
23 December 1997 (WT/DS110/2) and 27 December 1997 (WT/DS110/3) respectively, to be joined
in those consultations, pursuant to Article 4.11 of the DSU. Also, on 16 December 1997, the United
States requested consultations with Chile under Article XXII of GATT 1994 and Article 4 of the DSU
(WT/DS109/1). Peru and Mexico requested, in communications dated 17 December 1997
(WT/DS109/2) and 27 January 1998 (WT/DS109/3) respectively, to be joined in those consultations,
pursuant to Article 4.11 of the DSU. Joint cons ultations between the European Communities and the
United States, the requesting parties, and Chile, were held on 28 January 1998, in which Peru and
Mexico participated, but the parties were unable to settle the dispute.
1.8 On 9 March 1998, the European Communities requested the establishment of a panel pursuant
to Article 6 of the DSU (WT/DS110/4).
1.9 In its panel request, the European Communities claims that:
Like the measures which are subject of the Panel established on 18 November 1997,
the modifications introduced by Law No. 19.534, including those to be applied on a
transitional basis until 1 December 2000, are inconsistent with Chile's obligations
under the GATT. In particular, the modifications introduced by Law No. 19.534

impose a lower tax rate on domestic pisco th an on certain other like distilled spirits
and liqueurs imported from the European Communities, thus infringing GATT
Article III:2, first sentence. Those modifications also impose a lower tax rate on
domestic pisco than on certain other dir ectly competitive or substitutable distilled
spirits and liqueurs imported from the European Communities so as to afford
protection to Chile's domestic production, thereby violating GATT Article III:2,
second sentence.
1.10 The DSB agreed to this request for a panel at its meeting of 25 March 1998, establishing a
panel pursuant to Article 6 of the DSU with standard terms of reference. At this meeting, the DSB
further agreed, pursuant to Article 9 of DSU, that the Panel established at the DSB meeting of
18 November 1997, should also examine the complaint of the European Communities in

1.11 The Panel has the following standard terms of reference:
To examine, in the light of the relevant pr ovisions of the covered agreements cited by
the European Communities in documents WT/DS87/5 and WT/DS110/4, the matter
referred to the DSB by the European Comm unities in those documents and to make
such findings as will assist the DSB in ma king the recommendations or in giving the
rulings provided for in those agreements.
1.12 Canada, Mexico, Peru and the United States reser ved their rights to participate in the Panel
proceedings as third-parties.
1.13 On 10 and 11 June 1998, the European Comm unities and Chile, respectively, requested the
Director-General, pursuant to Article 8.7 of the DSU, to determine the composition of the Panel. On
1 July 1998, the Chairman of the DSB informed th e parties that the Director-General composed the
Panel as follows:
Chairman: Mr. Wilhelm Meier
Members: Mr. Mohan Kumar
Professor Colin McCarthy
1.14 The Panel had substantive meetings with the parties on 6 and 7 October 1998, and on
11 November 1998.
II. FACTUAL ASPECTS
A. M
EASURES IN ISSUE
1. Transitional System
2.1 The measure at issue is the so-called "A dditional Tax on Alcoholic Beverages" (" Impuesto
Adicional a las bebidas Alcohólicas", hereafter "ILA"), contained in Law No. 19,534.1

1 Law No. 19,534 of 13 November 1997, amending Article 42 of Decree Law 825/74 (hereafter, "Law
19,534/97") (EC Exhibit 3). The European Communities claims that the measure in issue is contained in
Decree-Law No. 825, of 27 December 1974, on the Tax on Sales and Servi ces (hereafter, "Decree-Law 825/74"
(EC Exhibit 4), amended by Law No. 19,534. The text of this Decree-Law was replaced by Decree-Law No.
1606, of 30 November 1976 ("hereafter", Decree-Law 1606/76) (EC Exhibit 6). In contrast, Chile claims that

2.2 The ILA is an excise tax levied on the sale and importation of alcoholic beverages. It is
payable by the seller or, in the case of imports, by the importer. The ILA takes the form of an ad
valorem tax. The tax basis is the same as for the assessment of the Value Added Tax.
2.3 Law No. 19,534 was signed by the President of the Republic of Chile on 13 November 1997,
and promulgated on 18 November 1997, and entered into force as of 1 December 1997, replacing
Decree-Law 825/1974, which provided a tax syst em until 30 November 1997 (hereafter, the "Old
Chilean System"). Law No. 19,534 provides a new tax system which will become applicable as of 1
December 2000, and a transitional system which is applicable until 1 December 2000 (hereafter, the
"Transitional System").
2.4 The Old Chilean System distinguished three typ es of distilled spirits ("pisco", "whisky" and
"other spirits", a residual category comprising all distilled spirits other than pisco and whisky) and
applied to each of them a different ad valorem tax rate.
2 The Transitional System also applies
different rates of taxes depending on whether the produc t is considered "pisco", "whisky" or "other
spirits," until 1 December 2000. Nevertheless, as a transitional measure, it provides for a progressive
reduction of the rate on whisky in accordance with the schedule shown in Table 1 below, while
applies the same rate to pisco as the Old Chilean System until the new tax system takes effect on 1
December 2000.3.4
Table 1
Applicable tax rates from 1 December 1997 to 1 December 2000
 Whisky Pisco Other Spirits
Until 30.11.1997* 70 % 25 % 30 %
From 1.12.1997 65 % 25 % 30 %
From 1.12.1998 59 % 25 % 30 %
From
1.12.1999/Until
1.12.2000
53 % 25 % 30 %
*Old Chilean System
2. New Chilean System
2.5 The new tax system introduced by Law 19,534 (hereafter referred to as the "New Chilean
System") abolishes the distinction between pisco, wh isky and "other spirits". Instead, all distilled
spirits are taxed according to a scale based on their degree of alcohol content.5
2.6 Law 19,534 provides that, as shown in Table 2 below, all spirits with an alcohol content of
35 or less are taxed at the rate of 27 %. From that base, the rate escalates in increments of 4

Law No. 19,534 constitutes an entirely new law, repe aling and replacing Decree-Law 825/74. The Panel
considers that there is no substantive difference between the two positions.
2 Article 42 of Decree 825/74, as lastly amended by Article 4.III of Law No. 18,413, of 8 May 1985
(hereafter, "Law 18,143/85") (EC Exhibit 11).
3 Transitional Article of Law 19,534/97 (EC Exhibit 3).
4 EC First Submission, Table 4.
5 Single Article of Law 19,534/97 (EC Exhibit 3).

percentage points per additional degree of alcohol, peaking at a rate of 47 % for all spirits bottled over
39.
Table 2
6
Tax rates applicable from 1 December 2000
Alcohol content Tax rate ad valorem
Less or equal to 35 27 %
Less or equal to 36 31 %
Less or equal to 37 35 %
Less or equal to 38 39 %
Less or equal to 39 43 %
Over 39 47 %

B. PRODUCTS IN ISSUE
2.7 The products in issue in this dispute are all di stilled spirits falling within the heading 22.08 of
the Harmonised System ("HS") nomenclature, including, but not limited to the following:
 all kinds of pisco falling within HS 2208;
 all kinds of whisk(e)y falling within HS 2208.30 (hereafter, "whisky");
 all kinds of brandy obtained by distilling gr ape wine or grape marc and falling within
HS 2208.20 (hereafter, "brandy");
 all kinds of rum and taffia falling within HS 2208.40 (hereafter, "rum");
 all kinds of gin and geneva falling within HS 2208.50 (hereafter, "gin");
 all kinds of vodka falling within HS 2208.60 (hereafter, "vodka");
 all kinds of liqueurs falling within HS 220 8.70, such as anisettes, curacao, cream
liqueurs, emulsions and bitters (hereafter, "liqueurs"); and
 all kinds of aquavit, korn, fruit brandies (such as plum brandy, cherry brandy, pear
brandy and cider brandy), ouzo and tequila falling within HS 2208.90 (hereafter,
"aquavit", "korn", "fruit brandies", "ouzo" and "tequila", respectively).

1. Pisco
2.8 Under Chilean law, the term "pisco" is a prot ected geographical indication, the use of which
is reserved exclusively for wine distillates produ ced and bottled in certain regions of Chile from
certain varieties of muscat grapes grown in those regions.
7

6 EC First Submission, Table 5.
7 The European Communities points out that according to the explan ations provided by Chile during
the consultations, the protected geographical indication for pisco was "made official" in 1931 by means of
Decree-Law 181. See Chile's answers to questions from the EC dated 22 July 1997 (EC Exhibit 1).

2.9 Article 28 (a) of Law No. 18,455/85
8 provides that the designation "pisco":
[...] is reserved for aguardiente produced and bottled, in units for consumption, in the
regions III and IV, made by distillation of genuine potable wine obtained from the
varieties of grapevines to be determined by regulation, planted in the said regions.
2.10 The term aguardiente, in turn, is defined in Decree 78/1986 9 (which implements Law
No. 18,455/85) as follows:
A distillate of wine, to which no additives have been added except sugar and water. 10
2.11 Decree 78/1986 also specifies that pisco may be produced only from wine obtained from one
or more of the following varieties of grapes of the species Vitis Vinifera L : Chasselas Musque Vrai ,
Moscatel Amarilla, Moscatel Blanca Temprana, Moscatel de Alejandría or Italia, Moscatel de Austria,
Moscatel de Frontignan , Moscatel de Hamburgo , Moscatel Negra , Moscatel Rosada or Pastilla ,
Moscato de Canelli , Muscat Orange, Pedro Jiménez and Torontel.11 In practice, most pisco is made
by blending spirits distilled from two or more of these types of grapes.
2.12 The so-called zona pisquera currently comprises Regions III (Atacama) and IV (Coquimbo).
These two regions lay between the parallels 27 and 32, some 600 kilometres north of Santiago, and
are characterised by a very dry and sunny climate. The grapes for the production of pisco are grown
along a series of narrow valleys irrigated by rivers flowing from the Andes into the Pacific, the so-
called five valles pisqueros: Copiapó, Vallenar, Elqui, Limarí and Choapa.
2.13 The production of pisco is dominated by tw o large co-operatives, each grouping several
hundred associated grape growers: Cooperativa Agrícola Pisquera Elqui Ltda (hereafter "Capel") and
Cooperativa Agrícola Control Pisquero de Elqui y Lima rí (hereafter "Control"). It is estimated that,
together, Control and Capel account for more than 90 % of the sales of pisco.
2.14 The main stages in the production process of pisco may be summarised as follows:
(i) harvesting and grinding of the grapes;
(ii) fermentation of the grape-juice in large earth enware or steel containers in order to
produce wine, with an alcohol strength of approximately 14;
(iii) distillation of the wine in copper pot stills.12 The raw spirit obtained at the end of this
phase has about 55-60;
(iv) maturation of the raw spirit in wooden contai ners for a relatively short period of time,
usually not exceeding several months. The best quality brands may be stored in
American oak casks for a longer period; and

8 Law No. 18,455, of 31 October 1985, laying down rules for the production, preparation and
marketing of ethyl alcohol, alcoholic beverages and vinegar (hereafter, "Law 18,455/85") (EC Exhibit 12).
9 Decree No. 78 of 31 July 1986 implementing Law 18,455/85 (hereafter, "Decree 78/1986") (EC
Exhibit 13).
10 Ibid., Article 1.2.
11 Ibid., Article 56.
12 According to the European Communities, the stills are similar to those used by the producers of
Cognac. The distillation process may be described as a "batch" process, rather than a continuous process,
although rectifiers are sometimes used to boost the strength of the spirit.

(v) finally, the spirit from the different distilleri es is centralised to be blended, diluted
with de-mineralised water in order to obta in the desired alcohol strength, filtered and
bottled.
2.15 By law, pisco must have an alcohol content of no less than
30; the four types of pisco are
designated as13:
 Pisco corriente or tradicional between 30  and 35;
 Pisco especial between 35  and 40;
 Pisco reservado between 40  and 43;
 Gran pisco 4 3  or more.

2.16 According to the explanations provided by th e Chile during the consultations, Chile's pisco
industry is currently producing and selling pisco of the following alcohol contents14:
 Pisco corriente or tradicional 30 , 32, 33
 Pisco especial 3 5 15
 Pisco reservado 4 0 
 Gran pisco 4 3 , 46 and 50

2.17 According to the regulations in force, the four different types of pisco are distinguished solely
in terms of their alcohol strength. 16 As already indicated by its name, pisco tradicional or corriente
used to be the largest selling type of pisco. Over the last few years, however, it has been overtaken by
pisco especial, which is now the best selling pisco category. Pisco reservado and gran pisco account
for about 9 % of the market.
2.18 Although there are no official statistics on the production or sale of the different types of
pisco, the European Communities submitted market da ta compiled by AC Nielsen, a private market
organization employed by the European distilled spir its industry to estimate the market share of each
type of pisco, as follows:17

13 Decree 78/1986, Article 56.
14 Chile's answers to questions from the EC dated 24 February 1998 (EC Exhibit 2).
15 According to the European Communities, the brand "C ontrol de Guarda" appears to be sold also at
36. See EC Exhibit 51.
16 Article 13 of Decree 78/1986 (EC Exhibit 13).
17 The European Communities submits the source of Table 4 as EC Exhibit 24.

Table 3
18
Pisco sales by category
 Aug 94/July95 Aug 95/July96 Aug96/July97
Tradicional 46.2 % 35.8 % 34.5 %
Especial 40.8 % 49.8 % 51.4 %
Reservado 5.5 % 6.4 % 6.3 %
Gran Pisco 4.4 % 4.8 % 4.2 %
Pisco sour19 3.0 % 3.2 % 3.7 %
Basis: % of total sales of pisco
2.19 Chile provides information con cerning production and sales of various types of distilled
spirits in Chile. Table 4 indicates the data for 1997:20

18 EC First Submission, Table 1.
19 The European Communities notes that pisco sour is not a variety of pisco but, rather, a cocktail made
with pisco. Specifically, Decree 78/1986 (Article 58) defines pisco sour as "[…] the cocktail produced and
bottled in regions III and IV, prepared with pisco, lemon juice or natural lemon flavouring […]". Table 3 shows
the share of pre-mixed pisco sour.
20 Chile First Submission, Annex III, Table 7. Chile additionally provides the following estimates by
the domestic industry of pisco production in 1998 (January to September): Pisco 30° - 8,613.0, Pisco 35° -
20,730.0; Pisco 40° to 46° - 2,465.0; Aguardiente min. 30° - 45.0; and Aguardiente min. 50° - 480.0 (million
litre).

Table 4

Volume in Thousands Litres and Value in Thousands of US$

 Production 1997 Imports 1997 Exports 1997 Apparent Consumption
1997
Type of Spirits Volume Value Volume Value Volume Value Volume Value
Total, Pisco of different
alcoholic content*
40,977.9 0.0 0.0 301.6 933.3 40,676.3
Pisco 30º * 16,276.5
Pisco 35º * 20,969.0
Pisco 40º - 46º * 3,732.5
Aguardiente
minimum 30º
 9.1 37.9
Aguardiente
minimum 50º

Other grape spirits 94.4 336.2 106.1 266.0
Brandy, cognac, armagnac
(minimum 38º)

Grapa (minimum 30º)
Whisky (minimum 40º) 2,484.7 13,799.7 0.2 3.6
Rum and other spirits of
sugar cane (minimum
40º)
 642.8 1640.8 0.3 1.6
Gin and geneva
(minimum 40º)
 198.9 967.8 0.0 0.0
Other Spirits 1,679. 9 6,412.9 111.3 287.2
Vodka (minimum 40º) 389.9 1,246.4 0.0 0.1
Liqueurs 183.1 1,359.6 41.7 71.8
Other spirits 1,106. 9 3,806.9 69.6 215.3
Sources:
(1) Production:
- Piscos according to alcoholic strength: Control Pisquero Ltd. and Capel Ltd.
- Aguardiente; Brandy, Cognac, Armagnac; grapa; whisky; rum and other spirits of su gar cane; gin and geneva;
vodka; other distilled spirits; fruit liqueurs; anisette, anise liqueur; arack, pastis, anesone; bitter liqueurs; cocktail s;
other spirits: Asociación de Licoristas de Chile.
(2) Exports and Imports: Central Bank of Chile.
Notes: (i) Bold type represents the sum, where possible, of the rows below.
 (ii) The row vodka (minimum 40°) is underlined for emphasis, since there are import and export statistics for the years 1996 and
1997.
2.20 Finally, the merger of the two largest producers of pisco, Control and Capel, was authorised
by Chile's competition authority as of 30 October 1 998. Their combined market share is 90%. In
giving this authorisation, the competition auth ority indicated that pisco had a high degree of
competition with other alcoholic beverages, such as wine, beer and whisky, given the practice of
ingesting pisco mixed with a non-alcoholic beverag es, and therefore, in the market for alcoholic
beverages, and despite the fact that the merger of the applicant co-operative companies would result
in a combined share of the pisco market of 98%, there are alternative products which consumers of
alcoholic beverages could choose to drink.
2. The Other Spirits in Issue
2.21 The names of the main types of distilled spirits at issue in this dispute, other than pisco, are
permitted to be used only for those alcoholic be verages which are defined by Decree 78/1986 in the
following terms21:

21 According to the European Communities, Decree 78/1986 contains no definition of rum.

(i) Whisky: "The distillate of the alcoholic fermentation of malted or unmalted mashes
of grain, which is subjected to ageing processes in wooden vessels, whether or not
coloured with natural caramel".22
(ii) Brandy: "Aguardiente aged in vessels of noble wood, whether or not coloured with
natural caramel, and whether or not sweetened with sugar".23
(iii) Gin: "Beverage obtained by flavouring rectified alcohol from starchy raw materials
with distillates, macerations or essential oils from juniper berries".24
(iv) Vodka: "Beverage obtained from alcohol from st archy raw materials, with or without
maceration of grass".25
(v) Liqueurs: "The product prepared from potable ethyl alcohols, distillates, fermented
alcoholic beverages, whether or not mixe d with each other, and with or without
natural or synthetic aromatic extracts. It may contain sweeteners, water, colorants or
any other permitted additive".26
2.22 Decree 78/1986 also prescribes the minimum alcohol content requirements for the use of the
main type names of distilled spirits in dispute, as follows27:
Table 528
Legally required minimum alcohol strength in Chile
Whisky, rum, tequila, gin 40
Brandy, cognac, armagnac 38
Aguardiente, fruit aguardiente, grappa 30
Fruit liqueurs 25-34
Anisettes 25-40
Bitters 25-30
Cocktails 12-16
Other liqueurs 25-28

22 Decree 78/1986, Article 1.42 (EC Exhibit 13).
23 Ibid., Article 1.5.
24 Ibid., Article 1.11.
25 Ibid., Article 1.41.
26 Ibid., Article 1.17.
27 Ibid., Article 12.
28 EC First Submission, Table 2, with corrections made by the Panel based upon Decree 78/1986,
Article 18 (EC Exhibit 13)..

C. H
ISTORY OF TAXATION OF ALCOHOLIC BEVERAGES IN CHILE
2.23 Between 1916 and 1954, pisco was totally exempted from the excise taxes imposed on the
other alcoholic beverages. Between 1954 and 1974, pisco was taxed at a ra te that was half of the rate
applied to all the other liquors.
2.24 In 1974, Decree-Law No 826/74 introduced a 40 % ad valorem tax on all categories of spirits,
including pisco. 29 At the same time, however, Decree-Law 826/74 imposed a 50 % surcharge
("recargo") on all imported beverages.30
2.25 In 1977, Decree-Law 826/74 was amended by Decree-Law 2,057/77, which abolished the
recargo.31 Simultaneously Decree-Law 2,057/77 lowered the rate of tax on pisco from 40 % to 25 %,
while the tax on other spirits was reduced from 40 % to 30 %.
2.26 In June 1979, Decree-Law No 826/74 was rep ealed and replaced by the ILA, a new tax
applied in conjunction with the Value Added Tax system. 32 At first, the ILA was applied at the same
rates as the tax which it had replaced, i.e. , 25 % on pisco and 30 % on all other distilled spirits. 33 But
in December 1983 the rate on distilled spirits othe r than pisco was increased from 30 % to 50 %,
while the rate applied to pisco was unchanged at 25 %.34
2.27 On 23 January 1984, the ILA was amended again in order to lower the applicable rate on
distilled spirits other than pisco and whisky fr om 50 % back to its previous level of 30 %. 35 At the
same time, the rate on whisky was further increased from 50 % to 55 %. 36 Thus, following these
changes, the ILA was applied at three different rates: 25 % on pisco; 55 % on whisky and 30 % on all
other distilled spirits.
2.28 In May 1985, the rate on whisky was increased once again from 55 % to 70 %.
37 Following
this change, the ILA rates have remained unmodi fied until the amendment approved in November
1997.
2.29 The table below summarises the evolution of th e applicable rates between 1974 and the entry
into force of Law 19,534 on 1 December 1997.

29 Article 3 of Decree-Law No. 826, of 27 December 1974 (hereafter, "Decree 826/74") (EC Exhibit 5).
30 Ibid.
31 Decree-Law No. 2,057 of 30 November 1977 amending Decree-Law 826/74 (hereafter "Decree
2,057/77")(EC Exhibit 7), Article 1.2.
32 Decree No 2,752, of 21 June 1979, integrating the taxes on alcoholic beverages within the VAT
system (hereafter, "Decree 2,752/79") (EC Exhibit 8). According to the European Communities, this Decree-
Law brought the taxation of alcoholic beverages within the scope of Decree-Law 825/74.
33 Ibid., Article 1.3.
34 Article 4.III of Law No. 18,267, of 1 December 1983 amending Article 42 of Decree 825/74
(hereafter, "Law 18,267/83") (EC Exhibit 9).
35 Article 1 of Law No. 18,289, of 23 January 1984 amending Article 42 of Decree 825/74 (hereafter,
"Law 18,289/84") (EC Exhibit 10).
36 Ibid.
37 Article 4.III of Law 18,413/85 (EC Exhibit 11).

Table 6
38
Evolution of taxes rates between 1974 and 1997
 Pisco Whisky Other spirits
With effect from 12/74 40 % 40%* 40 %*
With effect from 12/77 25 % 30 % 30 %
With effect from 7/79 25 % 30 % 30 %
With effect from 12/83 25 % 50 % 50 %
With effect from 1/84 25 % 55 % 30 %
With effect from 5/85 25 % 70 % 30 %
* imported spirits subject to the 50 % recargo until 1977.
III. CLAIMS OF THE PARTIES
3.1 The claim of the European Communities is that both the Transitional System and the New
Chilean System are inconsistent with Chile's obligations under GATT Article III:2, second sentence.
3.2 The European Communities claims that39:
(i) the Transitional System, which is applicab le through 30 November 2000, is contrary
to GATT Article III:2, second sentence, because it provides for the imposition of
lower internal taxes on pisco than on ot her directly competitive or substitutable
imported spirits which fall within the tax cat egories of "whisky" and "other spirits",
so as to afford protection to Chile's domestic production;
(ii) the New Chilean System, which will become applicable as of 1 December 2000, is
also contrary to Article III:2, second senten ce, because it results in the imposition of
lower taxes on pisco with an alcohol content of 35  or less than on other directly
competitive or substitutable imported spirits which have a higher alcohol content, so
as to afford protection to Chile's domestic production.40
3.3 In response, Chile contends that the New Chilean System is fully consistent with Article
III:2 because it taxes all distilled spirits, regardless of type and regardless of whether imported or
domestic, according to identical objective criteria of alcoholic strength and value (ad valorem).

38 EC First Submission, Table 7.
39 The European Communities notes that in its panel request, it also claimed a violation of GATT
Article III:2, first sentence. The European Communities states that even though certain spirits exported from the
European Communities to Chile (including in particular certain types of brandy) may be considered as being
"like" to pisco, it decided not to pursue that claim, gi ven that those spirits are in any event "directly competitive
or substitutable" with pisco.
40 The European Communities argues that the New Chilean System already constitutes mandatory
legislation, and as such, it may be the subject of dispute settlement under the WTO Agreement, citing Panel
Report on United States – Taxes on Petroleum and Certain Imported Substances, BISD 34S/136, paras. 5.2.1-
5.2.2.

3.4 Chile then claims that this Panel should reject the unwarranted and intrusive interpretation of
the reach of Article III that the European Communiti es has put forward in this dispute, and that in
keeping with the plain language and the history of Article III, the Panel should find that the New
Chilean System is fully consistent with Article III:2, second sentence.
3.5 Chile also argues that to the extent that the Pa nel considers the Transitional System to be at
issue notwithstanding the short time in which it will remain in effect, it would be appropriate for the
Panel to find that pisco is not directly competitive or substitutable with other distilled spirits in Chile,
and hence that the Transitional System also conforms with Article III:2, second sentence.
IV. ARGUMENTS OF THE PARTIES
A. O
VERVIEW
1. GATT Article III:2, second sentence
4.1 The European Communities puts forth the relevant GATT provision, GATT Article III:2,
second sentence, which reads as follows:
Moreover, no Member 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 1.
4.2 Further, the European Communities refers to Ar ticle III:1, which provides in relevant part
that:
The Members recognize that internal taxes ... should not be applied to imported or
domestic products so as to afford protection to domestic production.
4.3 The European Communities then i ndicates 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.
4.4 The European Communities further points out that in Japan - Taxes on Alcoholic
Beverages II41, the Appellate Body clarified 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 subst itutable imported and domestic products are
"not similarly taxed"; and

41 Appellate Body Report on Japan – Taxes on Al coholic Beverages (hereafter, " Japan - Taxes on
Alcoholic Beverages II "), adopted on 1 November 1996, WT/DS8/AB/R, WT/DS10/AB/R, WT/DS11/AB/R,
p. 24. See also the Appellate Body Report on Canada - Certain measures concerning Periodicals (hereafter
"Canada - Periodicals"), adopted on 30 June 1997, WT/DS31/AB/R, pp. 24-25.

(iii) whether the dissimilar taxation of the directly competitive or substitutable imported
products is "applied ... so as to afford protection to domestic production".
4.5 In addition, the European Communities points ou t that as a preliminary matter it must be
ascertained whether the measures at issue are "internal taxes". The ILA is levied on all distilled spirits
intended for consumption in Chile, whether locally manufactured or imported, and not just "on" or "in
connection" with the importation of distilled spirits . Accordingly, the ILA constitutes an "internal
tax" in the sense of GATT Article III:2, and not an "import charge" within the purview of GATT
Articles II and VIII.
4.6 Chile, while agreeing that the proper basis for analyzing whether a measure conforms with
Article III:2, second sentence, is the test set out in the ruling of the Appellate Body in Japan - Taxes
on Alcoholic Beverages II , points out that concerning these three el ements, the Appellate Body in
Japan - Taxes on Alcoholic Beverages II emphasized that:
[T]hese are three separate issues . Each must be established separately by the
complainant for a panel to find that a tax measure imposed by a Member of the WTO
is inconsistent with Article III:2, second sentence.
42
4.7 Chile then argues that the EC complaint does not and could not meet this three-part test.
Chile asserts that the European Communities, pe rhaps out of habit based on arguing about the
Japanese and Korean tax systems, devotes the largest pa rt of its argumentation to the first part of the
three-part test: the question of whether pisco is dir ectly competitive or substitutable with other spirits
in the Chilean market. Chile does not agree that the European Communities has met its burden with
respect to the first element. However, the issue of directly competitive or substitutable, which was at
the core of the disputes concerning the Japanese and Korean systems of taxation, is essentially
irrelevant in the analysis of the New Chilean System, because the new system eliminates all
distinctions based on type of distilled spirits. In stead, the New Chilean System applies an identical
system of taxation to all types of distilled spirits, regardless of whether they are like, competitive or
substitutable and regardless of origin.
4.8 In response, the European Communities contends that Chile's strategy in this case is to
divert the Panel's attention from the examination of Chile's own tax system. Chile attempts to do so
by focusing the discussion on other tax systems (both real and hypothetical), which are fundamentally
different from the New Chilean System. With the sa me purpose, Chile tries to focus the debate on a
number of superficial differences between this case and previous cases.
4.9 According to the European Communities, Chile has good reasons to follow this strategy.
Indeed, the New Chilean System does not withstand a close examination in light of the three-prong
test established by the Appellate Body in Japan – Taxes on Alcoholic Beverages II.
2. Transitional System
4.10 With respect to the Transitional System, the European Communities states that from 1985
to November 1997 pisco was taxed at the rate of 25 % ad valorem , whereas whisky, the main
imported distilled spirit, was taxed at the rate of 70 % and "other spirits" (a residual category
comprising all distilled spirits other than pisco and whisky) at the rate of 30 %.
4.11 The European Communities argues that in an attempt to address longstanding complaints
from the European Communities and other WTO Members, Chile amended its liquor tax system in

42 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 24 (emphasis added
by Chile).

November 1997, following protracted discussions between its Government and the local pisco
industry and a lengthy debate by the Chilean Congress.
4.12 According to the European Communities, the New Chilean System approved in
November 1997 will not take effect until 1 December 2000. In the meantime, the previous system
will remain in place, with the only difference that the tax rate on whisky will be progressively lowered
from 70 % to 53 %.
4.13 The European Communities argues that the Transitional System, which is applicable until 30
November 2000, is contrary to GATT Article III:2, second sentence, because it provides for the
imposition of lower internal taxes on pisco than on directly competitive or substitutable imported
spirits that fall within the tax categories of "whisky" or "other spirits", so as to afford protection to
Chile's domestic production.
4.14 Chile replies that the EC complaint about the Transitional System, in effect, seeks to
replicate previous EC complaints about Japanese and Korean systems of alcohol taxation. Chile notes
that by invoking the analysis of the Appellate Body in Japan - Taxes on Alcoholic Beverages II , the
European Communities argues, among other things, th at in Chile all distilled spirits are directly
competitive or substitutable.
4.15 Chile goes on to state that, with respect to th e Transitional System, it believes that there are
significant differences of fact and law between this case and the cases of the Japanese and Korean
systems that were found inconsistent with Article I II:2. While all three systems make distinctions
based on type of distilled spirit, there is much less difference in taxa tion under the Transitional
System, and there are much stronger bases for considering that pisco is not competitive or
substitutable in the Chilean market with any other type of spirit.
3. New Chilean System
4.16 The European Communities argues that the New Chilean Sy stem that will become
applicable as of 1 December 2000 is also contrary to Article III:2, second sen tence, because it results
in the imposition of lower taxes on pisco with an alcohol content of 35  or less than on directly
competitive or substitutable imported spirits which ha ve a higher alcohol content, so as to afford
protection to Chile's domestic production.
4.17 The European Communities asserts that the New Chilean System abolishes only as a formal
matter the distinction between pisco and the other types of distilled spirits. Instead, the applicable rate
varies according to (but not proportionally with) al cohol content. Specifically, all spirits with 35  of
alcohol content or less are taxed at the rate of 27 % ad valorem. From that base, the rate escalates by
4 percentage points for each additional degree of al cohol content, peaking at 47 % for all distilled
spirits above 39. Thus, for a mere five degrees increase in al cohol content, the applicable rate nearly
doubles. In contrast, similar differences in alcohol content, both above and below the 35-39 bracket,
do not entail any difference in taxation at all.
4.18
 The European Communities thus concludes that the New Chilean System is designed to
continue to afford protection to pisco at the expense of imported distilled spirits. In fact,
approximately 90 % of pisco is bottled at 30  to 35 and, therefore, will be taxed at the lowest rate of
27 %.
4.19 The European Communities further argues that in contrast, all imports of whisky, rum, gin,
vodka and tequila (which together account for more than 95 % of all imports of spirits into Chile) will
be taxed at the highest rate of 47 %. Furthermore, unlike pisco those spirits do not have the flexibility

to move down the scale. Under Chilean law, a ll of them must be bottled at no less than 40  and,
therefore, are automatically locked in the highest rate of 47 %.
4.20 According to the European Communities, the pr otective effects of the New Chilean System
are by no means incidental. The lack of internal coherence of the new system (as revealed in
particular by the spasmodic progression of the tax ra tes) evidences that the tax differentials serve no
legitimate purpose. Alcohol content has been chosen as a taxation principle simply because it
provides a basis for replicating indirectly the protec tive effects of the old system, and not because the
new system is genuinely aimed at discouraging alcohol consumption.
4.21 Chile replies that the New Chilean System, in terms of Article III:2, "similarly taxes" all
distilled spirits, regardless of type. All distilled spirits are taxed according to the objective, neutral
criteria of alcohol strength and value ( ad valorem ). The European Communities notes that low
alcohol pisco will bear less tax than high alcohol sco tch whisky, but that effect of the Chilean system
is no more inconsistent with Article III:2 than is the higher tax that high horsepower U.S.-built cars
may face in Europe relative to small European cars.
4.22 Chile contends that a violation of Article III has not occurred mere ly because, by some
measurements, an importe d product bears a higher tax than even a like domestic product, if the
difference in the tax is not based on nationality of the product and results from the application of
objective criteria. As will be demonstrated belo w, the European Communitie s itself has conceded in
past WTO cases that neutral, obj ective criteria such as value ( ad valorem ) and alcohol content are
permissible bases for a neutral tax system.
4.23 Chile points out that implicitly, the European Communities also concedes the legitimacy of an
alcohol content system in this case as well, but the European Communities still tries to argue that the
Panel should require still more : that the differentiation in ad valorem tax be directly and evenly
proportional to the differences in alcohol content. Th ere is no such requirement in the language or
history of Article III:2.
4.24 According to Chile, while the Eu ropean Communities tries to give the impression that this is
just one more complaint about taxation of alcoholic beverages in the mold of recent cases such as
those involving Japan (twice) and Korea, that is not the case. The New Chilean System is very
different from those alcohol tax systems successfully challenged in the past in that the New Chilean
System does not distinguish by type, but rather ap plies identical objective critieria to all products.
Chile argues that the European Communities is asking the Panel to expand the interpretation of
Article III in ways that are unprecedented and unwarranted.
4.25 Chile also indicates that the major distilled spirits exporting companies and countries have
enjoyed success in past cases in challenging tax laws where there was explicit discrimination based on
national origin of the products or where, as in the case of the Japanese and Korean systems, the
favored product was of a type that effectiv ely could only be domestic. Now the European
Communities asks this Panel to go further to ban ta x distinctions based on the neutral criterion of
alcohol content, at least if the distinction is not directly proportional to the difference in alcohol
content. For the European Communities, it is appare ntly not sufficient that taxes not discriminate by
national origin or by type, nor is it sufficient that the results of the application of the neutral criterion
will favor some imports as well as domestic products and disfavor so me domestic products as well as
imports. Finally - and perhaps most significantly - the European Communitie s ignores the fact that
the use of this objective criterion of alcohol conten t will enable foreign and domestic producers alike
to adapt their products in a very simple process (dilu tion with water) if they wish to obtain the most
favored tax treatment.

4.26 Further, Chile states that if the Panel accepts the EC reasoning, it would not be a far step from
such an interpretation to strike down national st andards that, though based on objective criteria and
applied without regard to national origin, had the effect of being less convenient or more burdensome
for many foreign producers than for many domestic producers.
4.27 Accordingly, Chile concludes that this Panel should reject the unwarranted and intrusive
interpretation of the reach of Article III that th e European Communities has put forward in this
dispute. Instead, in keeping with the plain langua ge and the history of Article III, the Panel should
find that the New Chilean System is fully consistent with Article III:2, second sentence.
B. "
DIRECTLY COMPETITIVE OR SUBSTITUTABLE"
1. Overview
4.28 The European Communities argues that pisco and the other distilled spirits are "directly
competitive or substitutable".
4.29 In response, Chile argues that the European Communities has not established that other
distilled spirits are directly competitive or substitutabl e with pisco. Chile does not deny that there is
some degree of substitutability among various distilled sp irits, but Chile disagrees that this degree is
large enough so as to fall within the directly competitive or substitutable products in the Chilean
market, within the meaning of Article III:2 second sentence.
4.30 Chile goes on to claim that the EC arguments on this point are at least relevant (though
unpersuasive) with regard to the Transitional Syst em, which imposes different rates of taxation based
on type of distilled spirit. However, the question of whether the different types of distilled spirits are
directly competitive or substitutable does not aris e in the New Chilean System. The liquor tax
systems of Japan and Korea examined by WTO panels involved tax structures organized around
product type. The New Chilean System is an entirely different system where differentiation in
taxation is based on alcohol content, not type of distilled spirit.
2. General Consideration
4.31 The European Communities begins with the argument that the scope of "directly
competitive or substitutable" products is broader than that of "like" products. Products which may be
too different in terms of physical characteristics or end uses to qualify as "like" for the purposes of the
first sentence of Article III:2 may still be found to be "competitive or substitutable" for purposes of its
second sentence.43
4.32 The European Communities points out that in Japan - Taxes on Alcoholic Beverages II , the
Appellate Body ruled that the terms "like product" mu st be construed "narrowly" in the first sentence
of Article III:2.44 This interpretation was deemed necessary in view of the fact that, as put by one of
the complainants in that dispute, Article III:2, first sentence, operates as "guillotine": once it has been
established that two products are "like", any tax differential between them is deemed prohibited,
without it being necessary to ascertain whether the tax differential is applied "so as to afford
protection".
4.33 Further, the European Communities notes that th e Appellate Body arrived at its conclusion
that the term "like" should be construed "narrowly" as follows:

43 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 25.
44 Ibid., pp. 19-20.

Because the second sentence of Article III:2 provides for a separate and distinctive
consideration of the protective aspect of a measure in examining its application to a
broader category of products that are not "like products" as contemplated by the first
sentence, the European Comm unities agrees with the Panel that the first sentence of
Article III:2 must be construed narrowly so as not to condemn measures that its strict
terms were not meant to condemn. Conse quently, the European Communities agrees
with the Panel also that the definition of ‘like products' in Article III:2, first sentence,
should be construed narrowly.
45
4.34 The European Communities also states that , in contrast, there is no suggestion in Japan -
Taxes on Alcoholic Beverages II that the notion of "directly competitive or substitutable" product
must also be construed "narrowly". This reflect s the different wording and structure of the second
sentence of Article III:2. Unlike the first sente nce, the second sentence ma kes express reference to
the first paragraph of Article III. This means that in order to establish a violation of Article III:2,
second sentence, it must be determined first, as one of three separate requirements, that the tax
differential is "applied ... so as to afford protecti on to domestic production". Therefore, a "narrow"
reading of the terms "directly competitive or subs titutable", unlike a "narro w" interpretation of the
terms "like product", is not required in order to ensure that only protectionist measures are condemned.
4.35 According to the European Communities, the drafting history of the GATT 1947 also
supports a broad interpretation of the scope of "direc tly competitive or substitutable" products. At the
Geneva session of the Preparatory Committee, delegates cited several examples of products that could
be considered sufficiently "competitive" to trigger the application of Article III:2, second sentence.
These examples included quite broad categori es of products, such as apples and oranges 46; linseed oil
and tung oil 47; and synthetic rubbe r and natural rubber. 48 The record discloses that no disagreement
was expressed by delegates with respect to the breadth of these examples. At the Havana Conference,
some delegates mentioned even larger categories of products, such as tramways and busses or coal
and fuel as examples of "directly competitive or substitutable" products.49
4.36 The European Communities argues that past pa nels which have interpreted the notion of
"directly competitive or substitutable products" have also taken a broad approach. The Panel Report
on Japan – Taxes on Alcoholic Beverages I 50 found that shochu and all other distilled spirits were
directly competitive and substitutable on the Japanese market. This finding was confirmed in Japan –
Taxes on Alcoholic Beverages II.
4.37 Also, the European Communities points out that another example is provided by the Panel
Report on EEC – Measures on Animal Feed Proteins , which concluded that vegetable proteins and

 45 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 20-21. The
European Communities points out that the Panel Report on Japan - Taxes on Alcoholic Beverages , (hereafter,
"Japan – Taxes on Alcoholic Beverages II "), adopted on 1 November 1996, WT/DS8/R, WT/DS10/R,
WT/DS11/R, para. 6.22 states: "Giving a narrow meaning to ‘like products' is also justified by the
inescapability of violation in case of taxation of foreign products in excess of [sic] domestic products".
46 E/PC/T/A/PV/9, p. 7.
47 E/CONF.2/C.3/SR.11, p.1 and Corr. 2.
48 E/CONF.2/C.3/SR.11, p. 3.
49 E/Conf.2/C.3/SR.40, p. 2. Nevertheless, the European Communities notes that unlike in the case of
the examples mentioned at Geneva, there was some disagreement among delegates with respect to these
examples.
50 Panel Report on Japan - Customs Duties, Taxes and Labelling Practices on Imported Wines and
Alcoholic Beverages, BISD 34S/83 (hereafter, "Japan – Taxes on Alcoholic Beverages I").

skimmed milk powder were "directly competitive or substitutable" products for the purposes of
applying the second sentence of Article III:5.
51
4.38 Chile contends that despite the slight and temporary practical effect of the issue whether
pisco is directly competitive or substitutable with any other distilled spirits, at least as a matter of
precedent, it is important to emphasize that the Eu ropean Communities has failed to substantiate its
claim that pisco is directly competitive or substitutable in the sense of Article III with European spirits.
4.39 Chile goes on to state that the European Co mmunities has been careful to include many
paragraphs and even some charts purporting to fu lfill each of the elements necessary to demonstrate
that other distilled spirits are directly competitive or substitutable with pisco in the Chilean market.
The Panel should not simply accept the EC's contentions which, in the view of Chile, do not stand up
to close scrutiny as proofs that th e products are directly competitive or substitutable. Chile notes that
the European Communities has provided what are undoubtedly thick studies and annexes, and the
Transitional System has some superficial similar ities to the Japanese and Korean cases. Chile urges
the Panel to reject the EC's arguments. Accep ting the EC's contentions regarding the Transitional
System would set an adverse precedent that would constitute yet one further significant step toward
requiring harmonization of taxation of increasingly di sparate products - even as panels continue to
claim that such is not their objective or intent.
4.40 Chile then states that the Panel should instead find that the European Communities has failed
to meet its burden of demonstrating that pisco is directly competitive or substitutable with other
distilled spirits in the Chilean market.
3. Potential Competition
4.41 The European Communities stresses that Article III:2, second sentence, is concerned not
only with tax differentials between products that are already actually competitive or substitutable on a
given market, but also with tax diffe rentials between products that are potentially competitive or
substitutable. Furthermore, the notion of potentia l competition must be deemed to include not only
competition that would exist "but for" the tax measures at issue, but also competition that could be
reasonably expected to develop in the future having regard, for example, to existing trends in the
market concerned or to the situation prevailing in other markets.
4.42 The European Communities explains that the re levance of potential competition, as defined
above, flows from the well-established principle that GATT Article III does not protect export
volumes but competitive opportunities. As stated by the Appellate Body in Japan – Taxes on
Alcoholic Beverages II:
[I]t is irrelevant that the "trade effects" of the tax differentia l between imported and
domestic products, as reflected in the volum es of imports, are insignificant or even
non-existent. Article III protects expectati ons not of any particular trade volume but
rather of the equal competitive rela tionship between imported and domestic
products.
52

51 Panel Report on EEC – Measures on Animal Feed Proteins, BISD 25S/49, para. 4.3.
52 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 16. See also Working
Party on Brazilian Internal Taxes, adopted 30 June 1949, II/181, 185, para. 16; Panel Report on United States -
Taxes on Petroleum and Certain Imported Substances, supra., para. 5.1.9; Panel Report on United States -
Measures affecting Alcoholic and Malt Beverages (hereafter, "United States – Malt Beverages"), BISD 39S/206,
para. 5.6; and Panel Report on United States - Measures Affecting the Importation, Sale and Use of Tobacco ,
BISD 41S/131, paras. 99-100.

4.43 The European Communities states that the recognition of the relevance of potential
competition for the purposes of Article III:2, second sen tence, is of particular importance in the
present dispute. In the first place, pisco has benef ited from protective taxation for a long time. As a
result, the current level of actual competition betwee n pisco and other spirits is necessarily less than
the level that could have devel oped under equal tax conditions. S econdly, distilled spirits, like many
foods and beverages, are so-called "experience goods", i.e., goods which must be purchased and
consumed in order to appreciate their aptitude to satisfy the consumers' needs. Furthermore,
consumption of spirits is largely based on habits, which only change graduall y. For those reasons,
market penetration is generally sl ow and short-term reactions to pr ice changes tend to be relatively
low.
4.44 Chile replies that the European Communities offers as an excuse that cross-elasticities are
often low for products that are new to the market . Such a comment hardly seems appropriate to the
case of whisky, which has a very long history in the Chilean market.
4. Relevant Factors and Their Evidentiary Weight
(a) Relevant Factors
4.45 The European Communities points out that in Japan – Taxes on Alcoholic Beverages II ,
the Appellate Body noted that "how much broader [the] category of 'directly competitive or
substitutable products may be in a given case' is a matter for the panel to determine based on all
relevant facts in that case".
53
4.46 Also, according to the European Communities, in the same report, the Appellate Body
referred specifically to the following factors as be ing relevant for assessing whether two products are
"directly competitive or substitutable"54:
(i) the physical characteristics of the products;
(ii) their end-uses;
(iii) their tariff classification; and
(iv) the "market place", and in particular the degree of elasticity of substitution between
the products concerned.
4.47 In response, Chile states that the question whether products are like, directly competitive or
substitutable under various GATT rules has provoked many disputes over the years, but has not led to
the development of any particularly clear or obj ective standards to guide WTO member governments
or their legislatures. The case by case approach of the panels to date may be thought desirable,
insofar as it leaves panels considerable discreti on for judgement as to what are permissible and
impermissible distinctions, but the cost of that di scretion is a loss in predictability and certainty for
national governments and legislatures.
4.48 Thus, Chile argues that panels have taken the approach of considering a variety of factors
(none of which are considered individually dispos itive) rather than applying any readily apparent
formula. In reading the various decisions, it is impossible to avoid the sense that there is as much
intuition as science lying behind past GATT and WTO decisions. Under such a standard, Chile

53 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 25.
 54 Ibid.

disagrees with the EC claim that its finest single ma lt whiskeys and its rarest cognacs must be viewed
as directly competitive or substitutable with Pisco corriente.
4.49 Chile states that the EC argument in this case nominally tracks the factors that the Appellate
Body endorsed in the Japan - Taxes on Alcoholic Beverages II case. Those factors include such
matters as physical characteristics, common end-uses, and tariff classifications, but also the "market
place".
4.50 Chile argues that in sum, each supposed elemen t of the EC case appears ill-founded. While
perhaps every factor need not be present with equal force to find two products to be directly
competitive or substitutable, every element should no t be so weak as the ev idence presented by the
European Communities. Accordingly, the Panel s hould find that the Eur opean Communities has not
shown that pisco and other distilled spirits are di rectly competitive or substitutable, and that the
Transitional System is consistent with Article III:2, even for the brief period it remains in force.
(b) Evidentiary Weight
(i) Physical Characteristics
4.51 The European Communities points out that as illustrated by the drafting history of
Article III:2 and past panel reports, two products need not have the same physical characteristics in
order to be "directly substitutable and comp etitive". As noted by the Panel Report on Japan - Taxes
on Alcoholic Beverages II :
[C]ompetition can and does exist among prod ucts that do not necessarily share the
same physical characteristics. In the Panel' s view, the decisive criterion is whether
they have common end uses ...
55
4.52 According to the European Comm unities, at the same time, howev er, it is obvious that if two
products have sufficiently similar physical characteristics, such similarity may in and of itself be
sufficient to conclude that the products in ques tion are apt to serve for the same end-uses and,
therefore, that they are "directly competitive or substitutable".
4.53 The European Communities argues that in order to be "directly substitutable and competitive"
two products need not have the same physical charac teristics. In fact, if there were no differences in
physical characteristics between two products, they would be "like" instead of "directly competitive or
substitutable". The decisive criterion for determin ing whether two products are "directly competitive
or substitutable" is whether they have common end-u ses. At the same time, it seems obvious that if
two products have sufficiently similar physical charac teristics, such similarity may in and of itself be
sufficient evidence to conclude th at the products in question are apt for the same end-uses and,
therefore, that they are "directly competitive or substitutable".
4.54 According to the European Communities, th e existence of differences in physical
characteristics between Japanese shochu and the othe r distilled spirits did not prevent the two panels
on Japan – Taxes on Alcoholic Beverages I and II from concluding that they were directly
"competitive and substitutable" in the Japanese market. Likewise, in Korea – Taxes on Alcoholic
Beverages, the panel concluded that soju was "directly competitive or substitutable" with a number of
other distilled spirits, despite the existence of di fferences with respect to factors such as alcohol
content, ageing, colour or flavouring. 56 The differences between pisco and other distilled spirits are

55 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.22.
56 Panel Report on Korea – Taxes on Alcoholic Beverages , 17 September 1998, WT/DS75/R and
WT/DS84/R, para. 10.67.

similar to those existing between shochu or soju and other distilled spirits. Therefore, those
differences cannot exclude of themselves a finding that pisco is "directly competitive or substitutable"
with other distilled spirits.
4.55 In rebuttal, Chile states that not all physical characteristics of the products involved need to
overlap for the products in question to be considered "directly competitive or substitutable". However,
Chile does consider that the Eur opean Communities needs to demonstr ate more than a coincidence of
one physical characteristic, in this case the alcohol content of the beverage, before claiming that
products are directly competitive or substitutable in the sense required by Article III.
(ii) End-uses
4.56 The European Communities states that as observed by the panel on Japan – Taxes on
Alcoholic Beverages II in the above quoted passage, common ality of end-uses is the "decisive
criterion" for establishing whether two products are "d irectly competitive or substitutable". In fact,
the other criteria are relevant only to the extent that they can provide an indication as to the existence
of such commonality of end-uses.
4.57 According to the European Communities, in order to be "directly competitive or
substitutable" for the purposes of Article III:2, sec ond sentence, two products need not be competitive
or substitutable with respect to all their possible end-uses. This was made clear by the Appellate
Body in Canada – Periodicals.
57 In that case, Canada argued that US magazines were not "directly
competitive or substitutable" with Canadian maga zines because, while they provided a reasonable
substitute as an advertising medium, they were poor substitutes as an entertainment and
communication medium. Thus, according to Cana da, US and Canadian magazines were only
"imperfect substitutes". The Appellate Body di smissed this argument by pointing that a case of
"perfect substitutability" would fall within Article III:2, first sentence.
4.58 The European Communities goes on to state that similarly, in Japan - Taxes on Alcoholic
Beverages I, the panel based its conclusion that Japan's Liquor Tax Law violated Article III:2, second
sentence, on the finding that there existed direct competition or substitutability among the liquors
concerned, "even if not necessarily in respect of all the economic uses to which the products may be
put".58
4.59 Further, the European Communities contends that from the principle that Article III is
concerned with the protection of competitive opportun ities, it follows that the end-uses to be taken
into account include all the objective (or functiona l) end-uses to which the products may be put,
irrespective of whether the products are currently being employed for those end-uses in the market
concerned. Similarity of actual end-uses may, of course, provide further evidence of substitutability,
but is not required for a finding that products are "directly competitive or substitutable".
(iii) Tariff Classification
4.60 In the view of the European Communities, tariff nomenclatures classify products in
accordance with their physical characteristics and end-uses. For that reason, as noted by the Appellate
Body in Japan – Taxes on Alcoholic Beverages II , "if sufficiently detailed, tariff classification can be
a helpful sign of product similarity".59

57 Appellate Body Report on Canada - Periodicals, supra., p. 28.
58 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.7.
59 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 21.

4.61 The European Communities points out that tari ff classification has already been relied upon
by several previous panel reports in orde r to make a "like" product determination.
60 A fortiori, tariff
classification may also be relevant for the purposes of determining whether two products fall within
the broader category of "directly competitive or substitutable" products.
4.62 According to the European Communities, two products falling within the same tariff position
may be covered by different bindi ngs and vice-versa. Tariff nomenclatures such as the Harmonized
System classify products according to their objec tive characteristics. For that reason, they may
provide useful guidance in order to determine whethe r products are "like" or "directly competitive or
substitutable".
4.63 Chile concedes the obvious point that all distilled spirits share a common tariff category;
however, according to Chile, the point is of virtua lly no legal significance, because there are 4-digit
HS categories which include products which are obvi ously not "directly competitive or substitutable";
for example, aviation gas and vaseline white oil (HS 2710), mackerel and ca viar (HS 1604), lobster
and crabmeat meal (HS 0306), and ivory and nails (HS 0507).
(iv) Market Place
4.64 The European Communities notes that in Japan – Taxes on Alcoholic Beverages II 61, the
Appellate Body approved the Panel's decision to lo ok at the "market place" and in particular to the
cross-price elasticity between the products concer ned. At the same time, however, the Appellate
Body emphasised that cross-price elasticity is "not the decisive criterion". According to the Appellate
Body, cross-price elasticity is but one of the means of examining the relevant market. In turn, looking
at the relevant market is but "one among a number of means" of identifying the products that are
directly competitive or substitutable in a particular case.
4.65 According to the European Communities, a hi gh rate of cross-price elasticity may be
sufficient to establish that two products are dir ectly competitive or substitutable for the purposes of
the second sentence of Article III:2. The opposite, howe ver, is not necessarily true. A relatively low
rate of cross-price elasticity does not of itself exclude the possibility that two products may be
"directly competitive or substitutable". Such a low ra te may simply be the result of the tax measures
at issue. Or it may reflect the fact that imports are new entrants in the market concerned, a hypothesis
that may be of particular significance in the case of experience goods such as those at issue in this
dispute.
4.66 The European Communities further points out that as noted by the Panel Report on Japan –
Taxes on Alcoholic Beverages II:
... a tax system that discriminates against imports has the consequence of creating and
even freezing preferences for domestic goods, In the Panel's view, this meant that
consumer surveys in a country with such a tax system would likely understate the
degree of potential competitiveness between substitutable products.62
4.67 According to the European Comm unities, when "looking at the market-place," it may also be
relevant to consider, in addition to cross-price el asticity, other factors such as the actual end-uses of
the products (as opposed to their objective end uses), th eir availability in different sales channels or

60 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.6. See also the Panel Report
on EEC – Measures on Animal Feed Proteins, supra ; and Panel Report on United States – Standards for
Reformulated and Conventional Gasoline, WT/DS2/R, adopted on 20 May 1996.
61 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 25.
62 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.28, citing the Panel Report
on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.7.

the way in which they are advertised. Neverthe less, when assessing the evidence related to these
factors, it must always be borne in mind that Article III:2 is concerned with the protection of
competitive opportunities and not of actual competition. Evidence that two products are sold in the
same channels and used for the same purposes can be taken as evidence that they are "directly
competitive or substitutable". The absence of such evidence, however, does not, in and of itself, lead
to draw the opposite conclusion.
4.68 Chile replies that the European Commun ities offers as an excuse that cross-price elasticities
are often low for products that are new to the mark et. Such a comment hardly seems appropriate to
the case of whisky, which has a very long history in the Chilean market. Furt her, Chile argues that
the regression analysis submitted by the European Communities has serious methodological flaws.
Chile further states that the Search Marketing su rveys submitted by the European Communities have
inconsistent results.
4.69 Chile further argues that common distribution channels are not strong evidence, and multi-
purpose channels are weaker still than dedicated channels.
4.70 The European Communities responds that the regression analysis it has submitted to the
Panel was conducted by a consultation firm at the request of the Chilean pisco industry. Further, it
claims that the regression analysis Chile submitt ed to the Panel has a more serious flaw of
multicolinearity.
5. Product Categories
4.71 The European Communities argues that all pisco must be considered as a single product for
the purposes of Article III:2. Accordingly, the exis tence of direct competition or substitutability must
be assessed with respect to the category of pisco as a whole and not with respect to each of the four
types of pisco.
4.72 The European Communities claims that, according to the regulations in force, the four
different varieties of pisco are distinguished solely in terms of their alcohol strength.
63 This means
that, for example, any pisco with 43 or more is entitled to use the designation gran pisco, irrespective
of the varieties of muscat grape from which it is ma de, the length of its ageing period or the type of
container in which it has been matured. As acknowledged by Chile during the consultations64, all that
is required in order to produce pisco especial or pisco corriente instead of gran pisco or pisco
reservado is adding some more water before bottling the product.
4.73 The European Communities then argues that this difference does not warrant treating each of
them as a distinct product for the purposes of Artic le III:2, second sentence, es pecially since, as will
be shown below, most pisco is consumed mixed with other non-alcoholic beverages or "on the rocks".
In Japan – Taxes on Alcoholic Beverages II , the panel noted that "a difference in the alcoholic
strength of two products dos not preclude a finding of likeness, especially since alcoholic beverages
are often drunk in diluted form".65
4.74 Further, the European Communities points out that as shown in Tables 7 and 8 below, most
other distilled spirits are also bottled at different alcohol strengths. Japanese shochu, for instance, is

63 Article 13 of Decree 78/1986 (EC Exhibit 13). In this connection, the European Communities notes
that Chile claimed in Chile's answers to questions from the EC, dated 24 February 1998 (EC Exhibit 2) that each
of the four types of pisco is made from different vari eties of grapes and according to a different manufacturing
process, in particular as regards the maturation phase.
64 Chile's answers to questions from the EC, dated 24 February 1998 (EC Exhibit 2).
65 Japan - Taxes on Alcoholic Beverages II, supra., para. 6.23.

bottled in a range from 20  to 45 . Yet, the two panels on Japan – Taxes on Alcoholic Beverages I
and II have treated all shochu as a single product, irrespective of its alcohol content.
4.75 The European Communities disagre es with Chile's claim that gran pisco and pisco reservado
are products of higher quality and, for that reason, are sold at higher prices than the other types of
pisco.
66 There is no clear correlation between quality /prices and alcohol strength. The European
Communities submitted a survey of re tail prices conducted in May 1998 by Search Marketing S.A. at
five big super-markets of Santiago (hereafter, "the 1998 SM price survey"). 67 This survey shows that
price differentials among brands of the same alcohol strength are often larger than price differentials
among strength categories within the sa me brand. Thus, for example, pisco especial of high quality
brands such as "Alto del Carmen", "Control de Gu arda" or "Mistral" is more expensive than pisco
reservado or even gran pisco of average quality such as the basic "Capel" and "Control" brands.
4.76 The European Communities further argues that, with respect to th e samples of pisco provided
to the Panel68, the bottles and labels of all piscos of the sa me brand tend to be identical, except for the
mandatory indication of their respective alcohol stre ngth and denomination. Promotional claims are
generally made with respect to all products of the same brand, rather than with respect to specific
alcohol strengths.
4.77 Further, according to the European Communities, the pisco industry has pursued a marketing
strategy apparently aimed at segmenting the pisco market in order to expand its consumer base and
raise unit profitability. This policy has taken two diff erent courses. The first of them was to develop
product categories based on alcohol strength, a strategy that was officially sanctioned by Decree-Law
78/1986. The second and more recent trend is to exte nd the line of brands of each producer. Thus, in
addition to its basic brand "Capel", Capel is now selling the "prestige" brands "Artesanos de
Cochiguaz" and "Alto del Carmen", as well as less expensive brands such as "Limarí" and "Límite".
In turn, Control's brand portfolio includes, besi des the brand "Control", the brands "Control de
Guarda", "La Serena", "Mistral", "Tres Erres" a nd "Sotaqui". The identit y of these new brands has
been built upon motives such as the place of origin of the grapes, traditional manufacturing methods,
product age claims, fancy packaging and differentiated advertising.69
4.78 The European Communities furthe r argues that most brands are sold in a wide range of
strengths, with the consequence that the number of brands/strengths now available in the market may
be close to 100, despite the fact that the two main producers account for more than 90 % of the sales.
The proliferation of new brands, each with a differe nt identity, has blurred the segmentation based on
alcohol content which the industry had attempted to build on the basis of the legal categorisation
established in Decree 78/1986. As already men tioned above, inter-brand differences in quality and
price may now be greater than intra-brand differences between strength categories.
4.79 The European Communities then concludes that in any event, pisco is by no means unique in
being sold in different types/qualities. If anything , pisco is a much more homogeneous product than
other spirits. For instance, to mention but the best known types of whisky, one may distinguish
between malt Scotch, grain Scotch, blended Scotch , Canadian, Irish, Bourbon and Rye, each with its
own specific characteristics. Moreover, within each of those types of whisky, it is still possible to

66 Chile's answers to questions from the European Communities, dated 24 February 1998
(EC Exhibit 2).
67 A copy is attached as EC Exhibit 23. The European Communities notes that additional confirmation
is provided by the price data shown in the 1997 report of The International Wine & Spirits Record (hereafter the
"IWSR Report"), pp. 80-81, Table G (EC Exhibit 19).
68 EC Exhibits 62-71.
69 See e.g. the description of Control's different brands contained in Control's Internet home page (EC
Exhibit 51).

draw further distinctions. Thus, in the case of bl ended Scotch, the trade makes a distinction between
"premium" blended Scotch (12 or more years old) and "standard" blended Sc otch (less than 12 years
old). The differences in terms of quality and price between the four varieties of pisco alleged by Chile
are not greater than those that exist between different types/qualities of whisky.
4.80 In response to a question posed by the Pa nel about product categories and comparisons, Chile
contends that there are both similarities and differences between, on the one hand, the cases of Boss
Suits/Discount Store Suits, Mont Blanc Pens/Bic Pe ns and, on the other hand, pisco and whisky or
other distilled spirits. In the cases of the suits and the pens, one product is essentially a luxury version
of the other, with corresponding differences in pri ce and presumably quality. As a result, in most
markets there is probably little substitutability be tween the products, as poor consumers cannot afford
Boss suits or Mont Blanc pens, while rich ones will not buy discount suits or pens where a choice is
available (although Chile thinks that even rich c onsumers may be more likely to use Bic Pens for
some purposes than to buy cheap suits). A hypothe tical "average" consumer of suites might see some
substitutability, but more likely would find neither a satisfactory alternative. Chile believes that the
differences in market segment and price are such that a higher tax on the luxury product would not
infringe Article III:2, even if all Boss suits were imported and all discount suits were domestically
made.
4.81 Chile goes on to argue that the case of pisco a nd other distilled spirits has some similarities,
but also some important differences. The analogy to the pens and suits cases would be more precise if
one compared a cheap, 30º pisco corriente to a high quality gran pisco, since one is a luxury version
of the other.
4.82 In Chile's view, the more appropriate analogies when comparing pisco corriente and, for
example, a good Scotch whisky or French cognac w ould be the difference between a cheap apple and
a top quality orange; Belgian endi ves and cabbage, or a cheap soybean oil and a high quality extra
virgin olive oil from Umbria. In each of these ex amples, the two different products are capable of
being used for the same purposes and, at some level of price and consumer desperation, might be used
interchangeably. However, their markets are in practice very different and they would not be
considered directly competitive or substitutable by consumers in most market s. Indeed, except when
pursuing the lowest possible taxes for its produc ts, the Scotch Whisky Association itself would
doubtless wholeheartedly reject the idea that its pro ducts were directly competitive or substitutable
with pisco corriente.
4.83 The European Communities notes that Chile's changes of analogies from vehicles to
vegetables does not help its case. Pisco corriente and "a good Scotch whisky" are compared by Chile,
respectively, to a "cheap apple" and a "top qualit y orange". However, apples and oranges were
precisely one of the examples of "directly competitive and substitutable products" cited by the drafters
of GATT. The qualification that the apple must be a "cheap" one and the orange "top quality" is
inappropriate. The present case is not just about expensive "good" Scotch and cheap pisco corriente.
It is about all kinds of whisky and of pisco. Th e European Communities has shown that the prices of
pisco and of other spirits already overlap, despite differences in taxation.
4.84 According to the European Communities, the example of "cheap soybean oil" and "high
quality extra virgin olive oil from Umbria" is flaw ed for similar reasons. The relevant comparison
would be with olive oil and soybean oil, without any further qualifications.
4.85 Also, the European Communities states that endives are not a "luxurious" product in Belgium.
Over time, they could become less expensive also in Washington DC, provided that they are not
subject to a "luxury" tax. In Europe, avocados or kiwis could have been considered as a "luxury" item
product 20 years ago. They would have remained so, had they been subjected to protective taxation.

6. Arguments on Each Factor
(a) Physical Characteristics
4.86 The European Communities argues that pisco and the other distilled spirits share the same
basic physical characteristics. All of them have the essential feature of being beverages containing
alcohol obtained from naturally fermented ingredie nts by using similar distillation processes. The
choice of raw materials from which the alcohol is di stilled and/or the use of post-distillation processes
such as ageing, colouring or flavouring confer to each type of distilled spirits its own distinctive
identity. The resulting differences, however, are no t so important as to render the various types of
distilled spirits non-substitutable with each other.
4.87 In Tables 7 and 8 below, the European Comm unities compares the physical properties and
manufacturing processes of pisco and the main t ypes of imported distilled spirits. The essential
differences between them may be summarised as follows:
(i) Raw materials: like most types of brandy ( e.g., cognac, armagnac, sherry brandy
70),
pisco is distilled from grape wine. Other spirits are made from grains (whisky, korn,
gin, vodka, aquavit, soju, shochu), pota toes (vodka, soju, shochu), sugar cane or
molasses (rum, ouzo), fruits (fruit brandies) or neutral spirits (gin, vodka, aquavit,
soju, shochu).
(ii) Colour: the colour of pisco may go from "clear" or "white" to "light amber". Whisky
and the majority of other brandy types are "amber".71 Rum, aquavit and fruit brandies
may be both "white" and "amber". Gin, vodka, ouzo and korn are generally "clear" or
"white".
(iii) Ageing: like whisky and brandy, pisco is matured in wooden casks. This
differentiates pisco from spirits such as vodka, aquavit, korn or ouzo, which are not
aged. Rum and certain types of fruit brandy may also be aged in wooden casks.
(iv) Flavouring: some spirits have specific fla vourings added during or after distillation.
For instance, gin has the distinctive feature of being flavoured with juniper berries
(v) Alcohol content: pisco is bottled at 30  to 50. Whisky, gin, rum, vodka, ouzo, korn
and aquavit, are bottled at 37/37.5 to 50. Brandy is bottled at 36  to 50 .

70 The European Communities notes that brandy can also be made from grape marc (e.g. grappa)
71 The European Communities notes that grappa is generally "white".

Table 7
72
Physical characteristics of distilled spirits

 Alcohol Strength
(% vol.)
Colour Added flavourings Body/flavour
(sensory attributes)
Whisky 37-50 Amber Yes Medium to high
Brandy 36-50 Amber/Clear* Yes Medium
Gin 37-50 Clear Yes Light to medium
Rum 37-50 Clear/Amber Yes Light to medium
Vodka 37-50 Clear Yes Light
Pisco 30-50 Clear/light amber Yes Light to medium
Soju 25-45 Clear/light amber Yes Light to medium
Shochu 20-45 Clear/ light amber Yes Light to medium
Ouzo 37.5-50 Clear Yes Medium to high
Korn 32-45 Clear No Light to medium
Aquavit 37.5-50 Clear/light amber Yes Light to medium
Fruit brandy 37.5-45 Clear*** Yes** Light to medium
* Grappa is an example of clear brandy
** Certain countries ( e.g., EC) do not permit flavourings in whisky, rum and fruit brandies
*** Except plum brandy (light amber/amber)

72 EC First Submission, Table 10.

Table 8
73
Manufacturing processes of distilled spirits
 Raw
material*
Distillation
strength (%
vol.)
Method of
distillation
Maturation in
wooden casks
Reduction
with water to
bottling
strength
Bottling
strength (%
vol.)
Whisky Grain Less than 95 Continuous or
pot still
Yes Yes 37-50**
Brandy Grapes Less than 95 Continuous or
pot still
Yes Yes 36-50
Gin Grain Neutral
spirits
At or above
95
Continuous No Yes 37-50
Rum Sugar cane /
Juices
Molasses
Less than 96 Continuous Varies Yes 37-55
Vodka Grain
Potatoes
Neutral spirit
At or above
95
Continuous No Yes 37-50
Pisco Grapes Less than 95 Pot still Yes Yes 30-50
Soju Grain
Potatoes
Neutral spirits
At or above
85
Continuous or
pot still
Varies Yes 25-45
Shochu Grain
potatoes
Neutral spirits
At or above
85
Continuous or
pot still
Varies Yes 20-45
Ouzo Molasses 55-80 Pot still No Yes 37.5-50
Korn Whole grain At or above
95
Continuous No Yes 37.5-50
Aquavit Grain
molasses
Neutral spirits
At or above
95
Continuous No Yes 37.5-50
Fruit brandy Fruits Neutral
spirits
Less than 86 Continuous or
pot still
No*** Yes 37.5-50
* Neutral spirit is an alcohol spirit distilled at no less than 95 % vol. from any material of agricultural origin.
** Many countries set a mi nimum alcohol strength of 40 % vol. for whisky, e.g., the EC, the USA and Chile. In some
countries, higher or lower min imum strength requi rements apply, e.g., Australia (37 %), Brazil (38 degrees Gay
Lussac) and South Africa (43 %). Canada sets no minimum strength for whisky.
*** Except plum brandy.

73 EC First Submission, Table 11.

4.88 According to the European Communities, the above differences are relatively minor and do
not prevent pisco and the other distilled spirits from being "directly competitive or substitutable"
within the meaning of Article III:2, second sentence. To the contrary, the degree of similarity
between pisco and other spirits is such that, even in the absence of any other evidence, it could be
sufficient for this Panel to conclude that they are "directly competitive or substitutable" products.
4.89 The European Communities considers that, indeed, some of the differences between pisco and
the other distilled spirits would not even be suffi cient to exclude a finding of "likeness". In
accordance with well-established case law, "minor differences in taste, colour and other properties
(including different alcohol contents) do not prevent products from qualifying as like products".
74 In
particular, previous panels have determined that differences in alcohol content do not, of themselves,
make two liquors "unlike". Thus, the two panels on Japan – Taxes on Alcoholic Beverages I and II
concluded that shochu was "like" vodka, even though shochu has generally a lower alcohol content. A
fortiori, differences in alcohol content cannot prevent two products from falling within the broader
category of "directly competitive or substitutable" products.
4.90 The European Communities points out that Panel Report on Japan – Taxes on Alcoholic
Beverages II noted in this regard that:
... a difference in the physical characteristi cs of alcohol strength of two products did
not preclude a finding of likeness, especially since alcoholic beverages are often
drunk in diluted form ...75
4.91 In the view of the European Communities, as ev idenced by Tables 7 and 8, the differences
between pisco and other distilled spirits are sim ilar to the differences between Japanese shochu and
other distilled spirits. For example, shochu is generally made from unmalted cereals, potatoes or
neutral spirits, unlike brandy, rum, whisky or fruit brandies; is not usually aged or coloured, unlike
brandy, whisky or rum; and has an alcohol content of 25  to 30 , unlike the main types of western
spirits, which have a strength of 37/37.5  to 50. Yet, despite those differences, shochu was found to
be directly competitive and substitutable with the ot her distilled spirits falling within HS 22.08 by the
two successive panels on Japan – Taxes on Alcoholic Beverages I and II.
4.92 According to the European Comm unities, the characteristic of being a "distilled alcoholic
beverage" is the essential feature of all the products in dispute. Even if there was no other evidence in
the record establishing the existence of actual comp etition on the Chilean market between pisco and
other spirits, the fact that all of them share that essential characteristic could, in and of itself, be
sufficient to conclude that they are objectively apt to serve the same end-uses and are therefore
"directly competitive or substitutable" within the meaning of the second sentence of Article III:2.
4.93 Chile responds that as to the much more objective question of common ingredients and
physical characteristics, it is apparent that the products share virtually no ingredients or characteristics,
other than containing alcohol. One might as read ily find trucks and bicycles to be substitutable
because both contain wheels.
4.94 Chile considers that it is not irrelevant that a ll the products in question are distilled alcoholic
beverages. However, in the evaluation whether the products are directly competitive or substitutable,
this single common characteristic is not in itself sufficient.
4.95 In Chile's view, previous panels considered that to evaluate products as being directly
competitive and substitutable, the complaining parti es need to show evidence that the products in

74 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 d).
75 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.23.

question share not only physical characteristics (such as nature and quality), but also similar end-uses,
channels of distribution and points of sale, marke ting strategies, elasticity of substitution, and price.
76
The European Communities failed to submit to the Pa nel evidence that is conclusive or reliable.
(Chile notes, for example, that in its evaluation the European Communities does not seem to take into
account that pisco is based on perishable grap es produced domestically, whereas whisky and other
distilled beverages are produced on the basis of gr ain, which can be produced, shipped and stored
anywhere.)
4.96 Chile does not consider that all physical char acteristics of the products involved need to
overlap for the products in question to be considered "directly competitive or substitutable". However,
Chile does consider that the Eur opean Communities needs to demonstr ate more than a coincidence of
one physical characteristic, in this case the alcohol content of the beverage, before claiming that
products are directly competitive or substitutable in the sense required by Article III.
4.97 The European Communities responds that together, ethyl alcohol and water account for
more than 99 % of the volume of all distilled spirits. Thus, even if Chile's assertion that pisco and
other spirits share "virtually no ingredients or char acteristics, other than containing alcohol", was true
in all cases (quod non), it would hardly be condemning. According to the European Communities, the
analogy drawn by Chile between ethyl alcohol and the wheels contained in bicycles and trucks is
manifestly inept. Wheels do not account for 99 % of the components of either bicycles or trucks.
Furthermore, the wheels of a truck are different from the wheels of a bicycle, whereas ethyl alcohol is
always the same product, irrespective of the spirit in which it is contained. Finally, unlike pisco and
the other distilled spirits, bicycles and trucks do not have similar end-uses. Someone invited to a
cocktail party in Santiago is likely to be offered th e choice between a pisco drink and a whisky drink.
If Capel or Control want to ship some pisco from La Serena to Santiago, they are unlikely to do so by
bicycle.
4.98 Chile further states that it does not deny that all spirits contain alcohol, nor that alcohol and
water account for over 99% of volume. However, it cannot be concluded from here that all such
spirits are directly competitive without much more proof.
4.99 Chile indicates that to accept that all spirits have the same end uses, because their basic
constitution is water and alcohol, is to say that the only consideration for the consumer is the alcohol,
no matter in which beverage it is contained. That is equivalent to say that pasta competes with bread,
because both of them are basically wheat flour and water.
4.100 Chile notes that distilled spirits are by no mean s the only products that share that same
characteristic. Wine and beer also contain appr oximately 99% of water and ethyl alcohol, but,
according to the European Communitie s, they are not directly competitive and substitutable. Chile
says that according to the European Communities, onl y some products that have the same intrinsic
characteristics are competitors. That is highly questionable reasoning.
4.101 Chile further states that the European Communitie s having insisted, albeit unpersuasively,
that distilled spirits should all be viewed as direc tly competitive or substitutable, it is impossible to
sympathise with claims that each producer must have a right to market its product based on its alleged
unique characteristics. The large exporters of di stilled spirits cannot condemn systems for making tax
distinctions based on arbitrary type distinctions and then turn aro und and insist that Article III not
only tolerate but actively enforce those type distinctions when that suits the interest of the exporters.
The creative effort to take the Panel through su ch mental gymnastics may warrant admiration on one
level, but does not warrant support as a matter of interpretation of Article III:2.

76 Report of the working party on Border Tax Adjustments , BISD 18S/97, para. 18; Panel Report on
Japan - Taxes on Alcoholic Beverages II, supra., paras. 6.22 and 6.28.

(b) End-uses
4.102 The European Communities argues that having the same basic physical characteristics,
pisco and the other distilled spirits are intrinsically su itable for the same end-uses. Furthermore, there
is evidence that, despite the competitive distortions caused by the current taxation conditions, pisco
and the other distilled spirits are already being em ployed by the Chilean consumers for similar end-
uses.
4.103 According to the European Comm unities, at the request of the EC spirits industry, Search
Marketing S.A., a market research consultant b ased in Santiago, conducted in December 1997 a
comprehensive survey of the drinking habits of a representative sample of spirits consumers (hereafter,
the "1997 SM survey").
77 The findings of this study show that pisco and the other distilled spirits are
drunk in similar styles, in the same occasions and places and by essentially the same categories of
consumers.
4.104 Chile argues that to accept that all spirits have the same end-uses, because their basic
constitution is water and alcohol, is to say that the only consideration for the consumer is the alcohol,
no matter in which beverage it is contained.
(i) Drinking styles
4.105 The European Communities presents Table 9 which summarises the findings of the 1997
SM survey with respect to drinking styles. 78 According to the European Communities, it shows that
pisco and the other distilled spirits are consumed in the same styles (straight, diluted with water, ice,
soft drinks or fruit juice and in cocktails), even if the order of preferences may vary.
4.106 The European Communities explains that "mixed wi th a soft drink" is the most usual style for
drinking pisco and all the other spirits, with the only exception of whisky. Nevertheless, the survey
shows that there is also substantial overlapping of end-uses between whisky and pisco: the leading
usage of whisky ("with ice") is also the third pr eference for pisco, whereas th e leading usage of pisco
("mixed with soft drinks") is the third preferred style for drinking whisky. Moreover, both whisky
and pisco are drunk "straight" and in "cocktail" by a significant percentage of respondents.

77 EC Exhibit 21.
78 1997 SM survey, at p. i and Section 4.3 (EC Exhibit 21).

Table 9
79
Drinking styles
 Pisco Whisky Gin Vodka Tequila Rum Brandy
With soft
drink
83 21 65 51 41 68 64
Lemon
("sour")
31 - - 3 11 2 2
Water - 1 8 2 5 3 -
"On the
rocks"
22 75 31 36 16 30 28
Cocktail 9 5 12 29 33 7 4
Straight 9 24 16 18 31 15 36
Other 3 1 - - - - -
Not
Applicable
/No
response
- 1 - - - - -
Basis: % of consumers of each type of spirit
(ii) Drinking occasion
4.107 According to the European Communities, Table 10 sets out the findings of the 1997 SM
survey with respect to drinking occasions. 80 It shows a marked convergence across all spirits types.
Not only are all spirits consumed in the same types of occasions, but the order of preference also tends
to be the same. Thus, at "parties" and "with friends" are mentioned as the two top preferences in
connection with pisco and all the other types of spirits, with only the exception of liqueurs.

79 EC First Submission, Table 12.
80 1997 SM survey, p. ii and Section 4.3 (EC Exhibit 21).

Table 10
81
Drinking occasions
 Pisco Whisky Gin Vodka Tequila Rum Brandy Liqueur
Parties 61 55 54 59 62 54 57 20
With
friends
59 64 77 65 72 72 65 42
Family
meetings
46 43 23 29 22 33 35 27
Week-
ends
34 24 23 35 24 18 27 6
Aperitif 15 14 8 15 8 9 9 8
After
work
10 6 8 11 4 3 6 -
During
week
8 6 8 7 4 3 6 -
Digestiv
e
7 12 6 9 6 11 9 42
Basis: % of consumers of each spirit
(iii) Drinking place
4.108 According to the European Communities, Tabl e 11 summarises the results of the 1997 SM
survey with respect to the place of consumption. 82 Again, it shows a remarkable convergence across
all spirits types. Off-premise consumption "at hom e" and at "friends' houses" stand out as the two
main preferences for drinking both pisco and all the other spirits.

81 EC First Submission, Table 13.
82 1997 SM survey, p. iii and Section 4.3 (EC Exhibit 21).

Table 11
83
Drinking places
 Pisco Whisky Gin Vodka Tequila Rum Brandy
Home 72 65 57 53 51 67 75
Friends'
house
60 58 62 55 67 61 56
Restaurant 31 18 13 16 14 9 13
Disco 20 19 26 35 28 23 14
Pub 20 16 30 42 31 18 12
Bar 12 9 1 22 14 21 5
Basis: % of consumers of each type of spirit
(iv) Consumer profile
4.109 According to the European Communities, Ta ble 12 shows that both pisco and the other
distilled spirits are widely consumed across all social and age segments.84

83 EC First Submission, Table 14.
84 1997 SM survey, p. iv (EC Exhibit 21).

Table 12
85
Consumer profile
 Socio-economic segment Age Gender
 High Middle Low 20/34 35/44 45+ Male Female Total
Pisco 93 88 97 89 96 93 91 93 92
Whisky 66 55 39 51 46 54 56 44 51
Tequila 43 43 27 58 24 17 34 42 37
Chilean
Brandy
7 17 30 19 16 25 21 19 20
Liqueur 15 15 20 19 11 18 11 25 17
Vodka 21 16 15 25 7 10 19 13 16
Rum 20 18 10 23 8 12 17 14 16
Gin 13 17 9 20 11 8 17 10 14
Brandy 1 3 2 4 - 3 3 2 3
Basis: % of consumers of each spirit
4.110 In rebuttal, Chile points out that with regard to end-u ses of different spirits, Table 9
demonstrates significant differences in the way c onsumers use the products, most notably the totally
different tendency of pisco and whisky drinkers to consume the respective products as mixed drinks.
4.111 Chile indicates that as to places of consumpti on and occasions for consumption, the survey
shows little more than that most Chilean vodka drinkers have a markedly greater tendency to consume
that product in discos and that Chileans generally pref er to consume all the different types of products
with friends (except liqueurs, which inexplicably attract a less sociable Chilean consumer). Otherwise,
this study has approximately the same probative valu e as if, in trying to decide whether meat and
bread were directly competitive or substitutable, a study were produced demonstrating that both
tended to be consumed at meal times (and with friends or family, Chile would guess).
4.112 Chile disagrees with the 1997 SM survey conclusion that "... pisco and other distilled spirits
are drunk in the same styles, in the same occasions and places and by essentially the same categories
of consumers". While it is not Chile's aim to rebut each one of these findings, Chile disagrees that
these findings (even if they were true) are conclu sive of "direct competition or substitutability" as
required by GATT Article III:2, second sentence.
4.113 Chile argues that following the EC's reasoning, it must conclude that all type of food are
directly competitive, because they are eaten basically by the same category of consumers (actually
everybody has to eat), in the same occasions and places (home, friend's home, restaurants, etc) and is
consumed in the same styles (cooked, raw, mixed with other food).

85 EC First Submission, Table 15.

4.114 Chile further casts doubt on the conclusions drawn by the European Communities regarding
drinking style. As it can be seen from Table 9, pi sco is mostly drunk with a soft drink (83% of
consumers) while whisky is mostly drunk "on the rocks" (75%); 31% of consumers drink pisco as a
"sour drink", while the closer spirit would be tequi la, with a mere 11% of its consumers. Table 9
shows that drinking styles are shared (actually it w ill be difficult to discover another drinking style),
but nobody could draw the conclusion that all distilled spirits are similarly drunk.
4.115 The European Communities contests Chile's argument that, in an y event, the responses to
the EC consumer surveys "do not establish that the products are directly competitive or substitutable".
For instance, contrary to the claims of Chile, Ch ilean vodka drinkers do not "have a markedly greater
tendency to consume that product in discos". In fact, according to the 1997 SM survey, consumption
of vodka at discos only comes fourth after consumption "at home", "at friends' places" and "at pubs".
4.116 In the view of the European Communities, th e survey data concerning places of consumption
are by no means irrelevant in order to establish substitu tability. That type of information is regularly
tracked by the spirits industry for marketing purpo ses. Further, the European Communities notes that
Korea built its unsuccessful defence in the recent Korea – Taxes on Alcoholic Beverages case on the
allegation that soju was drunk in different places than western spirits.
4.117 According to the European Communities, the fa ct that Chilean consumers prefer to drink
spirits "with friends" is also far from irrelevant. This points to one of the specific uses which
distinguish distilled spirits from othe r beverages: promoting socialisation. While many people prefer
to drink spirits with friends, most people would answer that they drink water when they are thirsty and
not when they are with friends.
(v) Advertising
4.118 The European Communities points out that when it markets its product, the pisco industry
appears to entertain no doubts with respect to the su bstitutability of pisco with other distilled spirits.
Quite to the contrary, pisco's promotional claims te nd to emphasise the similarity of pisco with other
distilled spirits, both in terms of physical characteristics and usage.
4.119 According to the European Communities, by wa y of example, Control's Internet homepage
answers to the question "what is pisco?" with the following description of its characteristics:
Combine the dryness of Gin, the versatility of Vodka, the raciness of Rum and the
bouquet of a delicate Cognac and you will discover the only distillation with this
unique and aromatic result.
86
4.120 According to the European Communities, also in its Internet homepage, Control describes the
end-uses of pisco as follows:
The distinct flavour and fresh aroma of Pisco control can be enjoyed by itself, on the
rocks, with lemon or fruit juice, your favourite cocktail or mix as well as with popular
soft drinks.87
4.121 The European Communities points out that the ve rsatility of pisco is also emphasised in the
drink recipe brochures ( recetarios) distributed by Control and Capel in Chile and abroad. 88 Those

86 EC Exhibit 53. The European Communities notes th at the same claim is made in Control's recipe
brochure (EC Exhibit 51). It is worth noting that Cont rol makes the same claim in the Spanish version of its
home-page.
87 EC Exhibit 53.

brochures promote the use of pisco in the same styles that are also characteristic of the other distilled
spirits: straight, on the rocks, with lemon or fruit juice, or with cola or soda.
4.122 The European Communities further notes that th e recipe brochures of both Capel and Control
go as far as to recommend the use of pisco in place of other distilled spirits that are customarily used
in well-known mixed drink recipes. Thus, for exam ple, Capel suggests preparing "caipirinhas" with
pisco instead of cachaca (so-called "pisquinhas"), Ma nhattans with pisco instead of whisky (so-called
"Chilean Manhattan"), or "margaritas" with pisco instead of tequila. Similarly, Control's brochure
provides recipes for preparing "pisco tonics" and "Control Manhattans".
4.123 Chile challenges the EC argument, saying that the European Communities also looks to the
internet for examples of common styles of adve rtising. Ironically, the European Communities
chooses to quote a pisco producer who concludes by calling pisco "the only distillation with this
unique and aromatic result". If the European Comm unities will scan further in the Internet, Chile
believes the European Communities will discover th at everything a human being can ingest is
advertised in rather similar terms on the internet.
4.124 The European Communities further responds that it has failed to find any Internet
information showing that the Chilean farmers make advertising claims in the Internet comparing the
"versatility" of milk to that of vodka or the "bouquet" of garlic to that of a "delicate Cognac".
(c) Tariff Classification
4.125 The European Communities notes that pisco and all the other distilled spirits fall within the
same HS heading, namely HS 22.08.
4.126 The European Communities points out that non- alcoholic beverages, as well as alcoholic
beverages obtained by fermentation such as beer or wine fall within other HS positions. As
mentioned above, the characteristic of being a "distill ed alcoholic beverage" is sufficient to establish
that all spirits have common end-uses and, ther efore, that they are "directly competitive or
substitutable".
4.127 The European Communities further points out that within HS Chapter 22, HS 2208 is at the
same level as the tariff positions for non-sweeten ed or flavoured water (HS 2201), flavoured or
sweetened water (HS 2202), beer (HS 2203), wine (HS 2204) vermouth (HS 2205) and vinegar (HS
2209). Arguably, each of those products constitutes (at the very least) a single category of "directly
competitive or substitutable products".
4.128 The European Communities explains that th e sub-headings within HS 2208 correspond each
to a well known type of spirit. The reason why spec ific sub-headings were created for those spirits,
and not for the other spirits, was simply that brandy, whisky, gin, vodka, rum and liqueurs are the
spirits which are internationally traded in largest volumes. Thus, in the 1996 HS a new tariff sub-
heading was created for vodka, which previously ha d been classified into the residual "other" sub-
heading, in recognition of the growing trade in that spirit.
4.129 In rebuttal, Chile states that it concedes the obvious point that all distilled spirits share a
common tariff category, however, a point which is of virtually no legal significance. It is obvious that
two products falling within the same four digit HS category are not necessarily "directly competitive

88 EC Exhibits 50 and 51. The European Communities notes that the recipe brochures of Capel and
Control are very similar to the promotional brochures published by the Scotch Whisky Association attached as
EC Exhibit 55. According to the European Communities, that similarity constitutes a further indication of
substitutability between pisco and whisky.

or substitutable" because applying this reasoni ng, oxygen and arsenic should be considered
"substitutable" because both fall u nder HS 2804; the same could be said then to aviation gas and
vaseline white oil (HS 2710); mack erel and caviar (HS 1604) lobster and crabmeat meal (HS 0306);
and ivory and nails (HS 0507). Therefore this evidence should also be rejected.
(d) Channels of Distribution
4.130 The European Communities notes that Table 13 below sets out the findings of the 1997 SM
survey
89 with respect to the availability of pisco and ot her distilled spirits in different sales channels.
It shows that all different types of premises market both pisco and all the other spirits and that, for all
of them, the preferred sales outlets are the same (supermarkets and liquor stores).
Table 1390
Retail purchase outlets
 Pisco Whisky Liqueur Brandy Tequila Gin Rum Vodka
Super
market
61 65 61 47 50 58 46 47
Liquor
store
41 26 32 39 40 43 34 43
Gift shop 3 8 6 9 5 7 6 -
Duty free 1 7 3 - 2 - 9 2
Grocery 4 1 - 5 4 - - 3
Air lines - 1 - - 1 3 2 -
Other 3 6 9 - 8 - 8 7
Basis: % of consumers of each spirit
4.131 According to the European Communities, a fu rther indication of substitutability between
pisco and other distilled spirits is the similarity of their presentation in retail outlets. A selection of
photographs taken from 6 retail ou tlets in Santiago in mid 1997 91 evidence that pisco and other spirits
are shown to consumers in the same shelf space areas. This shelving is responsive to the consumers'
need to make choices among substitutable products.
4.132 Chile points out that as to distribution channels, the European Communities puts great
weight on the tendency of supermar kets to show pisco on shelves near whisky and other distilled
spirits. One might on that basis argue that toot hpaste and soap are substitu table, because they share
shelf space.
4.133 The European Communities states that it does not put "great weight" on the fact that
Chilean supermarkets tend to show pisco on the sa me shelves as whisky and other distilled spirits.
The European Communities referred to that tende ncy as an additional indication of competition,

89 1997 SM survey, p. iii and section 4.3 (EC Exhibit 21).
90 EC First Submission, Table 16.
91 EC Exhibit 56.

among many other indications mentioned in its subm ission. For instance, the European Communities
has produced detailed survey evidence showing comm onality of distribution channels. The European
Communities doubts that Chile would consider it irrelevant if whisky and pisco were generally sold at
opposite corners of supermarkets. Finally, altho ugh toothpaste and soap may share shelf-space in
some cramped night shop patronised by busy lawyers in Washington DC, they tend to be displayed
separately in larger supermarkets.
4.134 Chile contests the EC statement that "evidence that two products are sold in the same
channels .... can be taken as evidence that they ar e 'directly competitive and substitutable'." Common
distributions channels are not strong evidence, and multipurpose channels are weaker still than
dedicated channels, such as gas stations or pharmacies . Supermarkets are, by no means, a "dedicated
channel", and finding that two products are sold main ly at supermarkets, doesn't prove anything about
their competitiveness.
4.135 Chile further states that even if it considers de dicated distribution channels, like gas stations
or pharmacies, it is hard to concl ude that two products sold through those channels are substitutable.
For instance, medicines sold only through pharmaci es are usually non-substitutable, as are gas and
lubricants sold primarily at gas stations.
4.136 In Chile's view, in the case of liquor stores, the only dedicated channel that could be
considered, besides spirits, they sell wine, beer and soft drinks (snacks and some confectionery could
also be added to this list).
4.137 Chile explains that it has requested AC Niel sen, a marketing research firm, to provide
information on distribution channels employed in Chil e by different type of food industries, pisco and
whisky. The results are shown in Table 14 below.
Table 14
92

Distribution Channels

Product Supermarket Traditional
tea 76.6% 23.4%
tomato sauce 76.0% 24.9%
rice 83.1% 16.9%
pasta 76.7% 23.3%
hot pepper sauce 77.3% 22.7%
pisco 46.2% 53.8%
whisky 66.0% 33.3%
 Source: AC Nielsen

4.138 Chile considers from these data that it can ob serve, that roughly 80% of tea, tomato sauce,
rice, pasta and red pepper is sold in supermarkets, while the remainder is sold through what they call
"traditional" channels. It is more than obvious that these products are not competitors or substitutable
among themselves, yet they share basically the same distribution channel.
4.139 Chile further states that other important information provided by AC Nielsen, is that 46.2% of
pisco is sold in supermarkets, while 53.8% is sold by the "traditional" channels. In the case of whisky,
66% is sold through supermarkets and only 33% through "traditional" channels. This is not surprising,
because whisky is primarily consumed by the wealth ier segment of population, while pisco is a more
popular spirit.

92 Chile Oral Statement at the Second Substantive Meeting, Table IV.

4.140 According to Chile, comparing AC Nielsen's and Search Marketing's outcome results, one
could question the accuracy of Search Marketing's fi ndings, that tell us that 61% of pisco is sold
through the supermarkets.
4.141 Chile indicates that it disagrees with the EC's poi nt regarding supermarket shelving. Despite
the EC's argument, the fact is that in Chilean Supe rmarkets lot of products that are, by no means,
substitutable (as soap and toothpaste) share the same shelves.
(e) Price Differentials
4.142 In rebuttal to the EC argument, Chile stresses the price differentials between pisco and
other distilled spirits using Table 15 below.

Table 15
93

Product Duty
Free
Price
US$
Alcohol
Content
(°)
Chilean
Custom
Duties
Price including
Chilean Duties
US$
New
Chilean
System
Price including
new tax system
US$
1 2 3 4 5 6 7
Whisky J W Red 10.96 43 11% 12.17 47% 17.88
Whisky J W Black 24.11 43 11% 26.76 47% 39.34
Whisky J W Gold 52.00 43 11% 57.72 47% 84.85
Whisky J W Blue 144.00 43 11% 159.84 47% 234.96
Canadian Club 11.41 40 0% 11.41 47% 16.77
Jack Daniels 14.07 45 11% 15.62 47% 22.96
Tequila (Cuervo) 11.97 38 0% 11.97 39% 16.64
Grappa 10.80 40 11% 11.99 47% 17.62
Pisco Especial 2.86 35 11% 2.86 27% 3.63
Pisco Reservado 3.89 40 11% 3.89 47% 5.72
SOURCES: Pisco prices from Chilean Industries.
 Prices of other products, from Pe ter Justessen Catalogue, 1998 edition.
Note: All prices are referred to 1 litre bottle.

4.143 Chile emphasises that pisco, in any of its different varieties, has a pre-tax price (i.e., duty free)
that is substantially lower than that of whisky. As column five of Table 15 shows, whisky (at a price
including Chilean custom duties of US$12.17) is 3.1 times more expensive than a pisco of same
alcohol strength (price of US$ 3.89). The same column shows that when comparing whisky with
Pisco Especial (35º strength) the price of the former is more than 4.2 times more expensive.
4.144 Chile further points out that the price difference between whisky and pisco of the same
strength is not altered when comparing prices incl uding the New Chilean System. Indeed, column
seven of the chart, shows that the price of whisky (US$ 17.88) remains 3.1 times more expensive than
pisco of same strength (price US$ 5.72). The price differential is so big that it is no wonder that
consumers, particularly in a country of relatively low incomes, prefer low cost spirits.
4.145 The European Communities responds that Table 15 is incomplete and misleading. It
compares the prices of a relatively expensive brand of whisky (Johnnie Walker) to what appears to be
the price of a relatively inexpensive brand of pisco. Furthermore, the prices are at different levels of
trade and, therefore, not comparable. The prices fo r whisky are retail prices (presumably in Chile), as

93 Chile Oral Statement at the First Substantive Meeting, Annex I.

shown in the catalogue of a supplier of duty free good s to the diplomatic trade, and include not only
freight and insurance but also what appears to be a rather substantial margin for the distributor. In
contrast, the prices for pisco are producers' prices at ex factory level.
4.146 The European Communities argues that both pisco and the other spirits are sold within a wide
range of prices. As shown in Table 16 below, th e price differences within the category of pisco may
be as large, both in absolute and in relative term s, as the price differences between pisco and whisky
shown in Chile's table. The European Communities cl aims that Chile does not appear to contest that
all types and brands of pisco constitute a single product and compete with one another.
Table 16
94
Retail prices of pisco, February 1997
Brand Price (pesos) Price difference index
Valle del Limarí 30 % 869 1
Capel 30 % 999 1.15
Tres Erres 32 % 1,459 1.69
Bauza 30 % 2,468 2.84
Control 35 % 1,295 1.49
Capel 35% 1,458 1.68
Control de Guarda 35 % 2,389 2.75
Alto del Carmen 35 % 2,458 2.83
Bauza 35 % 2,480 2.85
Control 40 % 1,519 1.75
Capel 40 % 1,588 1.83
Control de Guarda 40 % 2,699 3.11
Alto del Carmen 40 % 2,998 3.45
Bauza 43 % 3,628 4.17
Alto del Carmen 46 % 3,798 4.37
Chenaral 46 % 4,790 5.51
Source: ISWR Report, EC Exhibit 19, pp. 80-81
4.147 The European Communities further argues that pisco is not less expensive than other spirits.
Table 17 below evidences that, despite the price dist ortions caused by the differences in taxation, the

94 EC Response to Questions asked at the First Substantive Meeting, Table 1.

prices (tax included) of pisco overlap with the prices (tax included) of other types of spirits (including
whisky) which are more heavily taxed.
Table 17
95
Range of retail prices (including tax), February 1997
Spirit Lowest price (pesos) Highest price (pesos)
Pisco 869 4,790
Gin 2,175 5,580
Vodka 2,545 8,050
Rum 1,490 6,838
Brandy 1,375 114,900
Tequila 3,180 5,490l
Whisky 3,550 34,690
Source: ISWR Report, EC Exhibit 19, pp. 53-54, 58, 62, 65, 70, 75-76, 80-81
4.148 The European Communities also argues that in any event, a comparison of absolute price
differences is of limited value in order to establish whether two products are actually competing on a
given market. Basic economic theory tell us that it is more relevant to look at the response of
consumers to changes in the relative prices of the pr oducts, i.e., to their rate of cross-price elasticity. 96
The European Communities claims that it has provi ded to the Panel ample evidence (including two
studies commissioned by the pisco industry itself) s howing that there is a significant degree of cross-
price elasticity between pisco and the other spirits and, therefore, that they are directly competitive or
substitutable.
4.149 The European Communities adds that in the pr esent case, absolute price differences are even
less relevant in view of the nature of the produc ts concerned. Distilled spirits are consumer goods
which have a small value relative to income and ar e purchased many times over a short period of time.
This means that, even if one spirit was much mo re expensive than the other, a relatively small
decrease in the price of the more expensive one could be sufficient for consumers to increase the
number of occasions in which they drink that spirit instead of the less expensive one.97
4.150 The European Communities further alleges that absolute price differences can be the
consequence of the measures in dispute. A comparison of pre-tax prices is not sufficient to remove all
the distortions which a protective system of taxation may have caused over a long period of time. For
example, one of the effects of a protective system of taxation may be to favour the sale of premium
brands of imported spirits over less expensive brands . Also, protective taxes limit the sales growth of
the imported spirits and keep their selling and distri bution expenses at an artificially high level as
compared to domestic products sold in larger volumes.98

95 EC Response to Questions asked at the First Substantive Meeting, Table 2.
96 Panel Report on Korea - Taxes on Alcoholic Beverages, supra., para. 10.94.
97 See ibid., paras. 10.74 and 10.91.
98 Ibid., para. 10.93 and fn. 410.

4.151 The European Communities finally recalled that absolute price differences can be the
consequence of conjunctural factors such as movements in the exchange rates.
99
4.152 In response, Chile explains that its intention in providing Table 15 above was twofold: (1) to
illustrate for the Panel the significant price differen ce between pisco and whisky; and (2) to illustrate
for the Panel the disproportionately greater burde n imposed on a low-priced product by the use of a
specific tax (in this case the tax levied by some EC countries on alcohol), measured in ad valorem
terms.
4.153 Chile considers that the most accurate basis fo r comparing the prices in Chile of pisco and
whisky should be between ex-factory price of pisco, and the after customs duty price of whisky (CIF
+ import duties) in Chile. That comparison excludes any mark-up in the distribution channel.
4.154 Chile adds that the ex-factory prices of pisco ar e, on average, US$ 2.60 for pisco of 30º to 35º,
and US$ 3.60 for pisco of 40º to 46º. For importe d whisky the average CIF price, in 1997, according
to Central Bank of Chile statistics, was US$ 5.55. Adding an 11% ad valorem import duty, the
average after customs price of whisky was US$ 6.16.
4.155 Chile goes on to argue that these price differen ces between whisky and pisco are thus very
significant, almost double between whisky and high alcohol pisco, and more than double between
whisky and low alcohol pisco.
4.156 Further, Chile points out that it is unlikely that these prices are distorted by levels of trade in
any material way. While much more pisco than wh isky is sold in Chile, whisky is still imported in
substantial quantities. Further, far more whisky th an pisco is produced in the world, and that ample
production would presumably allow superior economies of scale for whisky.
4.157 Also, in Chile's view, the European Commun ities also affirms that "Distilled spirits are
consumer goods which have a small value relative to income ..." and interprets this to mean that "even
if one spirit was much more expensive that the othe r, a relatively small decrease in price of the more
expensive one could be sufficient for consumers to increase the number of occasions in which they
drink this spirit instead of the less expensive one". This is highly speculative on the part of the
European Communities and thus far remains unproven.
4.158 Further, Chile contests the EC statement with r espect to "... the distortions which a protective
system of taxation may have caused over a long period of time. For example, one of the effects of a
protective system of taxation maybe to favour the sale of premium brands of imported spirits over less
expensive brands". First, the effects of a repealed system are not relevant. Second, because even the
previous Chilean tax system operated on an ad valorem bases, there was no distortion in favor of
more expensive brands.
4.159 Finally, Chile disagrees with the EC's table of retail prices of pisco, which purports to show
an overlap between pisco and whisky. Chile argues that this is misleading, and points out that the
table does not reflect the fact that most pisco sold in Chile has a price of less that 3,000 pesos. In fact,
there is very little overlap except for premium piscos, which will also generally be taxed at the same
rate as whisky when the New Chilean System takes effect in December of 2000.

99 Ibid., fn. 410.

(f) Cross-Price Elasticity
(i) Market developments
4.160 The European Communities alleges that sales of pisco have consistently tracked changes in
factors that have a direct impact on the prices of ot her spirits (and in particular of whisky) but not on
the prices of pisco itself, such as ch anges in the ILA rates applied to those spirits, changes in the level
of the import duties on distilled spirits and fluctuations of the exchange rate between the Chilean peso
and the US dollar. This evidences that the demand fo r pisco is responsive to changes in the prices of
the other spirits and, therefore, that they are directly competitive or substitutable products.
4.161 According to the European Communities, the Chilean spirits market is largely dominated by
pisco. As set out in Table 18 below, in 1996 sales of pisco accounted for as much as 74
 % of the total
quantity sold in that market. The same table show s that sales of pisco have increased considerably
(by more than 400 %) since the early 1980s.100

100 The European Communities also refers to IWSR Report, p. 77, Table A (EC Exhibit 19).

Table 18
101
Chilean spirits market 1982 – 1996: sales (thousands of litre) and market share*
 1982 1984 1986 1988 1990 1992 1994 1996
Pisco
Sales
Share

1,100.00
44.1 %

1,600.00
59.0 %

2,075.00
68.8 %

2,650.00
70.4 %

3,190.00
72.5 %

3,675.00
70.6 %

4,347.00
72.9 %

4,501.00
73.8 %
Whisky
Sales
Share

497.00
19.9 %

258.00
9.5 %

223.50
7.2 %

249.00
6.6 %

224.50
5.1 %

224.50
4.3 %

249.50
4.2 %

264.00
4.3 %
Vodka
Sales
Share

48.00
1.9 %

52.00
1.9 %

52.00
1.7 %

52.00
1.4 %

54.00
1.2 %

65.00
1.2 %

79.00
1.3 %

93.00
1.5 %
Gin
Sales
Share

55.00
2.2 %

59.00
2.2 %

56.00
1.8 %

55.00
1.5 %

56.00
1.3 %

63.50
1.2 %

70.00
1.2 %

56.50
0.9 %
Rum
Sales**
Share**

54.00
2.2 %

50.00
1.8 %

48.50
1.8 %

53.00
1.4 %

61.75
1.4 %

80.50
1.5 %

99.50
1.7 %

101.00
1.7 %
Brandy
Sales
Share

55.00
2.2 %

80.00
2.9 %

130.50
4.2 %

164.00
4.4 %

209.00
4.7 %

265.25
5.1 %

289.25
4.8 %

194.50
3.2 %
Tequila
Sales
Share

1.00
0.0 %

Nil

0.25
0.0 %

1.25
0.0 %

3.75
0.1 %

14.00
0.3 %

32.50
0.5 %

72.50
1.2 %
Liqueur
Sales***
Share***

347.00
13.9 %

318.50
11.7 %

291.50
9.4 %

249.50
6.6 %

262.25
5.7 %

260.00
5.0 %

245.50
4.1 %

230.00
3.8 %
Other
Sales
Share

340.00
13.6 %

295.00
10.9 %

230.00
7.4 %

290.00
7.7 %

340.00
7.7 %

560.00
10.75 %

555.00
9.3 %

585.00
9.6 %
Total 2,497.00 2,712.50 3,107.25 3,763.25 4,401.25 5,207.75 5,967.25 6,097.50
* Source: ISWR report (EC Exhibit 19)
** Includes cachaca
*** Includes liqueurs, bitters, aperitifs, aniseed and fruit eaux de vie

4.162 The European Communities notes that all pisco sold in Chile is, by definition, produced
domestically. Imports of pisco from Peru and other sources (which must be sold as aguardiente) are
marginal.102

101 EC First Submission, Table 9A.
102 IWSR Report, p. 78, Table C.1 (EC Exhibit 19).

4.163 The European Communities further states that whisky is the best selling spirit after pisco. As
shown in Table 18 above, in 1996 sales of whisky accounted for 4.3
 % of the spirits market.
Domestic production of whisky is negligible. 103 It can be estimated that imports represent
approximately 94 % of total sales of whisky. 104 In turn, Scotch whisky accounts for 95 % of all
imports.105
4.164 The European Communities also notes that until the mid-1970's, imports of whisky remained
very small. Thus, in 1975 imports of Scotch wh isky amounted to barely 165 thousand litres, based on
UK Customs and Excise Export Statistics. 106 During the second half of the 1970s, imports of whisky
grew spectacularly. As of 1981, when they peaked , sales of Scotch whisky had reached a volume of
5.9 million litres. 107 This increase was the result of a combina tion of factors. In the first place, the
progressive reduction of import tariffs from 80 % at the beginning of 1976 to 10 % as of May 1979.108
Second, a parallel reduction in the ILA from 40 % plus the recargo in 1974 to 30 % in 1977, i.e., only
5 percentage points more than the rate on pisco , as Table 6 above. Finally, imports of whisky
benefited from a rapidly expanding economy with ve ry high growth rates as well as, between 1979
and 1981, from a strong peso pegged to the US dollar.109
4.165 The European Communities further asserts that dur ing the first half of the 1980s this trend
suffered a dramatic reversal. In 1982, th e Chilean economy entered into a deep recession 110 and the
peso underwent the first of a series of devaluations.111 Import duties on distilled spirits were increased
from 10 % to 20 % in 1983 and again to 35 % the following year.112 Last but not least, the ILA rate on
whisky was raised to 50 % in 1983, to 55 % in 1984 and to 70 % in 1985, thus increasing the tax
differential between pisco and whisky from 5 to 45 percentage points in less than two years, as shown
in Table 6 above. The imposition of higher tax es and import duties, allied to the new macro-
economic environment, had a devastating effect: sales of Scotch whisky dropped from 5.9 million
litres in 1981113 to just under 1.3 million litres in 1985114, i.e., by nearly 80 %.
4.166 According to the European Communities, Chile emerged from the recession in 1987 115 and
import duties were lowered to 11 % as of 1991.116 But the remaining tax differential, together with the
market dominance gained by pisco in the meantime , have so far prevented whisky from recovering its
former position. By 1996 sales of whisky still represented merely 39 % of the volume sold in 1981117,
and this despite a considerable increase in the ove rall demand for spirits. As a result, as set out in
Table 18 above, the market share of whisky shrank from 20 % in 1982 to just 4 % in 1996.
4.167 Further, the European Communities states that meanwhile, pisco sales have consistently
moved in the opposite direction. Between 1976 and 1981, pisco suffered from the spectacular
increase in whisky imports. Although sales of pisco c ontinued to grow in absolute terms, they did so

103 IWSR Report, p. 43, Tables A and A.1 (EC Exhibit 19).
104 Ibid.
105 Ibid.
106 EC Exhibit 57.
107 IWSR Report, at p. 43, Table A. (EC Exhibit 19).
108 EC Exhibit 57.
109 EC Exhibit 61.
110 The European Communities refers to EC Exhibit 58, and also to the IWSR report, p. 6 (EC
Exhibit 19).
111 The European Communities refers to EC Exhibit 61.
112 EC Exhibit 57.
113 IWSR Report, page 43, table A (EC Exhibit 19).
114 Ibid.
115 EC Exhibit 60.
116 EC Exhibit 57.
117 IWSR Report, page 43, table A (EC Exhibit 19).

at a much lower rate than the sales of whisky.
118 In 1982, when Chile was hit by recession, sales of
pisco fell by 20 %.119 In reaction to this, the pisco industry stepped up the pressure to obtain
additional protection against imports of whisky . As explained above, the Chilean authorities
responded to those demands with a series of successi ve increases in the import duties and in the ILA
rates on whisky. These measures proved highly effective. While sales of whisky continued to decline
until 1986 and stayed relatively flat thereafter 120, sales of pisco began to increase again in 1983 and
by 1984 had already exceeded their 1981 level. 121 Furthermore, the additional protection afforded by
the increase in tariffs and taxes on whisky allowed th e pisco industry to capture most of the growth of
the spirits market that took place during the fo llowing decade as the Chilean economy resumed its
rapid expansion. As a result, the market share of pisco increased from 44 % in 1982 to 74 % in 1996,
as shown in Table 18 above.
4.168 Referring to these tables, the European Commun ities further notes that liqueurs are the third
largest type of spirits in terms of sales volume, with approximately 4 % of the market. Most liqueurs
sold in Chile have a relatively low alcohol content. As shown in Table 5 above, all liqueurs (with the
only exception of anisettes) have a legal minimum strength below 35 . Imports represent less than
10 % of total sales. Together, vodka, gin and rum hold a further 4 % of the market. Imports account
for a substantial proportion of their sales: 36% of gin, 41 % of vodka and 55 % of rum. Despite the
considerable overall increase in demand for spirits, sales of these three types of spirits have grown
only moderately, with the consequence that they have all lost market share since the early 1980's, as
shown in Table 18 above.
4.169 The European Communities states that tequila entered into the Chilean market at the
beginning of the 1990's. Although it has enjoyed a considerable success, especially among young
consumers, it still represents under 2 % of the market. All sales of tequila are imported from Mexico,
as shown in Table 19 below.

118 The European Communities refers to IWSR Report , p. 77, Table A (EC Exhibit 19), and for the
period before 1980, to EC Exhibit 59.
119 IWSR Report, page 77, table A (EC Exhibit 19).
120 IWSR Report, page 43, table A (EC Exhibit 19).
121 IWSR Report, p. 77, table A (EC Exhibit 19).

Table 19
122
Sales of domestic spirits v. imports in 1996 (000 9 litre cases)*
 Domestic % Imported %
Pisco 4,501.00 100 Nil 0
Whisky 17.00 6.4 247.00 93.6
Vodka 55.00 59.1 38.00 40.9
Gin 36.00 63.7 20.50 36.3
Rum** 45.00 44.6 56.00 55.4
Brandy 190.00 97.7 4.50 2.3
Liqueur*** 208.50 91.0 20.5 9.0
Tequila Nil 0 72.5 100
Other 585.00 100 Min 0
Total 5,637.5 92.5 459.00 7.5
* Source: ISWR report (EC Exhibit 19)
** Includes cachaca
*** Includes liqueurs, bitters, aperitifs, aniseed and fruit eaux de vie

4.170 According to the European Communities, brandy accounts for approximately 3 % of the
spirits market. Domestic production represent nearly 98 % of the sales. The vast majority of
domestic sales are of the brand "Tres Palos", with an alcohol content of 38.
4.171 The European Communities concludes that, as al ready explained, the sales and market share
of pisco have consistently tracked changes in factor s that have a direct impact on the prices of the
other spirits, but not on the prices of pisco itself. Those changes include not only the changes in
internal taxation, but also changes in import duty rates and exchange rate fluctuations between the
Chilean Peso and the US dollar. This evidences that the demand for pi sco is responsive to changes in
the prices of other spirits and, therefore, that they are directly competitive or substitutable.
4.172 The European Communities adds that the correspondence between the sales/market share of
pisco and the prices movements of the other spirits is particularly noticeable during the period 1982 -
1986, where the changes in the prices of the othe r spirits were most dramatic (The European
Communities claims that a large portion of that peri od is not covered by the regression provided by
Chile).
4.173 The European Communities also explains that the correspondence is more easily observable
in the case of whisky than in the case of "other spirits". Several reasons may account for this. In the
first place, the tax increases were larger in the cas e of whisky. Second, "other spirits" started from a

122 EC First Submission, Table 9B.

smaller base than whisky. In rela tive terms, however, the loss of mark et share experienced by "other
spirits" is far from negligible. Gin and rum, for instance, suffered an 18
 % share loss between 1982
and 1986. Finally, "other spirits" include a larger share of domestic production, which was not
affected by changes in import duties and exchange rates.
4.174 In rebuttal, Chile contends that it should be noted that Tabl e 18 is not based on any official
statistics. Further, the European Communities with this chart atte mpts to prove that products are
directly competitive or substitutable by assuming that they are directly competitive or substitutable,
since the EC chart assumes a single market compo sed of the sum of the sales of each different
distilled spirit. Thus, the EC's economic logic is highly faulty.
4.175 Chile analyses the evolution of the consumption of whisky and pisco on the basis of the data
provided by the European Communities. Chart 1 be low shows for whisky the changes in per capita
consumption and prices during the pe riod 1982-1986. As can be seen , during this period the price of
whisky in real terms, that is, adjusted for intern al inflation, rose 67%. Per capita consumption of
whisky in this same period fell by 64%. No one should be surprised that consumption of a product
fell as its price rose in this fashion.
Chart 1
WHISKY: PRICE AND CONSUMPTION PER CAPITA
Base 1982 = 100
0
20
40
60
80
100
120
140
160
180
1982 1983 1984 1985 1986
Price Consumption per Capita

4.176 According to Chile, Chart 2 shows the changes in price and per capita consumption of pisco
during the same period 1982-1986. As can be seen, durin g this period the price of pisco in real terms
fell by 35% and consumption per capita rose 69%. It is similarly not surprising that a product whose
price significantly declines, increases in consumption.

Chart 2
PISCO: PRICE AND CONSUMPTION PER CAPITA
Base 1982 = 100
0
20
40
60
80
100
120
140
160
180
200
1982 1983 1984 1985 1986
Price Consumption per capita

4.177 In Chile's view, the increase in the price of whis ky during the period in question, is a result of
three principal factors: the depreciation of the Chilean currency, the increase of tariffs and the
increase of the tax on whisky. It analysed each factor independently:
(i) Depreciation of the Chilean currency: During the period from 1979 to 1982, the
Chilean peso maintained a stable relation with the dollar (Ch$ 39 = US $1). As a
result the crisis of the balance of paymen ts and other macro-economic factors, the
Chilean peso fell 88% between mid 1982 (whe n the first series of declines occurred)
and the end of 1986.
(ii) Increase of tariffs: In 1982, the import tari ff on whisky was 10 percent. The tariffs
increased to 20 % in 1983, 35 % in 1984 and then were reduced to 20 % in 1985. In
short, between the year of 1982 and 1986, there was a net increase in tariffs that
increased the final price of the imported products by 9.09
 %.
(iii) Increase in the taxes on liquor: In 1982 the tax that applied to whisky was at a rate of
30 %. These rates increased to 50 % in 1983, 55 % in 1984 and 70 % in 1985. In
short, the effect of the increase in taxes on whisky in the period of 1982 to 1986 was
to increase the price to the consumer by 30.8 percent.
4.178 Chile argues that taking into account of all th ese elements already in dicated, there was an
increase in the price of whisky - ceteris paribus - of 168 percent, most of which was caused by factors
having nothing to do with the increase in the tax on whisky. As it could be seen, not all of this
increase was transferred to consumer prices. This suggests a diminution of margins, an increase in the
local production of whisky and an increase in lowe r priced imported whisky, or some sort of a
combinations of these factors. In addition, the pri ce of pisco in Chile fell considerably, even though
the tax on pisco did not change during the period in question.
4.179 Chile adds that as to other types of distilled sp irits, it is not in a position to provide a similarly
detailed assessment because of the wide variety of domestic and imported spirits included in that

category. However, as in the case of whisky and pi sco, it would not be valid to assume that sales of
this array of domestic and importe d products held a relatively steady share of a hypothetical "distilled
spirits" market because the tax remained steady. Within that group, Chile can imagine that there
would have been a wide range of price effects, on individual types of domestic and imported spirits.
4.180 Chile also contests the EC statement that the period from 1982 to 1986 was not covered in the
regression study of Chile. Chile included in its regression study the period from 1983 to 1997, thereby
taking into account almost all the period of time in question. By contrast, the EC's study covered a
shorter period and the European Communities has presented only partial results of that study.
4.181 Chile further notes that the European Communiti es states that "the sales and market share of
pisco have consistently tracked changes in factors th at have a direct impact on the prices of the other
spirits, but not on the prices of pisco itself ... Th is evidences that the demand for pisco is responsive
to changes in the prices of the other spirits ..." The European Communities erroneously implies that
the changes in the sales of pisco wo uld be exclusively explained by the changes in such factors and
their effects on the prices of the other spirits, and not because of changes in the price of pisco. The
reasoning followed by the European Communities underestimates a fundamental aspect: if the price of
a good diminishes, the demanded quantity of that good increases (unless the demand for the good is
inelastic, which means inter alia that is a good with no substitutes) . The relation between the price
and sales of pisco is enough in order to explain the ch anges in the sales of pisco. As can be observed
in the results of the regression submitted by Chile, th e relation between the price of the other spirits
(whisky) and the sales of pisco is very low and statis tically not significant; therefore, this relation can
not explain by itself the changes alluded to.
4.182 Chile further notes that it produces more than 70 percent of the distilled spirits that are subject
to the highest tax under the New Chilean System, including whisky.
4.183 The European Communities disagrees with Chile's claim that the increase in consumption
of pisco between 1982 and 1986 was due to the decrease of the real price of pisco and not to the
increase in the price of whisky. The reduction of pisco's real price may have contributed to the
increase in pisco consumption, but was not the onl y cause. According to Chile's own data, between
1984 and 1986, the real price of pisco remained virtually constant. Yet, consumption per capita of
pisco rose by 24
 %. During the same period, the real price of whisky increased by 42 % and
consumption per capita fell by 25 %.
4.184 The European Communities contests Chile's argum ent that "[i]n short, the effect of the
increase in taxes on whisky in the period of 1982 to 1986 was to increase the price to the consumer by
30.8 percent". As the tax rate increased, the tax base increased too, due to the depreciation of the peso
and the increase of tariffs. As a result, the effect of the tax increase in the final price of whisky was
much more substantial. Thus, in the following tabl e, the tax increase has the effect of increasing the
final price of whisky by 286 %:
 1982 1986
Price in US$ 5 5
Price in Ch$ 195 1,025
Import duty 19.5 205
Tax 64.35 861
Retail Price 278.85 2,091

Contrary to Chile's claims, the tax increase acc ounts for the largest portion of the price increase
(44
 %).

4.185 Chile further responds that the math used by the European Communities to demonstrate the
effect of taxation in the price of whisky is misleading. Chile disagrees not only with the mathematics,
but also with the EC's conclusions drawn from that ex ercise. These conclusions show, at least, a lack
of understanding of ad valorem taxation systems. To demonstrate its point, in Table 20 below, Chile
presents an exercise, based in the EC 's data in which the tax rate is maintained at a flat level of 30
 %
throughout the period. In this case, tax per unit of whisky will rise fromCh$64.35 to Ch$369, and the
total price of whisky will rise from ch$278.85 to Ch$1, 599. According to EC's argumentation, this
means that taxation has an effect of raising the pri ce by 109% (even without changing the tax rate).
What really happens, is that the tax base, rose by 473%, and therefore, tax levied on an ad valorem
base varies accordingly.
Table 20123

Tax effect with a 30% ad valorem rate

 1982

1986 % Ch.
Price in US$

5 5 0%
Price in Ch$

195 1,025 425.6%
Import duty

19.5 205 951.3%
Pre-Tax Price

214.5 1,230 473.4%
Tax (30%)

64.35 369 473.4%
Retail Price 278.85 1,599 473.4%

(ii) The 1998 Search Marketing survey
4.186 The European Communities further claims that another consumer survey performed by
Search Marketing S.A. at the request of the EC spirits industry (the "1998 SM survey") 124 further
supports a finding that pisco and all other distilled spirits are directly competitive and substitutable.
4.187 According to the European Communities, the surveyors asked two questions to a
representative sample comprising over 400 consumers who had purchased both pisco and at least one
other spirit during the last six months.
4.188 The European Communities explains that the pur pose of the first question was to measure the
substitutability between pisco and other distilled spir its under current taxation and pricing conditions.
To that effect, the question was drafted in the following terms: "if you wanted to buy a bottle of pisco,
but pisco was not available, what of the following beverages would you buy instead?". Possible
answers included, in addition to other types of di stilled spirits, wine, beer, non-alcoholic beverages
and "nothing". The same question was then repeated for each of the other types of distilled spirits
covered by the survey.
4.189 The European Communities notes that Table 21 below summarises the answers given by the
respondents in the situation where they wanted to buy pisco but that spirit was not available. It

123 Chile Oral Statement at the Second Substantive Meeting, Table II.
124 EC Exhibit 22.

indicates that a large majority of consumers regard other distilled spirits as the closest substitute for
pisco.
Table 21
125
Response to the Question: "What would you buy if pisco was not available?"
Other spirits 70 %
Wine/Beer 17 %
Non alcoholic beverages 0 %
Nothing 13 %

4.190 The European Communities points out that in Japan – Taxes on Alcoholic Beverages II, Japan
submitted a consumer survey showing that, in case of unavailability of sh ochu, "only" 10 % of
consumers would switch to whisky and other spirits , whereas the remaining 90 % would turn to beer
or other beverages. The panel was of the view th at a 10 % switch was "proof of significant elasticity
of substitution" between shochu and other spirits.126
4.191 In the view of the European Communities, e qually significant, as shown in Table 22 below,
pisco was mentioned as the main alternative to each of the other spirits covered by the survey in the
hypotheses where those spirits were not available.
Table 22127
Response to the Question: "What would you buy if [whisky/tequila/brandy/rum/vodka/gin] was
not available?"
 Whisky Tequila Brandy Rum Vodka Gin
Pisco 50 % 56 % 52 % 43 % 48 % 45 %
Other spirits 25 % 17 % 15 % 19 % 21 % 19 %
Wine/beer 3 % 2 % 2 % 2 % 2 % 2 %
Non alcoholic beverages 0 % 0 % 0 % 0 % 0 % 0 %
Nothing 22 % 25 % 31 % 36 % 29 % 34 %
Basis: % of all respondents
4.192 The European Communities further explains th at the second question asked by the surveyors
aimed to measure the respondents' reaction to chan ges in the relative price of pisco and the other
distilled spirits. Respondents were initially asked to make purchase choices between all products at
current prices.128 They were then shown an estimate of th e prices that would prevail if all distilled

125 EC First Submission, Table 17.
126 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para 6.31.
127 EC First Submission, Table 18.
128 EC Exhibit 23.

spirits were taxed at the rate of 27 % ad valorem (i.e., the rate that will apply to most pisco as from
1 December 2000), and asked to make a choice at those prices. For these purposes, it was estimated
that the envisaged tax change would bring about an increase in the prices of pisco of 1.7 % and a
simultaneous reduction in the prices of whisky and of "other spirits" of 25.3 % and 2.3 %,
respectively.
4.193 According to the European Communities, the responses to this second question indicate the
existence of a significant degree of cross-price elasticity between pisco and other spirits. As shown in
Table 23, the share of respondents choosing whisky and other spirits instead of pisco would increase
from 17.7 % to 30.5 %, i.e., by as much as 72 %. The increase is particularly large in the case of
whisky, which would benefit from the largest price reduc tion in the event that all spirits were taxed at
27 %. The share increase is also substantial, even if less marked, in the case of "other spirits", which
would benefit from a smaller price reduction than whis ky. Finally, it is worth noting that the increase
in the share of whisky and "other spirits" takes place at the expense of all the categories of pisco, thus
refuting any possible claims to the effect that wh isky and "other spirits" compete only with certain
types of pisco.
Table 23
129
 At current prices At prices with 27 % tax Variation (%)
Pisco tradicional 12 % 9.7 % - 19.2 %
Pisco especial 47.2 % 42.3 % - 10.4 %
Pisco reservado + Gran
pisco
23 % 17.5 % - 23.9 %
Whisky 6.3 % 14.1 % + 124 %
Other spirits 11.5 % 16.4 % + 43 %

4.194 The European Communities alleges that the 1998 SM survey can show only the immediate
reaction of consumers to price changes. Yet, as discussed above, the consumption of distilled spirits
is based on habits, which only cha nge gradually. As a result, s hort-run elasticities of substitution
between distilled spirits are, as a general rule, much lower than long-run elastic ities. This mean that,
over a certain period of time, the price changes resu lting from the elimination of tax differentials are
likely to lead to a shift in consumption from pisco to other spirits even larg er than that shown in
Table 23 above.
4.195 In rebuttal, Chile argues that given the weakness of a complaint based on cross-price
elasticity (as noted in paragraph 4.[219] below, a lo w coefficient of 0.26 was computed as cross-price
elasticity for pisco and whisky), the European Co mmunities tries to bolster its argument with an
assortment of information based on a survey of 40 0 "representative" Chilean consumers. The EC
survey does not logically make the case that pisco is directly competitive or substitutable with other
spirits.
4.196 Chile further argues that the European Communities also attempts to use marketing surveys as
a kind of substitute for econometric analysis. Sp ecifically, the European Communities refers to

129 EC First Submission, Table 19 (p. 60).

marketing surveys in which various consumers were asked what they would buy if there were no
pisco and how they would react based on assumed increases in pisco prices accompanied by decreases
in whisky prices. Such surveys are inherently much less reliable th at an econometric analysis based
on 15 years of data. Further, even the respon ses the European Communities received do not establish
a directly competitive or substitutable relationship.
4.197 The European Communities responds that Chile seeks to discredit the consumer surveys
submitted by the European Communities, but fails to advance any specific ground to cast doubt on the
reliability of those surveys. Thus, for example, Ch ile appears to consider that it is sufficient to
describe the sample of one of those surveys as being composed of 400 "representative" Chilean
consumers in order to dispose ipso facto of that survey. The European Communities asks whether and
why Chile is suggesting that the sample was not statistically representative.
4.198 The European Communities further notes that Chile argues that consumer surveys are
"inherently much less reliable" than econometric studies. Previous panels, however, have not
hesitated to rely upon the findings of consumer surveys in order to establish that products were
"directly competitive or substitutable". In Japan – Taxes on Alcoholic Beverages II , the panel
discarded a flawed regression submitted by Japan in favour of a much more robust consumer survey
presented by the complainants.
130
4.199 Chile further responds that the last "evidence" provided by the European Communities, to
support the idea that there is a significant cross-price elasticity between pisco and other distilled
spirits, are the results of another survey conducted by Search Marketing, which is extremely weak.
4.200 Chile notes that the first piece of evidence cited by the European Communities, is the answer
made by consumers to the question "what would you buy if pisco is not available". The conclusions
to be drawn from this kind of question are highl y questionable, because, as any marketing survey
expert could tell, people facing situations that are not "normal" in their mind, tend to react in different
and unpredictable ways. Also, without a very well designed system to avoid inconsistent answers
(and the evidence provided by the European Commun ities does not lead to a conclusion as to whether
those measures have been taken or not) the results are of very little significance. Last – but not least –
the question was designed to actually "force" respondents to buy something else, or buy nothing, but
would not provide one of the most logical alternativ es "I will buy (pisco, whisky, gin, etc.) in another
store".
4.201 Chile further points out that the other piece of the Survey is a "quantitative" analysis, in which
the consumers, faced with a change in the pri ces of pisco, whisky and other liquors, show their
preferences in the new situation (Table 23). A detail ed analysis of this shows the inconsistency of the
results, because they don't resist any serious analysis and, therefore must be discarded as evidence.
4.202 Chile also argues that in fact, Table 24
131 shows that if the price of pisco increases 1.7%, the
price of whisky is reduced by 25.3% and the price of "other spirits" by 2.3%, then the consumption of
pisco will decrease by 15.5%, the consumption of whisky will increase by 123.8% and the
consumption of other spirits by 42.6%.

130 The European Communities refers to Panel Report on Japan - Taxes on Alcoholic Beverages II,
supra., paras. 6.28-6.32. According to the European Communities, Japan's regression had similar
methodological problems to those of Chile's regression analysis.
131 According to Chile, Table 24 is elaborated from data submitted by the European Communities.

Table 24
132

Substitution Elasticity

 PRICE CHANGE

DEMAND CHANGE
PISCO

+ 1.7 % - 15.5 %
WHISKY

- 25.5 % +123.8 %
OTHERS -2.3 % +42.6 %

4.203 Chile comments that some basic microeconomic discussion must be added here, in order to
make its points clear. It discussed the relationship between price elasticity (that is, how much the
price of the good itself influences the quantity sold of that good) and cross-price elasticity, that means,
how much the price variation of competitive goods, influence the quantity of the good at stake.
4.204 In the view of Chile, in "normal" goods, that is, goods that are consumed less if the price rises
and more if the price falls, the own-price elasticity must be greater or equal to the cross-price
elasticity of any competitive or substitutable good. If two goods could be substituted one for the other
without any cost for the consumer (that means, they are almost equal products), the cross elasticity
will be the same as the price elasticity (with sign changed) that is, a 1% increase in the price of a good,
has the same effect on the consumption as a 1% decrease in the price of its competitor. If there is a
cost in substituting those goods, then the same pe rcentage price variation in the competitive good
price has less effect on the demand than that percentage price variation of the good at stake. Thus,
normally the maximum cross elasticity is equal to the price elasticity.
4.205 With this concept in mind, Chile reviews the results of 1998 SM survey, shown at Table 23
above. The survey was conducted in such a way that the respondents faced an hypothetical "once and
for all" price variation, and therefore changes in demand are not influenced by changes in personal
income, tastes, habits, etc. The only variable that changes is the price of different spirits.
4.206 Chile goes on to state that if it takes the bor der condition, that is, that cross elasticities are
equal (in absolute value) to price elasticity (somethi ng not seen in the real world, but that presents the
best case to sustain the reliability of the survey), it may calculate (with the data included in Table 23)
what is the underlying minimum price elasticity.
4.207 Chile presents the following results:
Whisky: -5
Other Spirits: +2 (that is to say, an increase in price will mean an increase
in consumption)
Pisco: -0.5

4.208 In the opinion of Chile, the findings for whisky and other spirits are absurd, and speak loudly
about the lack of reliability of the survey.

132 Chile Oral Statement at the Second Substantive Meeting, Table V.

4.209 Chile explains that in the case of the whisky, a price elasticity of -5, means that a 10%
reduction in price (with the prices of every other sp irit unchanged) will lead to an increase in terms of
volume of 50%. This is absolutely out of range. The whisky industry will be very pleased to face
such a price elasticity, but this is not the case. C onsumer goods usually show price elasticity below 2.
This "finding" is also rebutted by the experience in 1982 – 1986. By then, the price of whisky grew
by 67%, and per capita consumption fell by 64%, theref ore price elasticity is at the most 1 (if there is
some cross elasticity with pisco, price elasticity will be even less than 1).
4.210 Chile concludes that no comments need to be made on the elasticities of other spirits, because
it is clear that nobody could sustain that case. Th is exercise shows that the 1998 SM survey is far
from being a robust consumer survey.
4.211 Chile also disagrees with the EC comment th at the "decrease in pisco price may have had
some influence in pisco consumption". It is easy to realize that, if a good has no response to its price
(the quantity is the same no matter what its price is ), its demand is said to be inelastic, and those
goods has no competitors. Chile has developed at length the reason why such goods have no
competitors. Therefore, the comment made by th e European Communities in its rebuttal should be
regarded as a plain economic error.
4.212 Chile claims that, in summary, the European Communities has failed to provide persuasive
and sufficient evidence of its assertion that pisco and other spirits are directly competitive or
substitutable, as requested by Article III:2, second sentence.
4.213 The European Communities contests Chile's argument that the 1998 SM survey is not
reliable because it did not offer as a possible survey response the option to go to another shop when
asking the question "what would you drink, if pisco were not available?". The hypothetical question
of the best alternative drink is part of the standard repertoire of survey design. As the survey offers
both the possibility to switch to another drink or to drink nothing at all, it provides a good indicative
assessment of the level of substitutability between pi sco and other types of alcoholic beverages. If
substitutability were nil, no choice of an alterna tive drink would have been made. The hypothetical
question is certainly not beyond the intellectual cap acity of a consumer. The proposal that the
respondent should have had the choice to go to another store is not a serious suggestion.
4.214 The European Communities also argues that it w as stated that the elasticities implied by the
survey lead to the impossible resu lt that the elasticity of whisky consumption with respect to pisco
prices (cross-price elasticity) is higher than the own- price elasticity. These results are certainly not in
violation of any economic principle. Evidently, th e survey choices made are plausible and intuitive.
Furthermore, the statement may confuse cross-price elasticity with elasticity of substitution. Without
going into the technical details, it has to be kept in mind that the market shares of whisky and pisco
are very unequal. By way of example, the Europ ean Communities refers to the own-price elasticity
the Chilean delegation appears to have derived fro m the survey, namely of 0.5 for pisco and 5 for
whisky. If whisky consumption is 8,000 cases annually and that of pisco 100,000 (the ratio roughly
represents the actual proportions), a 1 % price incre ase for pisco will lead to a reduced consumption
of 500 cases, a 1% increase in whisky prices will affect 400 cases of alcoholic drinks. It can easily be
seen that a price change in pisco can have more in fluence on whisky consumption than a price change
in whisky itself.
4.215 The European Communities asserts that this result would even be stronger if one applies own-
price elasticities that are less unequal than those de rived by the Chilean delegation. The European
Communities has used the Chilean values only as an example, because the European Communities
has no means of assessing how the Chilean delegation might have calculated them.

4.216 In conclusion, the European Communities allege s that therefore, Chile's argument does not
invalidate the technical correctness of the survey. Instead it can be summarised as stating simply that
the Chilean delegation believes that the substitutability is lower than those derived from the survey.
(iii) The 1995 Gemines study
4.217 The European Communities explains that it has had access to a study entitled "The possible
effects for the pisco industry of a reduction in the tax applied to whisky" carried out in August 1995
by Gemines, a respected firm of consultants, at the request of Chile's pisco industry (hereafter referred
to as "the 1995 Gemines study").
133 This study provides further evidence of significant cross-price
elasticity between pisco and whisky.
4.218 Further, the European Communities explains th at the objective of the study was to quantify
the effects for the pisco industry, and more generally for the economy of the zona pisquera , in the
hypothesis that the ILA was amended so as to equa lise the tax rates applied to pisco and whisky.
Gemines considered two different scenarios. Accord ing to the first scenario, pisco and whisky would
be taxed at 35 %. According to the second scenario, they would be taxed at 30 %.
4.219 According to the European Communities, as a fi rst step, Gemines estimated the cross-price
elasticity rate between pisco and whisky on the basi s of historical sales and price data covering the
period 1985-1992. The estimated rate was 0.26. This would indicate that if, for example, the prices
of whisky went up by 10 %, the sales volume of pisco would increase by 2.6 %. 134 According to
Gemines, that rate of cross-price elasticity is sufficient to conclude that pisco and whisky are
"substitutes, albeit to a moderate extent". 135 By contrast, on the basis of similar regressions, Gemines
reached the conclusion that neither wine nor beer could be considered as substitutable with pisco.136
4.220 The European Communities states that Gemines then proceeded to es timate the changes in
consumption of pisco and whisky th at would take place in each of the two scenarios above described.
As shown in Tables 25 and 26 below 137, Gemines concluded that sales of pisco would drop by 10.2 %
in the first scenario and by 8.6 % in the second scenario, whereas sales of whisky would increase by
5.8 % and 6.5 %, respectively.

133 EC Exhibit 20.
134 The European Communities notes that cross-price elasticity measures the relative change in sales of
one product as a result of a relative price change in another. However, cross-price elasticity itself is not neutral
to the existing market shares of the product involved, and is dominated by the product with the larger share.
 135 The European Communities notes that the authors of the study cautioned that the estimated rate was
likely to be lower than the current rate of cross-price elasticity. See 1995 Gemines Study, p. 57 (EC Exhibit 20).
136 1995 Gemines study, p. 61 and fn. 18 (EC Exhibit 20).
137 1995 Gemines study, p. 64 (EC Exhibit 20).

Table 25
138
First scenario
Pisco and Whisky taxed at 35 %
 Pisco Whisky
Price + 7 % - 18.6 %
Quantity sold - 10.2 % + 5.8 %

Table 26139
Second Scenario
Pisco and whisky taxed at 30 %
 Pisco Whisky
Price + 3.5 % - 21.3 %
Quantity sold - 8.6 % + 6.5 %

4.221 The European Communities comme nts that these figures may underestimate considerably the
increase in whisky consumption. In the first pl ace, Gemines did not take into account the additional
demand generated by whisky's cross-price elasticity to increases in the price of pisco, but only and
exclusively the elasticity of whisky to changes in its own price. Moreover, unlike in the case of pisco,
Gemines did not estimate whisky's actual rate of own-price elasticity. Instead Gemines limited itself
to "assume" a rate of 0.31 on the basis of "the charact eristics that exhibits this market and alternative
studies".
140 That "assumed" rate, however, seems too low. In fact, that rate would be inconsistent
with the cross-price elasticity rate of pisco in res ponse to changes in the prices of whisky previously
estimated by Gemines itself. On the basis of the latter rate (which itself appears to be an under-
estimate), an increase of 10 % in the price of whis ky would generate an increase in sales of pisco
which is much larger (2.6 % of approximately 75 % of the spirits market) than the total drop in sales
of whisky caused by the same price increase on th e basis of Gemines' assumed rate of own-price
elasticity for whisky (3.1 % of approximately 4 % of the spirits market).
4.222 The European Communities further notes that th e authors of the study cautioned that in
practice the decline in the sales of pisco was likely to be even greater than shown in the above tables
due to the fact that in both scenar ios the changes in the price of whisky were much bigger than those
considered in order to estimate the cross-price elasticity rate between pisco and whisky.
4.223 In rebuttal, Chile argues that with regard to cross-elasticity of demand, the European
Communities has been unable to demonstrate high cro ss-elasticity of demand. The study cited by the

138 EC First Submission, Table 19 (p. 62)
139 Ibid., Table 20.
140 1995 Gemines study, p. 63 (EC Exhibit 20).

European Communities shows only a "moderate" subs titutability between pisco and whisky, based on
the 1995 Gemines study. A more thorough study over a longer period, conducted for the Chilean
industry, as shown in Table 27 below, demonstrates an even lower degree of cross-elasticity. Such
low cross-elasticity hardly demonstrates that the products are, in terms of Article III:2 " directly
competitive or substitutable [emphasis supplied]".
Table 27
141

Cross-price elasticity of pisco with other spirits, wine and beer

 RESULTS OF THE REGRESSION
Statistics of the regression
Multiple coefficient 0,9878
Coefficient of R^2 0,9758
Adjusted R^2 0,9624
Typical error 0,0640
Observations 15

ANÁLYSIS OF THE VARIABLE
 Sum of the
squares
Average of
the squares
F Critical
Value of F
Regression 5 1,4895 0,2979 72,6767 5,32677E-07
Residual 9 0,0369 0,0041
Total 14 1 ,5264

ANALYSIS OF COEFFICIENTS
 Coefficients Typical
error
Statistic t Probability Inferior
95%
Superior
95%
Interception 3,5771 3,6554 0,9786 0,3534 -4,6920 11,8461
Variable X 1 (Income) -0,0072 1,2109 -0,0059 0,9954 -2,7465 2,7321
Variable X 2 (Pisco Price) -1,3109 0,4574 -2,8661 0,0186 -2,3456 -0,2762
Variable X 3 (Whisky) 0,1248 0,5158 0,2419 0,8143 -1,0421 1,2917
Variable X 4 (Wine Price) 0,5963 0,4030 1,4796 0,1731 -0,3154 1,5079
Variable X 5 (Beer Price) 0 ,3622 1 ,2132 0 ,2985 0 ,7721 -2 ,3823 3 ,1067

4.224 Chile explains that to estimate the cross- elasticity between pisco and other alcoholic
beverages, an econometric methodology analysis was de veloped on the basis of a time-series of data.
It is worth mentioning that econometric models ar e widely accepted as a useful tool to determine
whether two products are strong substitutes or not.
4.225 Chile goes on to explain that the econometric model reached a highly satisfactory adjustment
at global level, and the coefficient values (elasticitie s) have the sign expected by the economic theory:
an increase in per-capita income will lead towards an increase in per-capita pisco consumption; an
increase in pisco price will lead towards a dimini shing in pisco consumption. However the only
variable that, from a statistical standpoint has a significant coeffici ent (with a confidence level of
95%), was the pisco price, with a value of -1.31. That means that a 10% increase in the price of pisco,
will result in a decrease of 13.1% in pisco consumption. According to the results of this mathematical
model, the cross elasticity between pisco and whisky is not only very low (0.125), but statistically not
significant (with 95% of confidence). An elasticity of 0.125, means that a 10% increase in the price

141 Chile First Submission, Annex II.

of whisky (for whatever reason), will increase pisco consumption by 1.25%. But this elasticity, being
so low that these products cannot be considered clos e substitutes to each other, is also not significant
from a statistical standpoint, that means the elasticity could be 0.
4.226 According to Chile, in order to deepen this analysis, a second regression was made, but in this
case the per capita income variable was eliminated from the equation. It shows an improvement, and
the coefficients maintain the signs that the theory indicates. In this case, pisco and wine prices appear
as significant variables (with 95% of confidence), with the cross-price elasticity of wine being 0.59.
In this case, whisky also presents a low elasticity (0.128), which is not statistically significant (with
95% of confidence).
4.227 Further, Chile states, that in order to investigate further, the price of beer was eliminated from
the second regression analysis, since its elasticity coefficient is not significant (with 95% of
confidence), even though it is higher than that for whisky. In this case, the equation of the regression
only considers prices for pisco, wine and whisky. With this modification, the quality of the regression
improves, and the coefficients maintain the sign theo retically indicated. In this regression, the price
of pisco (elasticity = -1.50) and wine (cross elas ticity = 0.78) remain as significant variables (with
95% of confidence), while the price of whisky (cross elasticity = 0.07) remains as not significant.
4.228 Chile then argues that based on the previous commentaries, it can be concluded that, using the
econometric analysis (widely accepted at technical level), it is not feasible to demonstrate the
existence of a significant cross elasticity of demand between pisco and whisky.
4.229 Chile further explains that the methodology used in the above regression (demand model with
constant elasticity, estimated under the ordinary least squares) is identical to the one employed by
Gemines in the 1995 Gemines study. In this case, the results differ from those indicated in the
Gemines study because the price seri es used in one case and in the ot her are different: in the case of
the Gemines study, a quarterly series of prices was used, which covers the period 1985 - 1992 (seven
years). In the present case, an annual series of fifteen years was used (fro m 1983 to 1997). It is
necessary to indicate that upon using quarterly series, even though the number of observations
increases, a lot of distortions are introduced because of seasonal consum ption factors. Some of these
seasonal factors could be eliminated upon introducing variables such as a "dummy" (which is the
Gemines methodology). However, models constructed with "dummy " variables are generally of a
lesser quality than those models that do not require this class of variables, and this does not seem to be
the exception.
4.230 The European Communities alleges that the only piece of eviden ce put forward by Chile is
the regression analysis. The European Communiti es made several comments on it. First, the
regression has serious methodological problems. Sec ond, in spite of those problems, the regression
confirms that pisco and whisky compete with each other: pisco consumption goes up when the price
of whisky increases and falls when the price of wh isky goes down. Finally, contrary to the claims
made by Chile, the regression does not show a lo wer rate of cross-price elasticity than the 1995
Gemines study. Unlike the authors of the 1995 Gemi nes study, the authors of the Chilean regression
analysis have used a simple linear regression. This means that the parameters estimated by them do
not represent elasticities and, therefore, cannot be co mpared to the parameters estimated in the 1995
Gemines study.
4.231 The European Communities further contests that Chile has failed to rebut the extensive
evidence provided by the European Communities showi ng that pisco and the other distilled spirits are
"directly competitive or substitutable" in the Chil ean market. The only piece of evidence adduced by
Chile is the above regression analysis. That analysis concludes that the Chilean regression analysis is
afflicted by fundamental multi-collinearity problems which render the results extremely unstable and

deceptive. Further, the paucity of the data set used by Chile is such that it is not possible to address
those problems.
4.232 The European Communities explains that a difficu lty inherent to all time-series data is that
many valuables are "collinear". This is the term us ed by econometricians in order to describe the fact
that many values move in parallel over time without necessarily implying any causal relationship. An
often cited textbook example is that of cumulative rainfall and the consumer price index, which both
rise over time. A regression of one on the other would yield a high statistical correlation.
4.233 In addition, the European Communities recalls that cross-elasticity is not a one way
relationship. Pisco prices also affect whisky sales. In light of the respective market shares of the two
products, this reverse cross-price elasticity should ev en be larger than that the effect whisky prices
have on pisco sales. In the view of the European Communities, Chile makes no effort to address this
aspect.
4.234 Chile also points out that in the first place, it is for the European Communities to prove that
the regression analysis that it has submitted to th e Panel meets all the standards required to be
considered a sound econometric exercise.
4.235 Chile further notes that as the European Communities pointed out, there are a number of tests
to be carried out in the data employed in a regressi on, before one could use the results confidently.
Chile acknowledges the effort put forward by th e European Communities to review the Chilean
regression analysis that was made with the annual data covering the 1983 – 1997 period, and agrees
with the comments that the data contain some insolvable problems (namely multicolineality).
4.236 Chile argues that the EC's criticism are ironic, however, because the regression submitted by
the European Communities h as even more serious problems; it covers a smaller number of years (all
of them included in the regression submitted by Chile) and is further distorted by the use of quarterly
data. Finally, and even more important, the elasticity coefficient is not significant (at 95% confidence
level).
4.237 Chile again emphasized that in short, neither re gression analysis is sufficiently reliable, but
the EC's is less reliable than that of Chile, and it is the European Communities, not Chile, that has the
burden of the proof.
(iv) The 1996 Gemines study
4.238 The European Communities notes that following the submission to Congress of the 1995
Proposal by the Chilean Government, the pisco in dustry commissioned from Gemines a new study in
order to assess the impact of the proposed reduc tion of the taxes on whisky from 70 % to 50 %
(hereafter, the "1996 Gemines study").
4.239 The European Communities states that it has not been able to obtain a copy of the 1996
Gemines study. Nevertheless, its findings were wide ly publicised by APICH (the association of pisco
producers) in July 1996, following the announcement by the Government that it intended to submit an
amendment to the 1995 Proposal providing for an even larger reduction of the tax on whisky. Details
of the 1996 Gemines study were also cited by some members of the Chamber of Deputies during the
debate of the 1997 proposal.
142

142 As an example, the European Communities refers to the intervention by Representative Prokurika,
Minutes, p. 44 (p. 47 of the English translation).

4.240 The European Communities notes that according to press reports
143, the 1996 Gemines study
concluded that the reduction of the tax on whisky to 50 % envisaged by the 1995 Proposal would
cause a 47 % drop in the price whisky and, as a con sequence, a 17 % reduction in the sales of pisco.
The European Communities claims that the accuracy of those reports has not been disputed by Chile.
4.241 The European Communities notes that the first document it requested was the "1996 Gemines
study". The relevance for this dispute of that study is thus unquestionable. Yet, Chile's pisco industry
has refused to provide the 1996 Gemines study to the Panel.
4.242 The European Communities states that according to a letter from APICH (the association of
pisco producers) which has been forwarded by the Chilean Government to the European Communities,
the reasons for that refusal are twofold. The fi rst reason is that the study contains information
"confidential" to Capel and Control. The second reas on is that Capel and Cont rol were not "satisfied
with the results of the study, which did not achieve the expected results". For those two reasons, the
letter concludes, "the study was never made public".
4.243 The European Communities then claims that to begin with, one may doubt of the
"confidentiality" of business information which h as been shared by the two main pisco producers
without any apparent restriction. If it is true that the study contains confidential business information,
then Chile's anti-trust authorities would be well advised to ask for a copy.
4.244 The European Communities further points out th at, in any event, back in 1996 the pisco
industry did not treat the study as "confidential". In July of that year APICH convened a press
conference at which, brandishing the 1996 Gemines study as irrefutable evidence, APICH warned that
if the Government proposal was adopted, sales of pisco would fall by 17 %. This was the same press
conference at which the Chairman of APICH recalled that when at the beginning of the 1980s the tax
differential between pisco and whisky was reduced to 5 %, "pisco producers were almost chased out
of the market".
4.245 Also, the European Communities st ates that the press conference of July 1996 was part of a
strategy aimed at stopping the Government from submitting an amendment to the proposal then
pending before the Parliament that would have prov ided for a larger reduction of the tax on whisky.
With the same purpose, the 1996 Gemines study was also provided by APICH to some members of
the Chilean Congress, who quoted it extensively du ring the subsequent debate of the Government
proposal.
4.246 The European Communities alleg es that the inescapable conclusion is that in 1996 the pisco
industry was telling to the Chilean Government and to the Chilean Parliament a totally different story
from that presented to the Panel.
4.247 The European Communities argues that, in an y event, neither APICH nor the Chilean
authorities have explained why it is not possible to provide a non-confidential summary of the 1996
Gemines study. In view of that, the European Co mmunities would urge the Panel to draw appropriate
inferences from the attitude of Chile's pisco industry.
4.248 In rebuttal, Chile comments that the eagerness of the Eu ropean Communities to request
private documents prepared for the pisco industry as the Adimark study and Gemines 1996 study, is
absolutely abnormal in this type of process. On one hand, the European Communities, not Chile's
industry, has the burden of proving its assertions; on the other, nothing has prevented the European
Communities or its industry from conducting all the surv eys in Chile that they may wish; the Chilean

industry -- like the Scotch Whisky Association -- is under no obligation to provide the information or
advice it gets from private consultants.
(v) The Adimark Survey
4.249 The European Communities notes that the same press reports referred to another survey
commissioned by APICH (the "Adimark survey") in order to assess the reactions of the different
socio-demographic segments of the Chilean populati on to the proposed tax changes. The survey
concluded, inter alia , that young consumers, in particular, considered that the reduction in the tax
applied to whisky would provide a "good alternative to replace pisco".
144
4.250 According to the European Communities, the Adimark survey is a qualitative study based on
the opinions expressed by consumers within four "f ocus groups", composed of 6 to 8 people (all
males) each. The study covers two socio-economic segments: ABC1 (which is believed to correspond
to the middle-high to high income segments) and C2 (which would correspond to the middle-middle
income segment); and two group ages: from 19 to 24 years and from 25 to 36 years.
4.251 The European Communities explains that although the use of "focus groups" is a usual
research method for marketing purposes, its result s are less reliable than those obtained through
quantitative research methods (such as those used in the 1997 and 1998 Search Marketing studies
submitted by the European Communities). Noneth eless, the findings of the Adimark study provide
further confirmation that whisky and pisco are direc tly competitive and substitutable in the Chilean
market.
4.252 The European Communities states that according to the Adimark study, a decrease in the
price of whisky would provoke the following reactions in the ABC1 segment145:
(i) "a strong incidence in the frequency of wh isky consumption (it would be purchased
more often)";
(ii) "a feeling of displacement of pisco mainly (as opposed to other beverages)"; and
(iii) "a tendency to substitute [whisky] for the consumption of pisco (including for
consumption in 'carretes' by the young population)".
4.253 According to the European Communities, in the case of segment C2, reactions are more
nuanced, but nevertheless strongly supportive of a finding of direct competition. 146 On the one hand,
the consumers in this segment express the view th at, if the price of whisky decreased, they would
increase their consumption of whisky at the expense of pisco. On the other hand, they anticipate that
in the longer term they would progressively revert to pisco. However, the main reason given for that
prediction is that pisco is a "traditional" drink with a strong Chilean iden tity, whereas whisky is a
"foreign" spirit. Thus, the apparent resistance of c onsumers in this segment to a permanent change is
motivated by their subjective perceptions about th e identity of the products, rather than by the
existence of objective differences between them. T hose subjective perceptions are likely to change as
the consumption of whisky becomes more frequent and whisky looses its "foreign" label in this
segment (a process which, according to the study, w ould have already been completed in the higher
income ABC1 segment, where consumers have been exposed to foreign spirits longer and are less
"nationalistic" in their choices).

144 Ibid.
145 Adimark study, submitted by Chile, p. 18. See also pp. 20-21.
146 Ibid., pp. 18 and 21-23.

4.254 Chile argues that in regard with the Adimark survey, it is worth mentioning that it is a
qualitative study, based on 4 "focus group" of 6 - 8 people each. Therefore the total sample is just
about 30 people, which does not cons titute, under any consideration, a sample that allows for drawing
valid conclusions about market behaviour. This type of study, being a research method employed for
marketing purposes, conveys only preliminary results on the issue investigated. In terms of the
quality of the information provided, they are less reliable than normal and well conducted quantitative
market research analysis.
4.255 Chile goes on to state that as it has shown, th e illogical quantitative results of the Search
Marketing study render it useless as an evidence before this Panel; a fortiori, the Adimark survey has
even less usefulness as evidence.
4.256 Chile further argues that if, in spite of the above, the Panel would still consider the Adimark
survey as evidence, the conclusions drawn from it va lidate Chile's position, that is, that pisco and
whisky are competitive only to a very limited extend, based on the following:
(i) According to the survey pisco and whisky are both consumed by the ABC1 segment,
but in different occasions: Pisco when ha nging out with friends and whisky in
important social events (e.g ., wedding parties, official receptions at the European
embassies, and the like).
(ii) The survey shows that young people belonging to the ABC1 segment will change
from pisco to whisky only in case the price of whisky is reduced substantially, as to
reach the price of pisco, which seems extrem ely unlikely to occur, even if taxes are
not levied at all.
(iii) The survey shows those in segment C2 (the most important segment in terms of
consumption and certainly poorer than ABC1 ) would not substitute whisky for pisco
due to considerations concerning the national attribute of pisco.
(iv) According to the survey, the only substituti on that has been proved is that between
whisky and high alcohol content pisco (which is taxed identically with whisky).
(vi) Position of Domestic Industry and the Government of Chile
4.257 The European Communities also argues that the producers of pisco have recognised openly
that pisco and other spirits are directly compe titive and substitutable products. As mentioned above,
in July 1996 APICH gave broad publicity to the findings of the 1996 Gemines study, which concluded
that lowering the tax on whisky to 50 % would resu lt in a 17 % drop in the sales of pisco. According
to the same reports, Mr. Peñafiel (the general manager of Capel, speaking as the representative of
APICH) recalled on that occasion that:
... at the beginning of the 80s the tax di fference between pisco and whisky was 5 %
and pisco producers were almost chased out of the market. Nowadays, this is a latent
risk. The situation may have changed a lot, but whisky is a pole of attraction for an
important segment of the population.
147

147 El Diario , 2 July 1996, (EC Exhibit 30) . The European Communities adds that the successive
increases of the tax rate on whisky from 30 % to 70 % between 1983 and 1985 were prompted by complaints of
the pisco industry against growing imports of whisky.

4.258 The European Communities further points out that equally open as to the existence of a
competitive relationship between whisky and pisco w as Mr. Elorza, general manager of Control, who
reportedly stated that:
Any change in the taxes may strongly affect us. Pisco is an agricultural product and
for that reason the law is protectionist. In contrast, whisky is an industrial product.
148
4.259 The European Communities concludes that beyond these statements by two of the industry's
top managers, it is evident that the concern shown by the pisco producers throughout the amendment
process of the ILA would have been totally unwarra nted, had that industry not been convinced that
pisco and the other spirits are directly competitive and substitutable products.
4.260 The European Communities alleges that in partic ular, the pisco industry's request that the tax
rate be increased by 6 percentage points per degree of alcohol instead of by 5 percentage points (as
provided for in the 1995 Proposal) evidences that its main concern was to limit the reduction of the
taxes on whisky, rather than the increase of the taxes on high strength pisco. That concern would
have been irrational unless the pisco industry had recognised the existence of direct competition
between pisco and whisky.
4.261 The European Communities also claims that likewise, the st rong resistance of the pisco
industry to the further reduction of the tax rate on whisky to 40-45 % (instead of 50 %, as provided for
in the 1995 Proposal) that was envisaged by the Go vernment in July 1996 would have been senseless
if whisky and pisco were not directly competitiv e products, the more so since that reduction would
have benefited not only whisky but also pisco reservado and gran pisco.
4.262 The European Communities further asserts that si milarly, the pisco industry's insistence on a
long transitional period not just for phasing in the in crease of the taxes on pisco but also the reduction
of the taxes on whisky would be difficult to understand unless it was based on the assumption that
those two spirits are directly competitive and substitutable.
4.263 The European Communities goes on to state that the pisco industry was not alone in
considering that pisco and other spirits were directly competitive and substitutable. During the debate
of the 1997 Proposal by the Chamber of Deputies, the existence of direct competition between pisco
and whisky was assumed without discussion by all the speakers, including those who championed the
cause of the pisco industry. Ind eed, the representatives of the zona pisquera tended to emphasise that
relationship in order to demonstrate the extent of th e "sacrifice" consented by the pisco industry and,
therefore, the need for public financial support to that industry.
4.264 The European Communities further alleges that the open recognition by the Chilean
Government, as well as by many legislators, that the tax system in force until November 1997 needed
to be amended because it was "discriminatory" ag ainst whisky and favoured the pisco producers
necessarily presupposes the admission that pisco a nd other spirits are directly competitive and
substitutable.
4.265 The European Communities notes a recent factual development of some importance for this
dispute. According to press reports
149, Chile's anti-trust watchdog just authorised the merger of
Control or Capel, the two largest producers of pisco , with a combined market share of 99 %. The
main reason invoked by Chile's anti-trust authori ties for clearing the merg er was that the new
company will be subject to competition from other "substitutable" liquors, including imported

148 Qué Pasa, 2 March 1996 (EC Exhibit 26).
149 EC Exhibit 65.

distilled spirits. According to the same press re ports, another considerati on taken into account was
that the new company would be better positioned "to face external competition".
C. "
NOT SIMILARLY TAXED"
1. Overview
4.266 The European Communities argues that under the Transitional System pisco and other
"directly competitive or substitutable" distilled spir its are "not similarly taxed," and under the New
Chilean System, the majority of pisco and the other distilled spirits are "not similarly taxed". In both
cases, the tax differentials are well above de minimis.
4.267 The European Communities also claims that while the two panel reports on Japan – Taxes on
Alcoholic Beverages I and II stand for the proposition that the application of specific taxes in direct
proportion to the alcohol contained in each type of distilled spirits does not constitute "dissimilar"
taxation of the spirits, this reasoning does not apply to the New Chilean System.
4.268 In rebuttal, Chile states that in the New Chilean System, all spirits, regardless of type and
regardless of whether imported or domestic, are ta xed according to the identical objective criteria of
alcohol content and value, two obj ective criteria that have been widely accepted as taxation basis.
According to Chile, objective criteria can result in ta xation that, by some alternative measures, is not
identical; for example, a specific tax system results in a higher tax on low priced goods, measured in
ad valorem terms as well as distorting price relationships. However, in the view of Chile, GATT
Article III does not prohibit a tax or regulation simply because, as a result of the application of
objective criteria, some or even many imported pr oducts are by some measures treated worse than
some or many like or competing domestic products. This position is supported by past panel reports
and the Appellate Body in Japan - Taxes on Alcoholic Beverages II.
2. EC Main Argument
4.269 The European Communities states that, as confirmed by the Appellate Body in Japan –
Taxes on Alcoholic Beverages II , two competitive or substitutable pr oducts must be considered as not
being "similarly taxed" whenever the differen ce in taxation between them is more than de minimis.150
According to the same report, whether a ny particular tax differential is or not de minimis must be
determined on a case-by-case basis.151
(a) Transitional System
4.270 The European Communities points out that as shown in Table 1 above, the rate on whisky
will be higher than the rate on pisco throughout th e duration of the transitional period. Moreover,
despite the progressive reduction of the rate on whisky, the tax differential will remain very large. As
from 1 December 1999, when the tax differential will reach its lowest level, the rate on whisky (53 %)
will still be more than twice the rate on pisco (25 %). A tax differential of such magnitude is more
than de minimis.
4.271 The European Communities also notes that as shown in the same table, pisco will also be
taxed at a lower rate than the category of "other spirits" during the transitional period. The European
Communities argued that although the tax differential is smaller than the differential between pisco
and whisky, it is still large enough to be capable of affecting the competitive relationship between the
products concerned, as attested by the findings of the 1998 SM survey discussed above.

150 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 23.
151 Ibid.

(b) New Chilean System
4.272 The European Communities claims that the Appellate Body considered a similar situation
in Canada - Periodicals . One of the measures in dispute in that case was an internal excise tax
applied by Canada to "split-run" periodicals (both imported and domestic), which was not imposed on
"non-split-run" periodicals (whether imported or domestic). Canada claimed that there was no
violation of Article III:2 because imported periodicals "as a class" were not taxed in excess of
domestic products "as a class". The Appellate Body rejected this argument. According to the
Appellate Body, although all "split-run" periodicals were equally taxed irrespective of their origin, the
fact that imported "split-run" periodicals were not similarly taxed to domestic "non-split run"
periodicals was sufficient to establish that there was "dissimilar taxation" for the purposes of
Article III:2, second sentence:
Following the reasoning of the Appellate Body in Japan – Taxes on Alcoholic
Beverages, dissimilar taxation of even some imported products as compared to
directly competitive or substitutable products is inconsistent with the provisions of
the second sentence of Article III:2.
152
4.273 The European Communities further explains that in reaching that conclusion, the Appellate
Body invoked the well-known principle established by the Panel Report on United States – Section
337 of the Tariff Act of 1930, according to which:
... the "no less favourable treatment" requirement of Article III:4 has to be understood
as applicable to each individual case of imported products ...153
4.274 The European Communities then states that as evidenced by Table 3 above, under the New
Chilean System the majority of pisco will continue to be taxed at a lower rate than the main types of
imported spirits. Whereas pisco tradicional and pisco especial (which together account for 90 % of
the sales of pisco) will be taxed at 27 %, whisky, vodka, rum, gin and tequila will be taxed at 47 %
and brandy at a rate ranging from 39 % to 47 %. Those tax differentials are well above the de minimis
threshold.
4.275 In the view of the European Communities, the fact that under the New Chilean System some
pisco is taxed at the same rate as the main types of imported spirits does not mean that pisco and those
spirits are "similarly taxed" for the purposes of the second sentence of Article III:2. The imported
spirits in question do not compete with pisco reservado or gran pisco only. They are "directly
competitive or substitutable" with all types of pisco and, therefore, should be taxed "similarly" to all
pisco.
4.276 The European Communities also argue s that the two panel reports on Japan – Taxes on
Alcoholic Beverages I and II154 suggest that the application of sp ecific taxes on alcoholic beverages
according to alcohol content does not constitute "dissi milar taxation" for the purposes of Article III:2,
provided that the tax rate per degree of alcohol is the same, irrespective of the beverage in which the
alcohol is contained. The underlying rationale is that those taxes are not so much taxes on the
alcoholic beverages themselves as taxes on their principal common ingredient: the alcohol content.

152 Appellate Body Report on Canada - Periodicals, supra., p.29.
153 Panel Report on United States – Section 337 of the Tariff Act of 1930 (hereafter "United States -
Section 337"), BISD 36S/345, para. 5.14.
154 The European Communities notes that the taxes applied by Japan in that case were expressed in
terms of a certain amount of Yen per litre of beverage. That amount varied according to (but not proportionally)
to the alcohol content.

4.277 The European Communities refe rs to the Panel Report on Japan – Taxes on Alcoholic
Beverages I, which stated that:
[The] unqualified wording [of Article III:2, first sentence] does not necessarily mean
that there could never be circumstances in which different tax treatment of "like
products" was compatible with the General Agreement. The panel noted, for instance,
that GATT Article III:2, a) [ sic] permitted the non-discriminatory taxation "of an
article from which the imported product has been manufactured or produced in whole
or in part" and that such a non-discriminat ory alcohol tax on like alcoholic beverages
with different alcohol contents could result in differential tax rates on like products.
155
4.278 The European Communities then cl aims that the present dispute, however, is concerned with
a totally different system of taxation. To begin with, the ILA is an ad valorem tax and not a specific
tax. Furthermore, although the applicable rates va ry according to alcohol content, the ILA is assessed
on the value of the beverage, which is not directly related to the value of the alcohol content. For
those reasons, unlike the specific taxes c onsidered by the two panel reports on Japan – Taxes on
Alcoholic Beverages I and II, the ILA cannot be characterised as a tax on the alcohol content.
3. Chile - "Objective Criteria" Argument
4.279 Chile replies that there is no precedent for holding in consistent with GATT 1994 a system of
taxation that does not discriminate based on nationali ty and that employs strictly objective criteria for
any differentiation in taxes. Indeed, the same pa nels that condemned the Japanese System – and even
the European Communities itself in arguing those cases – observed that distinctions based on
objective and neutral criteria are permissible under Article III:2.
4.280 Chile also states that Article III does not prohi bit a tax or regulation simply because, as a
result of the application of objective criteria, some or even many imported products are by some
measures treated worse than some or many like or competing domestic products. The drafting history
of Article III makes this clear. In the latter stages of the drafting of what became Article III of the
GATT, the negotiating Sub-Committee responsible for this Article reported:
The Sub-Committee was in agreement that under the provisions of Article 18
[Article III of the GATT], regulations and taxes would be permitted which, while
perhaps having the effect of assisting the production of a particular domestic product
(say, butter) are directed as much against the domestic production of another product
(say, domestic oleomargarine) of which th ere was a substantial domestic production
as they are against imports (say, imported oleomargarine).
156
4.281 In the view of Chile, the logic of this unanimous understanding of the negotiators is
compelling. All WTO Members make tax and regula tory distinctions that fall unevenly by some
measures among products that might be considered lik e or directly competitive or substitutable in the
sense of Article III. Sometimes these distinctions will mean that many domestic products will, by
some measures, be taxed or regulated more favorably than many like or competing imports. But that
is not a violation of Article III, where criteria for the distinctions are objective and neutral.
4.282 Chile also argues that past panels have re peatedly acknowledged these considerations, noting
also that Article III is not intended to be used as a tool for harmonizing the tax systems of the WTO
Members,
157 and WTO Members retain almost complete freedom with respect to domestic policies

155 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 d).
156 Reports of the Committees and Principal Sub-Committees, ICITO 1/8, 64 (Geneva, Sept. 1948).
157 See Panel Report Japan - Taxes on Alcoholic Beverages I, supra.

that do not distinguish between the origin or destination of goods.
158 In United States - Measures
Affecting Alcoholic and Malt Beverages, the panel noted that:
The purpose of Article III is not to harmoni ze the internal taxe s and regulations of
contracting parties, which differ from country to country.159
4.283 Chile further argues that in Japan – Taxes on Alcoholic Beverages I , the panel affirmed this
principle with respect to Article III:2, noting that this Article "prohibits only discriminatory or
protective taxation of imported products but not the use of differentiated taxation methods as
such ..."160 The panel went on to say "that Article III:2 does not prescribe the use of any specific
method or system of taxation ..."161 This position was also endorsed by the Appellate Body in Japan -
Taxes on Alcoholic Beverages II.162
4.284 Chile then claims that the EC argument against the Chilean sy stem ignores these precepts of
Article III, and instead asks the Panel to strike down an objective and neutral tax system merely
because a result of the application of that system is that those EC beverages of high alcohol content
(and high price) will face higher taxes than those Ch ilean beverages (primarily certain kinds of pisco)
that are of relatively low alcohol strength (and price). In making this argument with respect to the
New Chilean System, the European Communities i gnores that many European products, including
those most similar to pisco, will benefit from the same lower rates of tax, while other European
products could be adapted for the Chilean market me rely by diluting with water the current relatively
high strength of the products -- as the European Communities has suggested could be done by pisco
producers. Equally, the European Communities ig nores that under the New Chilean System many
Chilean distilled spirits, including Chilean whisky, br andy and gin and very substantial quantities of
pisco that are marketed at relatively high prices and alcohol strength, will face the highest rate of
taxation.
4.285 Chile then concludes that the New Chilean Sy stem thus presents precisely the kind of
regulatory system that Article III is not intended to condemn:
(i) there is no distinction in taxation based on origin or on type;
(ii) many imports can benefit from the lowest ta x and all others could be easily diluted
for that purpose;
(iii) many domestic products of Chile will face the highest tax rates under the New
Chilean System; and
(iv) the objective standards mean that foreign pr oducers can readily adapt their products
to lower their taxes by a simple process.
4.286 In its support, Chile adds that the Appellate B ody has properly noted that "Article III protects
expectations not of any particular trade volume but rather of the equal competitive relationship
between imported and domestic products".
163 Foreign and domestic producers have an equality of
competitive opportunities, as they have an equal oppor tunity to adapt their production, if they so

158 Panel Report on United States - Measures Affecting Alcoholic and Malt Beverages (hereafter,
"United States - Malt Beverages "), BISD 39S/206, para. 5.25 and Panel Report on United States - Taxes on
159 Panel Report on United States - Malt Beverages, para. 5.71.
160 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 b).
161 Ibid., para. 5.9 c).
162 See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 26.
163 Ibid., p. 16 (citations omitted).

choose, in the way implicitly prefe rred under the New Chilean System, i.e. , by reducing alcohol
content.
4.287 Further, Chile notes that the European Commun ities itself in this matter recognizes that "the
New Chilean System abolishes formally the distinc tion between pisco and the other types of distilled
spirits". The criterion of alcohol content is neutra l and objective, and one that past panels and the
European Communities itself have cited as an exam ple of a tax category corresponding to objective
product differences.
4.288 Chile further argues that the panel in Japan - Taxes on Alcoholic Beverages I endorsed use of
alcohol content as a permissible objective means of taxation. The panel suggested that the application
of different tax rates would be consistent with Ar ticle III:2 if the different tax rates were based on
objective criteria, and relative alcohol content was specifically cited and endorsed as an example of an
approach that could be acceptable. In rejecting the Japanese tax structure subject to dispute in Japan -
Taxes on Alcoholic Beverages I, the panel observed that it:
was unable to find that the differences as to applicability and non- taxable thresholds
of the ad valorem taxes were based on corresponding objective product differences
(e.g., alcohol contents) and formed part of a general system of internal taxation
equally applied in a trade-neutral manner to all like or directly competitive liquors.
164
4.289 It should be observed, according to Chile, that the panel did not object to the existence of non-
taxable thresholds, nor did the panel require that th e system apply taxes in direct proportion to alcohol
content. Rather, the panel found the Japanese syst em deficient in applying a different scale to
different types of distilled spirits that had been found directly competitive or substitutable.
4.290 In its further support, Chile points out that in the United States - Taxes on Automobiles case,
the European Communities argued that the Japanese tax system examined by the panel in Japan -
Taxes on Alcoholic Beverages I, "did not correspond to a rational overall system for taxing all liquors,
such as one based on alcohol content".165
4.291 Chile also notes that the European Communities itself, in its challenge of the Japanese system
of taxation of alcoholic beverages specifically commended both alcohol content and value as
acceptable neutral ways of varying taxes on like and directly competitive practices. In this respect,
the European Communities argued that the panel in its analysis of an alleged violation of Article III
should:
determine whether the category as a whole is taxed in excess of the corresponding
category of domestic products. This w ould not be the case if the proportional
variations in taxation on the basis of, e.g., alcohol content, are equally and uniformly
applied to this category of like products, both domestic and imported.
166
4.292 Chile further notes that similar views have b een expressed before the European Court of
Justice ("ECJ"). The ECJ in Case 170/78, Commission v United Kingdom , 1983 ECR 2265 noted
that:
[T]he Commission has recommended that spirits should be charged at a higher rate of
duty according to alcoholic strength than liqueur wines. It appears, therefore, to have

164 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 b).
165 Panel Report on United States - Taxes on Automobiles, supra., para. 3.92 (emphasis added by Chile).
Chile also referred to Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.45.
166 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.48.

accepted that there are social reasons for im posing a relatively higher rate of taxation
on beverages with a higher alcoholic content.
4.293 In the view of Chile, on the contrary, the European Communities argues that under the New
Chilean System many spirits imported from the European Communities are and will be of relatively
high alcohol content, and therefore more heavily taxe d, while many spirits produced in Chile are and
will be of relatively lower alcohol content and hen ce less heavily taxed. While those points are true,
they present an incomplete picture of the facts and an inadequate basis to find a violation of
Article III:2. Much Chilean pisco is taxed at the lowest rate of 27%, but Chile also produces a large
volume of products containing 40  alcohol content or more, including domestically produced whisky,
gran pisco, pisco reserved, 40 brandy, rum, gin, and vodka, and th ese products will be taxed at a rate
of 47%, the highest tax bracket. It is also significant that many distilled spirits produced in Europe
and elsewhere contain 35  alcohol or less and will be taxed in Chile at a rate of 27%, including
aguardiente, grappa, fruit liquors, cocktails, other li quors, and even shochu. Therefore, just as some
domestically produced products benefit from the lowest tax bracket, it is equally true that a significant
amount of domestically produced whisky and gran pisco faces the highest tax rate of 47%.
4.294 Chile further provides Chart 3 to show the growing volume of sales of premium grades of
pisco with relatively high alcohol content that will face the highest rates of taxation under the New
Chilean System.

Chart 3
Sales volume and growth rates of premium grades of Pisco
(Pisco from 40º to 46º)

0
50.000
100.000
150.000
200.000
250.000
300.000
350.000
400.000
450.000
500.000
Mercado Cajas 40º a 46º
1990 1991 1992 1993 1994 1995 1996 1997
+83,51%
+27,20%
+53,80% +0,02% +3,61%
+28,29%
+25,08%

4.295 Chile also presents tables showing the best available information concerning production and
sales of various types of distilled spirits in Chile.167
4.296 Chile then concludes that in any event, where objective standards are applied, GATT
Article III does not require that intern al taxes and measures must always result in proportional effect
on imported and domestic products. To take an obvious example, ad valorem taxes are permissible
under GATT, even though imported products that ar e higher priced or already face customs duties
may thereby have to face higher tax per unit than domestic products. The European Communities

167 Chile First Submission, Annex III.

itself has endorsed the idea that horsepower or engi ne displacement taxes are permissible. Chile
agrees, even though such taxes almost certainly fa ll disproportionately heavily on automobiles of the
type that Americans or Canadians are more likely to produce.
4.297 Chile further rebuts the EC argument that the Ne w Chilean System cannot be characterized as
a tax on alcohol content because it is based on an ad valorem tax rather than a specific tax. The
European Communities states that th e Chilean tax, although varying according to alcohol content, is
"assessed on the value of the beverage, which is not directly related to the value of the alcohol
content" and thus cannot be "characterized as a tax on the alcohol content". It is not clear what point
the European Communities is trying to make here or how it furthers their argument, but in any event
their analysis is fundamentally irrelevant and l eads to an incorrect conclusion. The New Chilean
System is based on both alcohol content and ad valorem; two criteria that have been recognized and
accepted by previous panels under GATT as objective criteria.
4.298 Chile further argues that panels have even f ound that different systems could be used for
imported and domestic products, if objectively based. It is not necessary for this Panel to go that far
in this dispute, since the New Chilean System app lies an identical system without regard to whether
distilled spirits are imported or domestically produced. Nevertheless, it is instructive that the panel in
Japan - Taxes on Alcoholic Beverages I noted that:
Article III:2 does not prescribe the use of any specific method or system of taxation
… there could be objective reasons proper to the tax in question which could justify
or necessitate differences in the system of taxation for imported and for domestic
products.
168
This position was also endorsed by the Appellate Body in Japan - Taxes on Alcoholic Beverages II.169
4.299 Chile also argues that the overriding requirement of Article III:2 is not to discriminate in
favor of domestic goods and agains t imported goods on the basis of national origin of a product.
Almost all cases brought to GATT and WTO panels under Article III:2 have involved measures that,
on their face, afforded more favorable treatment to some or all domestic goods than to imported goods.
4.300 Chile explains that a legislator should also be aware that a measure that formally does not
discriminate based on nationality may nevertheless be found to contravene Article III:2, second
sentence, if the effect of the measure is to make more favorable treatment available exclusively or
virtually exclusively to domestic products to the disadvantage of imported products. GATT and WTO
panels have gone furthest in extending the concept of de facto discrimination based on national origin
of a product in the recent alcoholic beverage taxa tion cases against Japan and Korea. Both of those
countries had tax systems in which one type of distille d spirit was taxed at a far lower rate than other
distilled spirits. Further, in each case, domestic producers accounted for virtually all domestic
consumption of shochu or soju, because vari ous measures effectively prevented imports of
shochu/soju from competing in the domestic market . In these circumstances, where there was no
possibility for foreign producers to obtain the benef its of the low tax accorded to shochu/soju, and
where the panel found that the favoured product was like or directly competitive or substitutable with
other types of distilled spirits, these systems were held to contravene Article III:2.
4.301 In the view of Chile, on the other hand, laws and regulations based on objective criteria such
as those used in the New Chilean System have ra rely been challenged in the GATT and have never
been successfully challenged , even when the tax system may result in less favorable treatment for
some or many imported goods than for some or many domestic goods. For example, in the United

168 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 c).
169 See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 26.

States - Taxes on Automobiles case, the panel found that the United States had not breached
Article III:2 by imposing a luxury tax on ve hicles above a certain threshold value.
170 The U.S. tax
resulted in far higher taxes on certain European pr oducts, which dominated the U.S. market for cars
priced significantly above the threshold price and th us accounted for the vast majority of the revenue
collected from the tax on European cars. However, far more imports, including a significant number
of imports in the price categories most directly competitive with U.S. "luxury cars," paid a minimal
tax or no tax at all.
4.302 Chile further argues that while the reasoning of the United States - Taxes on Automobiles
panel (the so-called "aim and effects" test) was not followed subsequently by the Appellate Body, it
believes that the result would have been the same under the three part test applied by the Appellate
Body in Japan – Taxes on Alcoholic Beverages II.171 The luxury tax imposed by the United States was
based on objective criteria (a tax on the value of cars in excess of a fixed luxury level) that applied to
both domestic and imported cars, and imported cars could and did benefit from the tax exemption
granted to all cars below the exemption.
4.303 Chile then points out that comparing that sy stem to the Chilean system of taxation of
alcoholic beverages, it might be noted that it is e asier as a practical matter for foreign producers to
adapt the alcohol strength of their product than for car producers to reduce their prices.
4.304 Chile also notes that similarly, even though sp ecific taxes such as those imposed on alcoholic
beverages in several EC Member States have a marked discriminatory effect on low priced imported
products relative to high priced domestic products such as Scotch whisky or even imported high
priced products such as U.S. or Canadian whisky, Chile has believed that a challenge of such tax
systems under Article III (or Article I which requires most favoured nation treatment with respect to
matters covered by Article III:2) would probably not be successful because the tax standard is
objective, even if its effect disfavours low price products.
4.305 Chile also argues that it is likewise inconceiva ble that members of the WTO, particularly
developing country members, thought or think that, in joining the WTO and accepting thereby the
obligations of Article III:2, they were foregoing the right to use fiscal policy tools such as luxury
taxes or exemptions or reduced taxes for goods purch ased primarily by poor consumers, even if such
policies result in higher taxes on many imports than on many like or directly competitive products.
4.306 The European Communities replies that Chile's defence in this case is built upon the
argument that tax distinctions linked to differences in alcohol content do not constitute "dissimilar
taxation" because they are "objective" and "neutral". While those two terms are constantly repeated
by Chile, their precise meaning is nowhere explained. As shown below, the legal test embodied in
Chile's argument would lead in practice to unacceptable consequences.
4.307 The European Communities argues that to begi n with, one may wonder what qualifies as an
"objective" tax distinction. Or, rather, one sh ould ask what does not qualify as an "objective" tax
distinction. Differences between spirits with respect to factors such as ingredients, colour or even
taste are no less "objective" than differences in alco hol content. They are as readily observable and
can be measured with the same precision. In view of that, why should tax distinctions based on one or
more of those characteristics be treated differently than the tax distinctions based on alcohol content?
4.308 The European Communities further states that on the other hand, if one accepts the view that
"objective" tax distinctions betw een products may never constitute "dissimilar" taxation, the second
sentence of Article III:2 becomes redundant. Indeed , the existence of two "directly competitive or

170 See Panel Report on United States - Taxes on Automobiles, supra.
171 See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra.

substitutable" products presupposes, by definition, that there is some sort of "objective" difference
between them. Otherwise, they would be "like" products and any difference in taxation between them
would be caught by the first sentence of Article III:2.
4.309 The European Communities states that the relationship between th e two terms of Chile's test
is also far from clear. Does Chile consider that tax distinctions based on "objective" differences are
per se "neutral"? That proposition can be easily refute d. Many tax distinctions based on "objective"
differences are demonstrably protectionist, both in purpose and in effect.
4.310 The European Communities asks the Panel to cons ider, for instance, the tax distinction made
by Japan between shochu and whisky. That distinc tion is by no means a "subjective" one. There are
"objective" differences between those two spirits, including differences in alcohol content which are
even larger than those between whisky and pisco.
172 If Chile's interpretation was upheld, Japan could
re-introduce the same tax differentials that have al ready been condemned in two panel reports, simply
by replacing the explicit distinction between shochu and whisky with a distinction based on alcohol
content or on any other of the "objective" character istics (or a combination of them) that differentiate
shochu from whisky.
4.311 The European Communities alternatively asks th e Panel to consider the hypothesis that a
vodka producing country (say Finland) levied a ta x based on the degree of optical density (i.e. , the
colour of the beverage), which results in the appli cation of a 1000 % tax on "brown spirits" and a 1 %
tax on "white spirits". Would that be a "neutral " tax distinction simply because it is based on an
"objective" characteristic?
4.312 The European Communities argues that Chile itself has conceded implicitly that the
"neutrality" of a tax distinction cannot be presumed a priori. In fact, as part of its discussion under
the second element of Article III:2, Chile sets out to demonstrate why the New Chilean System is
actually "neutral". However, if the neutrality of a tax distinction had to be ascertained already as part
of the second element, the third element of Article III:2, second sentence, would become superfluous.
This point is illustrated by Chile's First Submissi on, where the arguments made by Chile under the
second element with respect to the alleged the "n eutrality" of the New Chilean System are then
repeated almost without variation in connection with the third element.
4.313 In conclusion, the European Communities states that it would agree that Article III:2, second
sentence, does not prohibit tax distinctions betw een directly competitive or substitutable products
which are "neutral". But the "neutrality" of tax distinction is not something which can be inferred
from the mere fact that the tax distinction is b ased on differences on alcohol content or on any other
"objective" product difference. The "neutrality" of tax distinction has to be established, on case-by-
case basis and having regard to all relevant fact ors, under the third element of Article III:2, second
sentence. In Japan – Taxes on Alcoholic Beverages II , the Appellate Body found that the panel had
erred "in blurring the distinction between [the issue of whether the products were similarly taxed] and
the entirely separate issue of whether the tax me asure in question was applied so as to afford
protection". The test put forward by Chile in this case incurs in the same mistake.173
4.314 The European Communities further contests Chile's argument that in the New Chilean System
"differentiation in taxation is based on alcohol content, not type of distilled spirit". This claim,
however, involves an obvious fallacy. Each type of spirit is typically produced within a certain range
of alcohol content. This difference has been recognised by Chile's regulations, which prescribe a
different minimum alcohol content for each of the most common types of spirits. As a result, tax
distinctions based on alcohol content lead necessarily to tax distinctions between types of spirits.

172 The European Communities notes that the most usual strength of shochu is 25.
173 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 26-27.

4.315 The European Communities mainta ins that the New Chilean Syst em ensures that the main
types of imported spirits (whisky, gin, rum, vodka and tequila, all of which have a minimum alcohol
content of 40 ) are taxed at the highest rate possible: 47 %. Meanwhile, the vast majority of pisco
(which has a minimum alcohol content of 30 ) is taxed at the lowest rate possible: 27 %. Thus, it is
indisputable that in the New Chilean System pi sco and the other spirits in dispute are still not
"similarly" taxed.
4.316 The European Communities further argues that Japan – Taxes on Alcoholic Beverages II
stands for the proposition that the application of specific taxes in direct proportion to the volume of
alcohol contained in each type of distilled spirit does not constitute "dissimilar" taxation. The
underlying reasoning is that, in that system of taxation, the taxed product is not the spirituous
beverage but the alcohol contained in the beverage.
4.317 In the view of the European Communities, this re asoning is not applicable in the case at hand.
The measure in dispute is an ad valorem tax and not a specific tax. And it is calculated on the basis of
the value of the beverage as a whole and not on th e basis of the value of the alcohol content.
Therefore, unlike the measures applied by Japan, it cannot be characterised as a tax on the alcohol
content. For that reason, the European Commun ities considers that the Panel should compare the
absolute rates applied to each spir it, rather than the rates per degree of alcohol contained in each type
of spirit.
4.318 The European Communities argues that in any ev ent, it has demonstrated that pisco and the
other spirits are also "not similarly" taxed even if one compares the rates per degree of alcohol. Each
degree of alcohol in whisky, gin, vodka, rum and tequ ila is taxed at a rate which is more than 50 %
higher than the rate applied to each degree of alcohol in pisco of 35.
4.319 The European Communities points out that Chile has acknowledged this tax differential, but
claims that the lack of proportionality between di fferences in taxation and differences in alcohol
content does not constitute "dissimilar" taxation. According to Chile, a difference in alcohol content
between two types of spirits (however small) c ould justify any conceivable difference in taxation
between them (no matter how large) that a Member may chose to apply. By way of justification,
Chile argues that alcohol content is an "objective" product characteristic and that distinctions based on
that criterion are always "neutral".
4.320 The European Communities maintains that Chile's position is refuted by Japan – Taxes on
Alcoholic Beverages I and II. The second panel report is particularly clarifying in this regard. In that
report, the panel based its conclusion that whisky and shochu were not "similarly" taxed on the fact
that the tax rate per degree of alcohol applied to whisky of 40  was higher than the rate per degree of
alcohol applied to shochu of 25 . This comparison would have been totally irrelevant if, as claimed
by Chile, differences in alcohol content could ju stify non-proportional differences in taxation. If
Chile's position was correct, the panel could not have reached the conclusion that shochu and whisky
were not "similarly" taxed except by comparing the rates per degree of alcohol applied by Japan to
whisky and shochu with the same alcohol conten t, something which the panel did not consider
necessary to do.
4.321 Agreeing with Chile in that Article III:2, sec ond sentence, does not prohibit tax distinctions
between directly competitive or substitutable produ cts which are "neutral," however, the European
Communities argues that, contrary to Chile, it believes that the "neutrality" of a tax distinction is not
something which can be presumed from the mere fact that the distinction in question is based on
alcohol content or on any other "objective product di fference". The "neutrality" of a tax distinction
has to be established, on a case-by-case basis and having regard to all relevant factors, under the third
element of Article III:2, second sentence.

4.322 The European Communities also contests Chile 's invocation as authority for its sweeping
proposition that tax distinctions b ased on differences in alcohol cont ent never constitute "dissimilar
taxation", of a somewhat obscure passag e contained in the Panel Report on Japan – Taxes on
Alcoholic Beverages I:
The Panel was unable to find that the di fferences as to the applicability and non-
taxable thresholds of the ad valorem taxes were based on corresponding objective
product differences (e.g. , alcohol contents) and formed part of a general system of
internal taxation equally applied in a trad e-neutral manner to all like or directly
competitive liquors (e.g. , "alcohol taxes" equally applied to all alcoholic
beverages).
174
4.323 The European Communities argues that the a bove passage, however, is inapposite for a
number of reasons. The European Communities explains that first, it relates to the interpretation of
the first sentence of Article III:2, a provision which h as a different scope and structure. The test laid
down by the panel is superfluous in the context of the second sentence of Article III:2, because tax
distinctions between "directly competitive or substitutable products" are always permissible, provided
that they are not applied "so as to afford protection".
4.324 The European Communities goes on to state th at second, the meaning of the passage is
notably ambiguous. The reading made by Chile is c ontradicted by several other passages in the same
report where the panel stated very clearly that tax distinctions between "like" alcoholic beverages with
different alcohol content may be compatible with th e first sentence of Article III:2 to the extent that
they can be explained as a non-discriminatory tax on the alcohol content:
The Panel was unable to find that these ta x differentials corresponded to objective
differences of the various distilled liquors, for instance that they could be explained
as a non-discriminatory taxation of their respective alcohol contents.175
It followed from the clear wording of Artic le III:2 that imported liquors "shall not be
subject … to internal taxes … in excess of those applied … to like domestic
products". The Panel was of the view that this unqualified wording must not
necessarily mean that there could never be any circumstances in which different tax
treatment of "like products" was compatible with the General Agreement. The Panel
noted, for instance, that GATT Article III:2 [ sic] permitted the non-discriminatory
taxation "of an article from which the im ported product has been manufactured or
produced in whole or in part", and that such a non-discriminatory alcohol tax on like
alcoholic beverages with different alcoholic contents could result in different tax rates
on like products.176
4.325 The European Communities argues that finally, Chile's reading is incompatible with the
findings of Japan – Taxes on Alcoholic Beverages - II , where the Appellate Body confirmed that the
"aim-and-effect" of a tax distinction is irrele vant for the purposes of the first sentence of
Article III:2.177

174 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para 5.9 b).
175 Ibid., para 5.9 a).
177 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra. See also Appellate
Body Report on European Communities – Regime for the Importation, Sale and Distribution of Bananas ,
WT/DS27/AB/R, para. 241.

4.326 Further, the European Communities maintains that the statement made by the European
Communities in Japan – Taxes on Alcoholic Beverages II which is cited by Chile has been taken out
of context. In Japan – Taxes on Alcoholic Beverages - II, the proponents of the "aims-and-effect" test
argued that the so-called "two-step" test put fo rward by Canada and the European Communities was
too rigid. In response to a question from the Pa nel, the European Communities suggested that the
two-step approach could be assorted of two "fle xibilities". The first flexibility was to make a
"narrow" interpretation of the term "like". Th e second "flexibility" amounted in practice to the
creation of a praetorian exception for graduated sy stems, subject to certain conditions aimed at
ensuring their neutrality. The passage quoted by Chile purports to describe the scope of the suggested
second "flexibility". Eventually, the panel, and la ter the Appellate Body, accepted the first flexibility,
but not the second one. In any event, the second "flexibility" did not offer an unqualified exception
for all tax distinctions based on alcohol content. The passage quoted by Chile refers to "proportional"
tax variations, which are "equally and uniformly ap plied" to both importe d and domestic products.
Chile's tax system does not satisfy any of those requi rements. Furthermore, the second "flexibility" is
unnecessary in the context of Article III:2, second sen tence, because the third element ("so as to
afford protection") already serves that function.
4.327 The European Communities then concludes that in any event, the passage invoked by Chile
makes it clear that tax distinctions based on "obj ective product differences", including distinctions
based on differences in alcohol content, cannot be presumed to be "neutral". Rather, it must
established in each particular case that they are "equ ally applied in a trade-neutral manner to all like
or directly competitive liquors". As demonstrat ed by the analysis ma de by the European
Communities under the third element of Article III: 2, second sentence, Chile's measures do not meet
this standard.
4.328 Also, the European Communities refers to Chile's citation of the following passage of Japan –
Taxes on Alcoholic Beverages I:
Article III:2 does not prescribe the use of any specific method or system of taxation
… there could be objective reasons proper to the tax in question which could justify
or necessitate differences in the system of taxation for imported and for domestic
products.
178
The European Communities then argu es that the passage is both irrelevant and misleading. It is
irrelevant because the present dispute does not con cern the application of two different taxation
methods to domestic and imported products, but rather the application of a single taxation method
which affords protection to domestic production.
4.329 The European Communities also explains that it is misleading because, read in isolation, it
could suggest that the panel accepted that "objective" reasons could justify the application of different
taxes to domestic and imported produc ts. In reality, however, the point made by the panel was that
the application of two different taxation methods to domestic and imported products ( in casu the
application of different methods for assessing the tax base) is not per se contrary to Article III:2.
Rather, in order to establish a violation of that prov ision, the complainant has to demonstrate that the
application of two different methods results in th e imposition of a higher tax burden on imports than
on domestic products. This becomes clear in the two sentences that follow the passage cited by Chile:
The Panel found that it could also be comp atible with Article III:2 to allow different
methods of calculation of price for tax pur poses. Since Article III:2 prohibited only
discriminatory or protective tax burdens on imported products, what mattered was, in

178 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 c).

the view of the Panel, whether the application of the different taxation methods
actually had a discriminatory or protective effect against imported products.
179
4.330 The European Communities points out that these two sentences have been omitted by Chile,
but not in the citation of the same passage made by the Appellate Body in Japan – Taxes on Alcoholic
Beverages II. 180 Significantly, the Appellate Body referre d to this passage in the context of its
discussion of the third element of Article III:2, second sentence, and not in connection with the
second element.
4.331 The European Communities also contests Chile 's invocation of the findings of the Panel
Report on United States – Taxes on Automobiles with respect to a luxury tax applied by the Unites
States on vehicles over a certain threshold value. That Panel Report, however, was never adopted
because both the complainant and the defendant were dissatisfied with the panel's reasoning.
4.332 The European Communities further points out that although the Panel Report on
United States – Taxes on Automobiles is based on the so-called "aims-and-effects" approach,
according to which whether or not two products are "like" depends on whether the regulatory
distinction has the purpose and the effect of a ffording protection to domestic production, this
approach was rejected by the panel 181, and then by the Appellate Body in the Japan – Taxes on
Alcoholic Beverages II case.182 The Appellate Body has confirmed its rejection of that approach in
EC – Measures affecting the Importation, Sale and Distribution of Bananas.183
4.333 Moreover, the European Communities argues that even under the "aims-and-effects"
approach, the mere fact that a tax distinction is b ased on an "objective" criterion is not sufficient to
exclude per se the application of Article III:2. In United States – Taxes on Automobiles the panel
examined whether in casu the tax distinction had the "purpose" and the "effect" of affording
protection to domestic production. According to th e European Communities, Ch ile's strategy in the
present case, however, is to prevent the Panel from c onducting that type by analysis by arguing that
since the products are "similarly" taxed, it is not necessary for the Panel to look at the third element
of Article III:2, second sentence.
4. Reach of Japan/Korea – Taxes on Alcoholic Beverages cases
4.334 Chile disagrees with the EC's evident determination to portray the New Chilean System as a
replication of the tax systems of Japan and Korea that previous panels found inconsistent with
Article III:2, second sentence. The New Chilean System is fundamentally different from the Japanese
and Korean tax systems for alcoholic beverages, both of which discriminated based on type of
distilled spirits and both of which favoured a type that was and could be only supplied domestically
for all practical purposes. By contrast, the New Chilean System does not differentiate by type of
distilled spirit, but instead applies an identical tax scale, imposing an identical ad valorem tax
depending on degree of alcohol content to all distilled spirits (except beer and wine) regardless of type
and whether imported or domestic. Ironically, the European Communities asks the Panel to condemn
the Chilean system by analyzing that system in te rms of effects on a subjective classification system
(i.e., type) that Chile explicitly abandoned as a ma tter of tax classification in enacting Chilean Law
19,534.

179 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para 5.9 c). [emphasis added by
the European Communities).
180 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 29.
181 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 6.18.
182 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 15-23.
183 Appellate Body Report on European Communities – Regime for the Importation, Sale and

4.335 Chile contends that the EC effort to wrap this case in the mantle of successful challenges of
the Korean and Japanese systems fails because it ignores fundamental differences between the cases
and the systems. The Panel should reject the EC's unjust and ill-founded effort to stretch prior rulings
in ways that do not conform with the language, practice, or intent of Article III:2.
4.336 Chile explains that while there are many di fferences between the Japanese and Korean cases
and this case involving Chile, the mo st fundamental difference is that the systems at issue in the
Japanese and Korean cases both taxed by type of distilled spirits, whereas the New Chilean System
taxes all types identically, according to alcohol content and value.
4.337 Chile maintains that the European Communities tries to avoid this distinction by ignoring it.
Thus the European Communities starts off its case with a lengthy argument about whether different
distilled spirits are directly competitive or substituta ble. That issue was cr itical in the Japan and
Korea cases, precisely because those tax systems impos ed different taxes according to the type of
distilled spirit. Japan and Korea each created ten or more tax categories, based on different types of
distilled spirit, each bearing its own separate rate or scale of taxation, with shochu in Japan and soju
in Korea having the lowest rate or scale of taxation. There was virtually no doubt that the differences
in taxation were more than de minimis and that imports had no prospect of benefiting from the lowest
rates of taxation (since shochu and soju were ef fectively not imported). Thus the only critical
question under Article III:2, second sentence, was whet her the types of products taxed at a low rate
were directly competitive or substitutable with the types taxed at higher rates.
4.338 In the view of Chile, the New Chilean System, however, does not so differentiate by type.
That is why Chile has repeatedly pointed out that whether different types of spirits are directly
competitive or substitutable in the Chilean market is essentially irrelevant under the New Chilean
System, since that system does not make distinctions by type. Chile does not, in fact, consider that
pisco is directly competitive or substitutable with whisky for the reasons stated in previous
submissions by Chile. However, Chile does not re ly on the differences between pisco and other types
of distilled spirits in claiming the consistency of the New Chilean System with Article III:2, because
the system does not impose taxes based on type.
4.339 According to Chile, the European Communities tr ies to obscure this fundamental difference
by arguing that the effect of the New Chilean System is to tax types of distilled spirits that are
customarily or by law sold at higher degrees of alcohol strength at higher ad valorem rates than types
sold at lower alcohol strengths. Undoubtedly that is true, but that result does not infringe Article III:2.
The reason the Korean and Japanese systems we re found inconsistent with GATT 1994 was not
because tax distinctions based on type of distilled spirit per se violate Article III:2. The core problem
with those systems was that the effect of the particul ar type distinctions in those systems was to favor
a particular product that was effectively not imported, and thus the type distinction had the effect of
discriminating in favor of an almost exclusively national product.
4.340 Chile further argues that the critical flaw in the EC's analysis arises from the EC's effort to
stretch the analysis of past panels considerably beyond any past precedents, including the Japan and
Korea alcoholic beverage tax cases. The panels in the Japan and Korea cases were dealing with
discrimination based on the subjective concept of type of distilled spirits, where products are
distinguished according to how and sometimes wher e they are made. The use of those subjective
criteria had the direct effect of limiting the benefits of the most favorable tax to a type of product
which was produced locally and which, in practice, could not be imported into those countries.
4.341 Chile maintains that faced with an entirely di fferent situation with the New Chilean System,
the European Communities asks this Panel to go one gigantic and impermissible step further than past
panels. It takes a Chilean System that differentiate s by the objective standard of alcohol content, and
asks the Panel to view that system in terms of its effect on different types of distilled spirits. The

European Communities argues as though previous panels had established a rule that Article III
requires no tax discrimination based on types of distill ed spirits, and therefore that distinctions that de
facto have different impacts on different types are then also inconsistent with Article III:2, or at least
should be so considered.
4.342 Chile emphasizes that beyond the point that not hing in the Japan or Korea cases mandates
such a further extension of the holding of those cas es, there are very significant legal, logical and
practical differences between systems such as those of Japan and Korea that codify a distinction based
on a subjective and qualitative concept such as "typ es" of products and systems based on objective
criteria applied equally to all products that are directly competitive or substitutable, regardless of type.
According to Chile, the European Communities tries to give the obj ectively based Chilean system an
aura of subjectivity by analyzing the New Chilean System on the basis of its effect on different
subjective types of products. Then, ignoring or dismissing inconvenient facts – the significant and
increasing quantity of pisco and other products that will be subject to high taxes and the actual and
potential trade in low-tax products – th e European Communities claims that the de facto
discrimination by type that the European Co mmunities claims to see in turn constitutes a de facto
discrimination based on nationality. If this unprecedente d theory is sustained, all that will be required
to find a violation of Article III:2 will be to conjure the right kind of subjective classification system
that will validate a case based on di fferential effects of an objective tax system. It would not even
affect the analysis if the more heavily taxed type of product is produced in substantial quantities in the
taxing country as well as imported, since that fact existed in the Japan case, but did not affect the
Appellate Body's ruling.
4.343 Chile argues that many of the claims of th e European Communities are absolutely wrong
since the new Chilean taxation system for alcoholic beverages is based on an objective criterion and
the fact that the tax paid by each product is b ased in two factors: alcohol content and price (i.e., ad
valorem) of the product, regardless from its type, origin and labeling.
4.344 According to Chile, the Europ ean Communities confuses the issu e when pointing out that the
system is conceived so that pisco, which has a lowe r alcohol content, will pay less taxes, while other
imported products will pay higher taxes. The truth and the correct and fair way of describing the New
Chilean System is that the system is conceived so that pisco having a low alcohol content, as well as
all other domestic or imported spirits of low alcohol content, will be subject to lower tax rates, while
pisco with high alcohol content, as well as all othe r domestic or imported spirits of high alcohol
content, will be subject to higher tax rates. C onsequently, the higher or lower tax rate is solely
determined by the alcohol content of the product a nd not by its origin, as the European Communities
seems to suggest. In any system within this "phi losophy" (i.e., to tax based on alcohol content), the
result will be that those products with less alcohol will be subject to a relatively lower tax also.
4.345 Chile explains that concerning the ad valorem component of the new system, it has opted to
maintain an ad valorem system since in an economy as open as the one in its country, competition
factors, such as product price relationships, have to be preserved. The ad valorem taxation system
does not alter this competitive attribute of products (i.e., price relationships), as opposed to those in
which an absolute value is determined according to alcohol content, thus introducing a degree of
distortion biased for the benefit of products of higher prices since the tax is a lower proportion of in its
final price.
4.346 Chile further argues that ad valorem taxes are not illegal simply because domestic products
are cheaper than imports, and thus bear less tax per unit. To take an example, EC Member States
impose specific taxes on distilled spirits that, measured in ad valorem proportional terms, result in
low-priced Chilean products bearing much greater proportionate taxes than spirits that the EC
considers directly competitive or substitutable. The following chart demonstrates how the tax system

of four Member States all impose these proportiona tely higher taxes on Chilean pisco than on their
own domestic products.
4.347 As an example, Chile presents Table 28
184 which compare the specific tax on pisco of 35º,
pisco of 40º, whisky 43º, cognac VSOP, brandy Fund ador and brandy Carlos I in some EC Member
States, and Table 29185 which also compares the specific tax applied in these EC Member States in ad
valorem terms.

 Table 28186

SPECIFIC TAX TO ALCOHOLIC BEVERAGES IN SOME EC MEMBER STATES (US$/lt)
MEMBER STATES Pisco Pisco Whisky Whisky Cognac Brandy
 35 40  43  43 VSOP Fundador Carlos I
Spain 2.66 3.04 3.26 3.26 3.04 2.88 3.04
Great Britain 11.37 13.00 13.97 13.97 13.00 12.35 13.00
France 6.34 7.05 7.47 7.47 7.05 6.76 7.05
Germany 5.60 6.40 6.88 6.88 6.40 6.08 6.40

Table 29187

SPECIFIC TAX TO ALCOHOLIC BEVERAGES IN SOME EC MEMBER STATES MEASURED
IN AD VALOREM PROPORTIONAL TERMS (%)
MEMBER STATES Pisco Pisco Whisky Whisky* Cognac* Brandy*
 35 40  43  43 VSOP Fundador Carlos I
Spain 92.9 78.1 57.3 29.8 9.6 37.4 13.4
Great Britain 397.9 334.2 245.1 127.5 40.9 159.9 57.2
France 221.9 181.2 131.0 68.1 22.2 87.6 31.0
Germany 195.9 164.6 120.7 62.8 20.2 78.8 28.2
Notes: Prices in US$/lt CIF/ex-factory: Pisco 35 : US$ 2.86; Pisco 40 : US$ 3.89; Whisky 43 : US$ 5.70;
Whisky* 43: US$ 10.96; Cognac Remy VSOP* 40 : US$ 31.74; Brandy Fundador* 38 ; US$ 7.72; Brandy
Carlos I* 40: US$ 22.72.
*Prices: Duty Free

4.348 According to Chile, this shows that the specifi c tax on alcoholic beverages applied in these
EC Members States is relatively higher to those al coholic beverages with lower alcohol content.
Chile indicates that it is not asking the Panel to deal with a new complaint, but rather to demonstrate
that neutral, objective systems can have these di sproportionate effects shown, without infringing
Article III.
4.349 Further, Chile notes that European Communities complains that the New Chilean System is
based on both alcohol content and value, which th e European Communities terms a hybrid. The real
EC complaint here appears to be that Chile should copy the EC Member State systems, which apply a
specific tax per degree of alcohol. Again, Chile has noted that ad valorem taxes have long been
endorsed by the WTO and by economists, whereas specific taxes are much more likely to distort
competition. Further, there is no element of Ar ticle III that forbids using both objective criteria,
which in tandem also serve the objective of ma king the New Chilean System materially more

184 Chile Oral Statement at the First Substantive Meeting, p. 4.
185 Ibid.
186 Chile Oral Statement at the First Substantive Meeting, p. 4.
187 Ibid.

progressive than using a flat ad valorem rate or worse, the EC's specific tax system, which would be
that much more regressive.
4.350 The European Communities replies that Chile insists that its New Chilean System is
different from the Japanese tax system and the Korean tax system. In reality, however, the differences
are only superficial.
4.351 The European Communities states, in response to Chile's claim that the New Chilean System
does not differentiate "by type," that a trick as old as protectionism is to base regulatory distinctions
on product characteristics which distinguish indi rectly between domestic and imported products.
Chile's system is slightly more sophisticated than the Japanese system or the Korean system, but no
less protective in both purpose and effect.
4.352 The European Communities claims that the alcohol content thresholds chosen by Chile
evidence that the New Chilean System has been devised so as to rep licate the effects of the explicit
tax distinctions between "types" made in the ol d system. The minimum alcohol content of most
imported spirits is 40°, whereas 35  is the most usual alcohol content of pisco especial , which
together with pisco tradicional of 30  accounts for more than 90 % of the sales of pisco. As
confirmed by Chile's responses to the questions posed by the Panel, there can be no rational
explanation for choosing precisely those two thresholds, other than affording protection to pisco.
4.353 The European Communities contests Chile's argu ment that another "fundamental" difference
would be that its New Chilean System is based on "objective" criteria, whereas the Japanese and the
Korean system were based on "subjective" criteria. Chile, however, never explains what distinguishes
an "objective" criterion from a "subjective" one. The differences between whisky and shochu did not
exist only in the minds of the Japanese taxmen. There are "objective" differences between shochu and
whisky, including differences in alcohol content whic h are even larger than those between pisco and
whisky. Those "objective" differences, however, we re not considered as a valid justification for
taxing whisky more heavily than shochu.
4.354 The European Communities also contests Chile 's argument that shochu and soju were
"effectively not imported" into Japan and Korea, resp ectively. This misrepresents the facts of those
two cases. Shochu and soju were imported in re latively small quantities, compared to domestic
production, but neither of them was an "inherently" domestic product. For example, in 1995, imports
of shochu accounted for 2.4 % of the sales of shochu in Japan.
188 In comparison, in 1996 imports into
Chile of low strength liqueurs (the only imported products which in practice will benefit from the
lowest tax rate) represented less than 0.4 % of th e domestic sales of spirits with a minimum alcohol
content of 35 % or less, as shown in Table 19 above. Thus, the New Chilean System is more
protective than the Japanese system by Chile's own standard.
4.355 The European Communities maintains that Chile's strategy in this case is to divert the Panel's
attention from the examination of Chile's own tax sy stem. Chile attempts to do so by focusing the
discussion on other tax systems (both real and hypothetical), which are fundamentally different from
the New Chilean System. With the same purpose, Ch ile tries to focus the debate on a number of
superficial differences between this case and previous cases.
5. "Direct Proportionality" Argument
4.356 The European Communities also points out that the two panel reports on Japan – Taxes on
Alcoholic Beverages I and II stand for the proposition that the application of specific taxes in direct
proportion to the alcohol contained in each type of distilled spirit does not constitute "dissimilar"

188 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para 4.175.

taxation of the spirits. The underlying reasoning is that, in such a system of taxation, the taxed
product is not the spirit but the alcohol contained in the beverage. For example, the European
Communities applies a uniform specific tax per h ectolitre of pure alcohol to all the products
containing ethyl alcohol, including, but not limited to, distilled spirits falling within HS 2208.
189
4.357 The European Communities maintain s that this reasoning does not apply in the case at hand.
The measure applied by Chile is an ad valorem tax applied on the value of the beverage as a whole
and not on the value of the alcohol content. Moreover, the value of the beverage is not directly related
to the value of the alcohol content. Therefore, Ch ile's measure cannot be characterised as a tax on the
alcohol content. For that reason, the European Communities considers that, in order to determine
whether pisco and the other spirits are "similarly ta xed", the Panel should compare the rates per bottle
of each spirit, and not the rates per degree of alcohol.
4.358 The European Communities claims that in any event, it has shown that pisco and the other
spirits are also "not similarly" taxed when one co mpares the rates per degree of alcohol. Specifically,
each degree of alcohol contained in a bottle of whisky, gin, rum, vodka or tequila is taxed at rate
which is more than 50 % higher than the rate a pplied to each degree contained in a bottle of pisco
especial.
4.359 The European Communities notes that Chile has acknowledged that the rates per degree of
alcohol vary from one spirit to another, but that it claims that the lack of proportionality between
differences in taxation and differences in alcohol cont ent does not amount to "dissimilar" taxation. In
other words, according to Chile, if there is a diffe rence in alcohol content, however small, between
two spirits, then no conceivable tax differentia l which a Member may see fit to apply can be
considered as "dissimilar" taxation of those spirits.
4.360 In the view of the European Communities, Chile's position is logically untenable. If the taxed
product is the alcoholic beverage, then one should compare the rates per unit of beverage volume,
irrespective of their alcohol content. On the other hand, if the taxed product is the alcohol content, the
comparison should be made between the rates per un it of alcohol volume, regardless of the beverage
in which it is contained.
4.361 The European Communities notes that in any event, as shown in Table 30, in the amended
ILA the tax rate per degree of alcohol is not unifo rm but varies from product to product. Each degree
of alcohol in whisky, gin, vodka, rum and tequila is taxed at 1.175 % while each degree of alcohol in
pisco of 35  is taxed at only 0.771 %. Thus, pisco and the main types of imported spirits are not
"similarly" taxed even if the comparison is made by reference to their alcohol content.

189 See Council Directive 92/83/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92) and Council
Directive 92/84/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92).

 T a b l e 3 0
190
Alcohol content Ad valorem rate Percentage points per
degree of alcohol
15 27 % 1.8 %
20 27 % 1.35 %
25 27 % 1.08 %
30 27 % 0.9 %
35 27 % 0.771 %
38 39 % 1.026 %
40 47 % 1.175 %
43 47 % 1.093 %

4.362 The European Communities also points out that if the rate per degree of alcohol was the same
for all spirits as the rate currently applied to pisco of 35 , the resulting ad valorem rates would be as
follows:
Table 31191
Alcohol content Current ad valorem rate Ad valorem rate if the
rate per degree of
alcohol was 0.771 %
15 27 % 11.57 %
20 27 % 15.42 %
25 27 % 19.28 %
30 27 % 23.13 %
35 27 % 27 %
38 39 % 29.30 %
40 47 % 30.84 %

190 EC First Submission, Table 21.
191 Ibid., Table 22.

4.363 The European Communities then concludes that if the taxed product is the alcoholic beverage,
then one should compare the rates per unit of bevera ge volume, irrespective of their alcohol content.
On the other hand, if the taxed product is the alcohol content, the comparison should be made between
the rates per unit of alcohol volume, regardless of the beverages in which it is contained.
4.364 In rebuttal, Chile notes that the European Communities implies that it could accept the ad
valorem and alcohol content standards of the Chilean law, if only the taxes were proportional. Then,
Chile argues that there is no rule of proportionalit y in the WTO and, if there were, the European
Communities would be in violation of its own rule because wine and beer are taxed less per degree of
alcohol than whisky and other distilled spirits. Indeed , the EC's argument in this respect with regard
to Chile is remarkably similar to the complaint of the Scotch Whisky Association about tax systems
that favor wine and beer in Member Countries of the European Union. There are many other "non-
proportional" taxes, including all specific taxes , for example. Furthermore, the European Court of
Justice upheld a non-proportional tax on engine disp lacement under the EC's own national treatment
provisions. The United States also taxes wine and beer at much lower rates per degree of alcohol,
using a system that also produces large variations in tax for small differences in alcohol content of its
wines.
192
4.365 Chile points out that ultimately, the Europ ean Communities itself see ms to recognize that
Article III does not require taxes or regulations to ha ve equal effects by all standards of measurement,
as the European Communities ultimately appears to re ly on a theory that the deficiency of the New
Chilean System is not that the taxes vary by alcoho l strength, but rather that the tax does not vary in
direct proportion to alcohol strength, as shown for example in Tables 30 and 31 above. Chile does not
deny the veracity of those charts, but Chile strongly disagrees that Article III requires a rule of direct
proportionality with respect to alcoholic beverage taxes.
4.366 Chile notes that the Europ ean Communities appears to suggest that decisions on Japan -
Taxes on Alcoholic Beverages I and II support the EC proposition that taxes employing an alcohol
content standard must establish tax rates directly pr oportional to the degree of alcohol in order not to
constitute dissimilar taxation. In fact, the panels in those cases did not decide that issue. The panels
only said that taxation must be based on objective criteria, and that Japan could not use a different
scale of alcohol-based taxation for different types of directly competitive or substitutable alcoholic
beverages, but the panels did not say that taxes must be directly proportional to alcohol strength.
4.367 Chile maintains that GATT Article III:2 has never been interpreted to require such a direct
proportionality rule. As Chile has already noted above, the Japanese systems were faulted for
establishing significantly different tax scales for different types of distilled spirits that the panels held
to be like, directly competitive or substitutable. Th e panels did not find fault, however, with the lack
of direct proportionality to liquor content.
4.368 The European Communities replies that contrary to Chile's protestations that this issue has
not been decided by previous panels, Chile's positi on is refuted by the findings of the two Panel
Reports on Japan – Taxes on Alcoholic Beverages I and II. The second panel report is particularly
clear in this regard. In that report, the panel b ased its conclusion that whisky and shochu were not
"similarly" taxed on the fact that the rate pe r degree of alcohol applied to whisky of 40  was higher
than the rate per degree of alcohol applied to shochu of 25 .
193 This comparison would have been

192 26 U.S.C.A. § 5001.
193 The European Communities notes that under Japan' s Liquor Tax Law, the tax rate varied within
each of the four tax categories ("s hochu", "whisky/brandy", "spirits" and "liqueurs") according to alcohol
content. For example, the tax rate on shochu B of 25  was Y102,100 per kiloliter and the rate on shochu B of
40 Y284,100 per kiloliter. Shochu is produced within the range of 20  to 45 , but 25  is the most usual
strength.

totally irrelevant if, as claimed by Chile, differences in alcohol content coul d justify non-proportional
differences in taxation. If Chile's position was correct, the panel could not have reached the
conclusion that shochu and whisky were not "sim ilarly" taxed except by comparing the rate per
degree of alcohol applied by Japan to whisky of 40  and to shochu of 40 , something which the panel
did not consider necessary to do.
194 The European Communities mainta ins that similarly, the panel
reached the conclusion that vodka was taxed "in exce ss of" shochu by comparing the rate per degree
of alcohol applied to vodka of 38  to the rate per degree of alcohol applied to shochu of 25  and not
the rate per degree of alcohol applied to shochu of 38195
4.369 Chile further responds that it should also be born in mind that requiring a direct
proportionality rule is not only unprecedented and unwarranted under th e plain language of
Article III:2, but it serves no valid policy purposes not already served simply by requiring objective
standards. A large benefit for international trad e in having objective standards such as the alcohol
strength criterion of the New Chilean System is th at domestic and foreign producers have the ability
to adapt their production to reduce the tax or regul atory burden, if they so choose. As discussed
below under the third element of the Article III:2 test, the New Chilean Sy stem allows foreign
producers, if they so choose, to dilute their product to qualify for lower levels of Chilean taxes. While
in some cases that may be inconvenient for export ers in much the way different national labeling or
packaging requirements can be inconvenient, Artic le III does not require harmonization of standards
to the convenience of large global exporters.
4.370 In the view of Chile, thus, the European Co mmunities recognizes the right to differentiate
products based on objective criteria such as the al cohol content of a beve rage and in doing so
implement a neutral based system that does not infr inge Article III. Chile has enacted such a law
based on the very same objective criteria that th e European Communities has recognized as valid: the
alcohol content of the various spirits, which do es not discriminate among the various domestic and
foreign participants.
4.371 Chile argues that similar views have been e xpressed before the European Court of Justice
("ECJ"). The ECJ in Case 170/78, Commission v United Kingdom, 1983 ECR 2265 noted that:
[T]he Commission has recommended that spirits should be charged at a higher rate of
duty according to alcoholic strength than liqueur wines. It appears, therefore, to have
accepted that there are social reasons for im posing a relatively higher rate of taxation
on beverages with a higher alcoholic content.196
4.372 Chile reiterates that the New Chilean System do es not make distinctions based on type of
distilled spirits, but rather taxes every distilled spir it (except wine and beer) according to the same
scale based on alcohol content and value. The Eu ropean Communities uses a different objective scale
for taxation of alcoholic beverages, levying a speci fic tax per degree of alcohol content for distilled
spirits. Both the Chilean and EC systems by so me measures discriminate against products based on
price and alcohol content. Ad valorem systems, measured by specific rate per volume unit, fall most
heavily on high priced goods, but economists agree that ad valorem systems are fairest in preserving
competitive relationships. Specific rate taxes by comparison distort competition in favor of high price
goods, if measured on an ad valorem basis.
4.373 According to Chile, the European Communities c ontinues to attack the New Chilean system
based on an unfounded theory that taxation based on alcohol content must be proportional. In some
respects, the EC's argument seems to be motivated by an effort to make the EC's own tax system into

194 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., paras. 6.33 and 2.3.
195 Ibid., paras 6.24 and 2.3.
196 The ECJ in Case 170/78, Commission v United Kingdom, 1983 ECR 2265.

a fixed GATT rule, as the European Communities insist s on the use of not just directly proportional
but specific taxes. There is no basis for such a claim. Chile has already pointed out that the European
Communities does not even follow its own rule of pr oportionality with respect to beer and wine. The
U.S. system for wine is even less proportionate.
4.374 Chile contends that if the EC's rule is applied to the effect that tax rates must be constant per
degree of alcohol in order to meet the non dissimilar taxation test, it follows that an ad valorem flat
rate would breach that test, as it shown in Table 32.
Table 32
197

TAX PER DEGREE OF ALCOHOL
ASSUMING A 30% FLAT AD VALOREM RATE

Alcohol Content

Tax per degree of alcohol
25°

1.20 %
30°

1.00 %
35°

0.86 %
40°

0.75 %
45° 0.67 %

4.375 Chile maintains that such a proportionality test would invalidate luxury taxes that fall more
heavily on luxury goods, or more lightly on low-pri ced staples, since such taxes are unlikely to be
directly proportionate, which would be contrary to their very purpose.
4.376 Chile states that while the EC practices are not at issue, it hopes that the broader perspective
of the Panel will lead it to reject the EC's insistence on a proportionality test and preference for
specific duties as the preferred or only analytical perspective for assessing compliance with Article III
of the GATT 1994.
4.377 According to Chile, both the EC and Chilean syst ems treat wine and beer separately. Chile
taxes beer and wine relatively higher, measured in terms of degrees of alcohol, and the European
Communities taxes wine and beer lower per degree of alcohol.
4.378 Chile notes that in another effort to bolster its complaint, the European Communities argues at
several points that the Japan - Taxes on Alcoholic Beverages II case settles the issue whether there
can be non-proportionate increases in tax based on alc ohol content. Japan's system taxed shochu and
whisky according to two very different scales of sp ecific taxes, which significantly favoured shochu
over whisky. Contrary to the EC's rather surpri sing claim, the panel did not reject the Japanese
system because of a non-proportionate distinction in tax per degree of alcohol content, but rather
because the scale for two different types of spirit was entirely different and advantageous only and at
all points to shochu.
4.379 Chile further maintains that it is likewise inconceivable that members of the WTO,
particularly developing country members, thought or think that, in joining the WTO and accepting

197 Chile Oral Statement at the Second Substantive Meeting, Table I.

thereby the obligations of Article III:2, they were foregoing the right to use fiscal policy tools such as
luxury taxes or exemptions or reduced taxes for goods purchased primarily by poor consumers, even
if such policies result in higher taxes on many im ports than on many like or directly competitive
products.
4.380 In the view of Chile, the kind of flawed interpretation proposed by the European
Communities in this case would set a bad precedent for not just alcoholic beverage cases, but also for
other cases in which countries differentiate in the application of internal taxes on the basis of
objective criteria. For example, virtually any luxur y tax will have the effect of taxing high priced
products more, even proportionately more than lo w-priced goods. Borrowing one of the examples
from the Panel's questions, a Boss suit is surely as s ubstitutable with a suit sold in a discount store as
Scotch whisky is with Pisco Corriente. The EC's analysis would therefore prohibit a luxury tax on
high priced suits, if most taxed suits were impor ted and there was substantial production of untaxed
suits domestically. An even more closely anal ogous case would be an exemption from tax for low-
price cooking oil, which would inevitably result in olive oil bearing a higher tax than, for example,
palm oil or soybean oil. Such a tax would be ille gal under the EC's analysis of Article III, and no
exemption would save it.
4.381 Chile further argues that similarly, horsepower or engine displacement taxes, both of which
have been common in Europe, would also breach Artic le III, if, as a result, some types of imported
vehicles were treated less favorably than some types of vehicles predominantly produced domestically.
Under the EC's theory, the United States and Canada would have justifiable complaints against the EC
Member States because such taxes result in importe d types of vehicles bearing higher taxes than
domestic types.
4.382 Chile emphasizes that the New Chilean System does explicitly impose taxes according to
alcohol content. However, that kind of objectively based discrimination, like discrimination by
horsepower, engine displacement, or (in luxury tax syst ems) value, has not been considered to violate
Article III:2. Yet, by the EC's logic, if it could be shown, for example, that an engine displacement
tax resulted in higher taxes on, for example, spor t utility vehicles that were largely imported, and
lower taxes on small commuter cars that were larg ely produced domestically, then the engine
displacement tax would become inconsistent with Article III:2 for distinguishing in its effects between
types of directly competitive or substitutable vehicles.
4.383 Chile further puts forth that the European Communities itself does not observe a rule of direct
proportionality for its own alcoholic beverages. Many EC Member States impose proportionately
much lower taxes per degree of alcohol on beer and wine than on distilled spirits. The Scotch Whisky
Association shows the following discrepancy in tax per degree of alcohol in various Member States of
the European Communities:

Table 33
198
Proportionality of taxes per degree of alcohol on several The European Communities members
 Austria Belgium Denmark Finland France
Wine Nil 426 856 2,162 30
Beer 347 425 780 2,888 257
Spirits 723 1,651 3,674 5,097 1,440
 Germany Greece Ireland Italy Luxembourg
Wine Nil Nil 2,559 nil Nil
Beer 196 309 2,049 351 197
Spirits 1,297 999 2,847 648 1,035
 NL Portugal Spain Sweden UK
Wine 441 Nil Nil 2,937 1,911
Beer 424 275 168 1,746 1,619
Spirits 1,497 814 686 5,955 2,843
(ECU per hectoliter of pure alcohol)199
4.384 Chile notes that it cites this chart not to criticize the EC Member State tax systems nor to
argue that beer and wine, which are not at issue in this dispute, should be regarded as competitive or
substitutable products (though it is very clear that the Scotch Whisky Association believes that to be
the case and is promoting arguments in that regard th at are remarkably similar to the EC's arguments
in this dispute). Rather, Chile refers to the char t to demonstrate that even the European Communities
(despite the Scotch Whisky Association) does not rea lly believe in a rule of direct proportionality for
alcohol taxes. It might be added that tax systems of other countries exempt low value items from
some forms of indirect taxes, such as low cost clothing or food. Luxury taxes and other kinds of
progressive taxes similarly are particularly likely to have substantial effects on imports -- but such
taxes are not considered to violate Article III merely because of a lack of direct proportionality.
4.385 The European Communities notes that Chile incorrectly argues that the fact that the EC
Member States apply different rates per degree of alcohol to wine, beer and spirits involves a
"recognition" by the European Communities that tax differentials do not have to be proportional to
alcohol content. Contrary to what appear to be Chile's expectations, the European Communities does
not consider it necessary to deny that wine, beer a nd spirits are not "similarly" taxed in the European
Communities. It is self-evident from the table produced by Chile that they are not. This, however, is
far from constituting per se a violation of Article III:2, as Chile implies. To begin with, it would have
to be established that wine, beer and spirits ar e "directly competitive or substitutable" products,

198 Chile First Submission, Table 3.
199 The Scotch Whisky Association, Bulletin Board - Case for Taxation Reform (visited 24 Sept. 1998)
<http:www.scotch-whisky.org.uk/bb-txrfm.htm>.

something which could be rather difficult, especially by Chile's own strict st andard. Even then, it
would still be necessary to show that the tax diffe rentials afford protecti on to the EC domestic
production. One may suspect that the very successful Chilean wine exporters would not subscribe the
argument that, by taxing more heavily whisky than wine, the United Kingdom affords protection to its
non-existent production of wine.
4.386 The European Communities also notes that Ch ile states the following in support of its
allegation that the European Communities has "recogn ised" that the application of taxes that do not
vary in proportion to alcohol content does not constitutes dissimilar taxation:
The ECJ in case 170/78, Commission v. United Kingdom, 1983 ECR 2265 noted that:
... the Commission has recommended that spirits should be charged a higher rate of
duty according to alcoholic strength than liqueur wines. It appears, therefore, to have
accepted, that there are social reasons for imposing a relatively higher rate of taxation
on beverages with a higher alcohol content.
4.387 The European Communities contests that to begi n with, this is not something which the ECJ
said. Instead, this was an argument made by the United Kingdom, the defendant in that case. In any
event, the quoted passage does not support Chile's pos ition. The quoted statement argues in favour of
imposing a higher rate on spirits than on liqueurs "for social reasons". It does not argue that doing so
would not constitute "dissimilar" taxation. To the contrary, to the extent that it refers to a "higher rate
of taxation" the quoted statement admits explicitly the obvious fact that under the proposed system
liqueurs and spirits would not be "similarly" taxed.
4.388 The European Communities also states that fo r the same reasons, the arguments drawn by
Chile from the fact that some EC Member States apply car taxes that vary according to horsepower
are also irrelevant.
200 If a country applies higher taxes to large cars than to small ones, then it is
indisputable that large cars and small cars are "not similarly" taxed. A different matter is whether
small cars are "directly competitive or substitutable" with large cars. And still a different matter,
whether applying higher taxes to large cars "affords protection to domestic production".
4.389 The European Communities goes on to argue that in this connection, it is worth noting that,
contrary to Chile's assertions, the European Court of Justice ("ECJ") has never given an unconditional
endorsement to the application of car taxes linked to engine power. The ECJ has ruled that those
taxes may be compatible with Article 95 of the EC Treaty provided only that they are "free from any
discriminatory or protective effect". 201 In a number of decisions, the ECJ has found that the
application of car taxes linked to engine power was contrary in casu to Article 95 because it afforded
protection to the domestic car production of the Member State concerned. The tax systems
condemned by the ECJ had features which made them very similar to Chile's liquor tax system, such
as arbitrary thresholds or disproportionately steep increases beyond the point where there is no
significant domestic production.
202

200 The European Communities notes that the suggestion to the effect that the US "is more likely" to
produce cars with higher horsepower than the European Communities is simply wrong. Most Mercedes, BMWs
and Jaguars, as well as Porsches or Ferraris, are still assembled in the European Communities.
201 See e.g. the Judgement of 9 May 1985, Case 112/84, Michel Humblot v. Director des services
fiscaux (ECR 1985, pages 1367-1380); and the Judgement of 17 September 1987, Case 433/85, Jacques Feldain
202 The European Communities points out that for example, in Humblot (para. 16) the ECJ ruled that:
"Article 95 of the EEC treaty prohibits the chargi ng on cars exceeding a given power rating for tax
purposes of a special fixed tax, the amount of which is several times the highest amount of the

D. "
SO AS TO AFFORD PROTECTION TO DOMESTIC PRODUCTION"
1. Overview
4.390 The European Communities first notes that in Japan - Taxes on Alcoholic Beverages II, the
Appellate Body provided the following approach for establishing whether dissimilar taxation of
directly competitive or substitutable products is a pplied "so as to afford protection to domestic
production":
[W]e 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 fu ll consideration to all the relevant facts
and all the circumstances in any given case.
203
4.391 The European Communities goes on to state that an example of how this approach is to be
applied is provided by the analysis made by the Appellate Body in Canada – Periodicals. 204 In that
case, the Appellate Body concluded that the "design a nd the structure" of the measure was to afford
protection to domestic production on the basis of the following factors:
(i) the magnitude of the tax differential;
(ii) several statements by the Canadian authorities recognising that the protection of
domestic production was one of the measures' policy objectives; and
(iii) the demonstrated actual protective effect of the measures.
4.392 The European Communities points out that similarly, in Korea – Taxes on Alcoholic
Beverages205, the panel based its finding that the measures afforded protection to domestic production
on the following elements:
(i) the magnitude of the tax differentials;
(ii) the structure of Korea's Liquor Tax Law, and more specifically the lack of rationality
of the product categorisation; and
(iii) the fact that there was virtually no importe d soju, so that the beneficiaries of the
measure were almost exclusively domestic producers.

progressive tax payable on cars of less than the said power rating for tax purposes, where the only cars
subject to the special tax are imported, in particular from other member States".
203 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 29.
204 Appellate Body Report on Canada - Periodicals, supra., pp. 30-32.
 205 Panel Report on Korea - Taxes on Alcoholic Beverages, supra., paras 10.101-10.102.

4.393 Chile first responds that given that the taxation is not dissimilar, it is not surprising that the
European Communities likewise fails to demonstrate th e third element of a violation of Article III --
that the dissimilar taxation operates so as to afford protection to domestic production. In fact, since
the European Communities n eeds to demonstrate all three elements of a violation of Article III:2,
second sentence, the Panel could forego a decision on th e first and third elements in the interest of
judicial economy. Considerations of judicial economy may be especially pertinent here, since a
system that does not discriminate based on nationalit y and uses neutral, objective standards cannot be
considered protectionist in any event.
4.394 Chile also replies that there is no precedent for holding inconsistent with GATT 1994 a
system of taxation that does not discriminate based on nationality and that employs strictly objective
criteria for any differentiation in taxes. Indeed, the same panels that condemned the Japanese system
– and even the European Communities itself in argui ng those cases, observed that distinctions based
on objective and neutral criteria are permissible under Article III:2.
4.395 Chile further states that Article III does not pr ohibit a tax or regulation simply because, as a
result of the application of objective criteria, some or even many imported products are by some
measures treated worse than some or many like or competing domestic products. The drafting history
of Article III makes this clear. In the latter stages of the drafting of what became Article III of the
GATT, the negotiating Sub-Committee responsible for this Article reported that:
The Sub-Committee was in agreement that under the provisions of Article 18
[Article III of the GATT], regulations and taxes would be permitted which, while
perhaps having the effect of assisting the production of a particular domestic product
(say, butter) are directed as much against the domestic production of another product
(say, domestic oleomargarine) of which th ere was a substantial domestic production
as they are against imports (say, imported oleomargarine).
206
4.396 In the view of Chile, the logic of this unanimous understanding of the negotiators is
compelling. All WTO Members make tax and regula tory distinctions that fall unevenly by some
measures among products that might be considered lik e or directly competitive or substitutable in the
sense of Article III. Sometimes these distinctions will mean that many domestic products will, by
some measures, be taxed or regulated more favorably than many like or competing imports. But that
is not a violation of Article III, where criteria for the distinctions are objective and neutral.
4.397 Chile also argues that past panels have re peatedly acknowledged these considerations, noting
also that Article III is not intended to be used as a tool for harmonizing the tax systems of the WTO
Members,207 and that WTO Members retain almost complete freedom with respect to domestic
policies that do not distinguish between the origin or destination of goods. 208 In United States - Malt
Beverages, the panel noted that:
The purpose of Article III is not to harmoni ze the internal taxe s and regulations of
contracting parties, which differ from country to country.209
4.398 Chile further argues that in Japan – Taxes on Alcoholic Beverages I , the panel affirmed this
principle with respect to Article III:2, noting that this Article "prohibits only discriminatory or
protective taxation of imported products but not the use of differentiated taxation methods as

206 Reports of the Committees and Principal Sub-Committees, supra.
207 See Panel Report on Japan - Taxes on Alcoholic Beverages I, supra.
208 Panel Report on United States - Malt Beverages, supra., para. 5.25 and Panel Report on United
States - Taxes on Automobiles, supra., para. 3.108.
209 Panel Report on United States - Malt Beverages, supra., para. 5.71.

such ..."
210 The panel went on to say "that Article III:2 does not prescribe the use of any specific
method or system of taxation ..."211 This position was also endorsed by the Appellate Body in Japan -
Taxes on Alcoholic Beverages II.212
4.399 Chile notes that the EC argument against th e Chilean system ignores these precepts of
Article III, and instead asks the Panel to strike down an objective and neutral tax system merely
because a result of the application of that system is that those EC beverages of high alcohol content
(and high price) will face higher taxes than those Ch ilean beverages (primarily certain kinds of pisco)
that are of relatively low alcohol strength (and low price). In making this argument with respect to the
New Chilean System, the European Communities i gnores that many European products, including
those most similar to pisco, will benefit from the same lower rates of tax, while other European
products could be adapted for the Chilean market me rely by diluting with water the current relatively
high strength of the products -- as the European Communities has suggested could be done by pisco
producers. Equally, the European Communities ig nores that under the New Chilean System many
Chilean distilled spirits, including Chilean whisky, br andy and gin and very substantial quantities of
pisco that are marketed at relatively high prices and alcohol strength, will face the highest rate of
taxation.
4.400 Chile concludes that the New Chilean System thus presents precisely the kind of regulatory
system that Article III is not intended to condemn:
(i) there is no distinction in taxation based on origin or on type;
(ii) many imports can benefit from the lowest ta x and all others could be easily diluted
for that purpose;
(iii) many domestic products of Chile will face the highest tax rates under the New
Chilean System; and
(iv) the objective standards mean that foreign pr oducers can readily adapt their products
to lower their taxes by a simple process.
4.401 Chile adds that the Appellate Body has properl y noted that "Article III protects expectations
not of any particular trade volume but rather of the equal competitive relationship between imported
and domestic products". 213 Foreign and domestic producers have an equality of competitive
opportunities, as they have an equal opportunity to adapt their production, if they so choose, in the
way implicitly preferred under the New Chilean System, i.e., by reducing alcohol content.
2. Transitional System
4.402 The European Communities argues that the following facts and circumstances regarding
the "design, structure and architecture" of the transitional system, as well as its "overall application on
domestic as compared to imported products" constitute evidence that it is applied "so as to afford
protection" to Chile's domestic production:
(i) the very magnitude of the tax differentials;
(ii) the absence of any legitimate policy purpose for applying a lower tax rate to pisco;

210 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.9 b).
211 Ibid., para. 5.9 c).
212 See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 26.
213 Ibid., p.16 (citations omitted).

(iii) the fact that pisco is, by law, a domestic product;
(iv) the fact that pisco accounts for the vast majo rity of the Chilean production of distilled
spirits;
(v) the fact that almost all whisky, as well as a significant proportion of the main liquors
falling within the category of "other spirits" are imported; and
(vi) the admission by the Chilean authoriti es that the adoption of Law 19,534 was
necessary because the system in place was "discriminatory".
4.403 In the view of the Eu ropean Communities, in Japan - Taxes on Alcoholic Beverages II , the
Appellate Body observed that the very magnitude of the difference in taxation between Japanese
shochu and other distilled spirits was sufficient ev idence to conclude that the Japanese Liquor Tax
Law was applied so as to afford protection to the domestic production of shochu.
214
4.404 The European Communities then ar gues that the same is true in the present dispute. The tax
differential between pisco and whisky is so large that it can only be explained by the purpose to afford
protection to pisco.
4.405 The European Communities also points out that in Japan - Taxes on Alcoholic Beverages II ,
the taxes in dispute were specific taxes per litre of beverage instead of ad valorem taxes. This makes
it extremely difficult to compare the tax differentials at issue in the two cases. Nevertheless, it is
worth noting that, according to the complainants, in Japan - Taxes on Alcoholic Beverages II the
differences in specific taxes translated into a diffe rence in tax/price ratios between shochu and whisky
of between 10 % and 32 % of their retail sales price. 215
4.406 The European Communities further notes that ac cording to the explanations provided by
Chile during the consultations, the tax differentials between pisco, on the one hand, and whisky and
"other spirits", on the other hand, purport to serve two different objectives:
(i) Protection of public health: it was sought to create a disincentive for the consumption
of spirits with a higher alcohol degree, in order to reduce the negative social impact
associated with excessive alcohol consumption;
(ii) Fiscal policy: those liquors, which are subj ect to higher taxes, are those with the
characteristic of luxury goods. The highe r tax applied to those goods fulfils the
objective that indirect taxes apply in a differentiated manner to luxury goods as a
mechanism of income redistribution. Those taxes, known as "luxury taxes", are
applied also to other products, both in Chile and in other countries.
4.407 The European Communities then maintains that it is obvious, however, that the application of
a much lower rate to pisco than to whisky and "other spirits" cannot be justified by either of those two
alleged objectives.
4.408 The European Communities further explains that in the first place, pisco does not always have
a lower alcohol content than whisky or "other spirits ". Approximately 10 % of the sales of pisco have
40 or more. Moreover, the remaining 90 % of pisco has between 30  and 35 , i.e. , only 5 to 10
degrees less than most imported spirits. It is manif estly disproportionate to attach to such a small
difference in strength a tax differential of as much as 28 to 45 percentage points ad valorem. Finally,

214 Ibid., p. 29.
215 See Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.159.

the category of "other spirits" includes many liquors ( e.g., most liqueurs) that have a lower alcohol
content than pisco.
4.409 The European Communities then ar gues that the Chile claim that the application of a lower
rate to pisco is justified for reasons of income distribution is also spurious. Pisco is not inherently less
expensive than other spirits. More over, there is evidence that pisco is consumed by all social groups
and not just by the less affluent.
216 Similarly, whisky and the other liquors are widely consumed
across social boundaries. 217 In any event, previous panels have established that this type of
consideration cannot provide a valid justification for taxing dissimilarly two directly competitive or
substitutable products.
4.410 In support of this argument, the European Communities points out that in Japan – Taxes on
Alcoholic Beverages I, Japan claimed that the tax differentials at issue in that case were not contrary
to Article III:2 because they were based on "... th e tax-bearing ability on the part of consumers of
each category of liquor". The panel rejected this defence in the following terms:
The Panel was of the view that the use of product and tax differentiations with the
view of maintaining or promoting certain production and consum ption patterns could
easily distort price-competition among like or directly competitive products by
creating price differences and price-relate d consumer preferences which would not
exist in case of non-discriminatory internal ta xation consistent with Article III:2. The
Panel noted that the General Agreement did not make provision for such a far-
reaching exception to Article III:2 and that the concept of "taxation according to tax
bearing ability of prospective consumers" of a product did not offer an objective
criterion because it relied on necessarily subjective assumptions about future
competition and inevitably uncertain consumer responses ...
218
4.411 The European Communities further notes that, in Japan – Taxes on Alcoholic Beverages II ,
the Appellate Body noted that Japanese shochu was insulated from imports of shochu originating in
Korea and other third countries by tariff barriers. As a result, by applying a lower tax rate to shochu,
Japan favoured exclusively domestic production.219
4.412 The European Communities then ar gues that Chilean pisco is even more effectively isolated
from imports of like products. "Pisco" is a geogr aphical denomination reserved by law to certain
spirits produced in certain regions of Chile. Thus , the tax advantage provided to pisco benefits
exclusively domestic products, not merely de facto (as in Japan – Taxes on Alcoholic Beverages II)
but also de jure.
4.413 The European Communities goes on to claim that it may be estimated that pisco accounts for
approximately 80 % of the Chilean production of dist illed spirits, as shown in Tables 18 and 19 above.
For comparison, in Japan – Taxes on Alcoholic Beverages II , sales of shochu represented, according
to the complainants, "almost 80 %" of Jap an's total production of distilled spirits. 220 Therefore, by
applying a lower tax rate to pisco, Chile affords pr otection not just to its domestic production of pisco
but more generally to the majority of its domestic industry of distilled spirits.

216 The European Communities refers to the 1997 SM survey, p. iv (EC Exhibit 21).
217 Ibid.
218 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.13.
219 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 31.
220 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para. 4.95.

4.414 In the view of the European Communities, whereas pisco is an exclusively domestic product,
approximately 95 % of whisky, the main spirit af ter pisco, as well as a substantial proportion of the
liquors falling within the category of "other spirits" are imported.
221
4.415 The European Communities further notes th at as stated by the Appellate Body in Japan –
Taxes on Alcoholic Beverages II 222 in order to establish that a tax measure is applied "so as to afford
protection to domestic production", it is not necessary to show that the legislators had the subjective
intent of affording such protection. On the other hand, it is evident that where the existence of that
intent can be clearly established, it may constitute additional evidence that the measures in dispute are
applied in a protective manner.
4.416 The European Communities adds that in Canada - Periodicals , the Appellate Body relied
upon some statements by the Canadian Government regarding the policy objectives of a measure as
one of the factors supporting the finding that the me asures at issue were applied "so as to afford
protection to domestic production".223
4.417 The European Communities then claims that the Chilean Government (through its Minister of
Foreign Affairs) as well as many legislators of a ll political parties recognised openly that the tax
system in place until November 1997 had to be amended because it was "discriminatory" and
favoured the pisco producers. The transitional regime provided in Law 19,534 will prolong that
system into the year 2000. Consequently, the admiss ion by the Chilean authorities that the system in
force until November 1997 afforded protection to the pisco producers, also involves an admission that
the Transitional System will continue to do so.
4.418 Chile responds that the purpose of the Transitional Sy stem was to allow time for domestic
and foreign producers and distributors to prepare for the changes under the New Chilean System, and
also to begin phasing in immediate benefits for whisky producers.
4.419 Furthermore, in Chile's view, pisco and the im ported products are not directly competitive or
substitutable and, therefore, the Panel need not reach this issue with respect to the Transitional System.
Chile also indicates that the Transitional System is an issue of little practical consequence, as it will
expire soon.
3. New Chilean System
4.420 The European Communities claims that the following factors and circumstances constitute
evidence that the New Chilean Syst em will also be applied "so as to afford protection" to Chile's
domestic production:
(i) the magnitude of the tax differentials;
(ii) the tax distinctions do not serve any legitimate policy purpose;
(iii) the majority of Chile's domestic production of distilled spirits is taxed at the lowest
tax rate;
(iv) nearly all imports are taxed at the highest tax rate;

 221 Ibid.
222 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 27.
223 Appellate Body Report on Canada - Periodicals, supra., pp. 30-31.

(v) the New Chilean System reflects the term s previously agreed by the Chilean
authorities with the pisco industry; and
(vi) the positions taken by the pisco industry during the amendment process of the ILA
involve a recognition that maintaining a ta x differential between low strength pisco
and whisky will afford protection to the pisco industry as a whole.
4.421 Chile replies that it is readily apparent, if the Panel c hooses to consider this element, that the
New Chilean System does not operate "so as to afford protection to domestic production". The
European Communities offers up six reasons that th e New Chilean System should be considered "to
afford domestic protection". None of the six contentions have merit when applied to the New Chilean
System.
4.422 In the view of Chile, it is also essential to no te in this regard that, unlike systems based on
distinctions between different types of distilled spir its, it is a relatively simple matter for foreign and
domestic producers to adapt to the neutral and objec tive standards of the Chilean system. A whisky
producer cannot readily become a pisco producer, but a producer of any spirit of 40  alcohol can
readily dilute the product to 35 . The European Communities already produces many products
(grappa, fruit liqueurs, etc.) that qualify for the lo west taxes and even more products that would
qualify if only, as the European Communities suggests be done for pisco, some water is added to the
current high alcohol products before bottling. Ar ticle III simply does not obligate sovereign Member
governments to harmonize their neutral taxation system to the convenience of foreign producers in the
way sought by the European Communities in this case. The New Chilean System affects domestic
producers of spirits in the same manner as it affect s importers of alcoholic beverages, and does not
prevent foreign producers of spirits from importing any low alcohol content spirits benefiting from a
lower level of taxation on the basis of their alcohol content.
4.423 Chile further states that the European Co mmunities devotes many pages listing excerpts from
Chile's legislative debate about the new taxati on system. Some of these examples show that
legislative representatives of the regions that pr oduce pisco in Chile were seeking to minimize the
adverse effects of a New Chilean System on pisco producers and, because adverse effects could not be
avoided, also sought other governmental help for their constituents. At least in the case of the
legislative history, the European Communities, while presenting a distorted picture, did note many
remarks from legislators who announced that the ne w system was eliminating discrimination against
foreign products. Chile submits that if such deve lopments infringe Article III or are even evidence of
such infringement, then all WTO Members are in deep peril, not least the European Communities.
4.424 Chile points out that the Appellate Body has al ready cautioned against this kind of subjective
effort to discern motivation. In Japan - Taxes on Alcoholic Beverages II , the Appellate Body stated
that the issue of "affording protection to dom estic production" is an objective question of effect, not a
subjective question of the intent of legislators.
224
(a) Magnitude of Tax Differentials
4.425 The European Communities points out that in Japan - Taxes on Alcoholic Beverages II, the
Appellate Body observed that the very magnitude of the difference in taxation between Japanese
shochu and other distilled spirits was sufficient ev idence to conclude that the Japanese Liquor Tax
Law was applied so as to afford protection to the domestic production of shochu.225

224 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 27-28.
225 Ibid.

4.426 The European Communities then maintains that under the new sy stem the tax differentials
will still be large enough to be, in a nd of themselves, evidence of protective application. Indeed, in
the case of spirits of 40 or more other than whisky the tax diffe rentials will be even larger than under
the preceding system.
4.427 In response, Chile first contests the citation by European Communities of "the magnitude of
the tax differentials of the New Chilean System". Th e EC's analysis of this point fails for the same
reason that the EC's allegations of dissimilar taxa tion fail. The EC's argument makes no more sense
than a claim that ad valorem taxes are illegal in any country where imports are generally more
expensive than the domestic products with which they compete. The differen tial in the New Chilean
System is nil because all products face the same ta x scale and all products have the same opportunity
to be adapted in a way that will minimize their tax burden.
4.428 Chile argues that perhaps the European Communities may see the fallacy of its logic more
clearly if that logic is applied to the systems of taxation of alcoholic beverages that are used by EC
Member States. Chile has alread y shown, in Tables 28 and 29 above, how the use of specific rate
taxes per degree of alcohol (which is the tax system used by a number of EC Member States)
discriminates against low price beverages and in fa vor of higher priced beverages, which are more
commonly produced in the European Communities. These points are elaborated further in Tables 34
and 35 below. Applying the same logic that th e European Communities seek s to apply to the New
Chilean System, the EC Member States would be guilty of violating Article III:2, second sentence. In
the European Communities, the resu lt of the use of specific taxes is that pisco is taxed relatively
heavily compared to expensive cognac. Accordi ng to the European Communities, cognac and pisco
are directly competitive and substitutable. Cognac is thereby protected from imported pisco
(evidenced by the low import penetration in the European Communities of pisco and other imported
brandies).
4.429 Chile further maintains that even ignori ng for the moment the discrimination in ad valorem
terms that arises from a specific rate tax, the EC Member States would still be in violation of
Article III:2 if the EC's analysis in this dispute were applied to the Member States who impose taxes
per degree of alcohol content. The tax per degree of alcohol results in a substantially higher tax on
two beverages of the same price, for example, one having 46° alcohol, the other 35°. Therefore, in
both absolute and ad valorem terms, an imported Gran Pisco would face a substantially higher tax
than a low-alcohol European product such as Campari. By the theory that the European Communities
seeks to apply to Chile, this m eans that the EC Member States' systems have the result of
discriminating by type, and a type of imported spirit (Gran Pisco) is taxed significantly more heavily
than the directly competitive or substitutable domestic product, Campari.
4.430 According to Chile, by the application of the EC 's logic, the differences in tax on different
types of competing spirits that result from Member State tax systems similarly would easily be found
to operate "so as to afford protection to domestic production". The difference in tax alone might be
enough to establish the protective effect of the EC Me mber States' taxation systems. In addition, one
might note the obvious "architectural" features favoring low alcohol beverages such as those
commonly produced in the European Communities, wh ich means only certain types of distilled spirits
are favoured in these countries. To complete the analogy to the logic that the European Communities
seeks to apply to Chile, one might also seek evid ence that some politician from the area where the
low –taxed product is made had boasted of his or he r success in helping the domestic industry. Thus
guilt under Article III:2 would be complete, by th e standard of analysis that the European
Communities wishes to apply to Chile in this dispute.
4.431 Chile notes that the European Communities will perhaps protest that the EC system is
nevertheless GATT-legal because it is necessary, in terms of Article XX of GATT 1994, to protect
human health from the effects of alcohol. That expl anation, however, is difficult to sustain in the face

of other EC alcoholic beverage laws that prescribe minimum alcohol content, and that tax the alcohol
content of wine and beer much less than distilled spirits. As the European Communities points out in
the literature appended to its responses to the Pane l's questions, some EC authorities believe that
health problems are connected to the issue of amount of alcohol consumed, not the concentration in
different beverages.
4.432 Chile further notes that in pointing out the above, it is not asking the Panel to find the EC
Member States guilty, an issue that is not even before this Panel. Chile is seeking to demonstrate,
however, the fallacy and dangers of the EC analysis , which seems to have been drawn more from the
Scotch Whisky Association's crusade to equalize al cohol taxes in the EC Member States than from a
correct analysis of Article III:2.
4.433 Chile then extends its analysis to demonstrat e that the alleged protection that the Chilean
taxation system provides to pisco is far less signifi cant than the protection offered to whisky by the
taxation system applicable in various EC Member States, as can be observed in the following table.
226
In effect, the Chilean taxation system offers a 16 % protection to spirits of 35° or less (including
pisco 35°) vis-à-vis spirits of 39° or more (inc luding whisky), regardless of national origin.
Protection for pisco of 40º or more is nil. In contrast, the taxation system of several Member States of
the European Communities results in between 23% and 44% protection for whisky vis-à-vis pisco 35º;
and between 13% and 26% protection for whisky vis-à-vis pisco 40º. This is due, as Chile has pointed
out in several instances, to the fact that pisco co sts much less than whisky, and thus is affected
proportionally much more than whisky by a specific tax.

226 Chile explains that the methodology that was used for the calculation of the Protection of the
Special Tax of Whisky (in the selected country members of the European Communities) is:
Protection = RPDI
 R P A I
where:
RPDI: is the Price ratio after Tax.
RPAI: is the Price ratio before Tax.
In this methodology, the calculation comprises both the protection of custom duties and taxes.
In the case of the protection of Pisco in Chile, the methodology used is:
Protection = RPDI - 1
 RPAI

Table 34
227
DEGREE OF PROTECTION OF WHISKY IN COMPARISON TO
PISCO IN SOME COUNTRY MEMBERS OF THE EUROPEAN
COMMUNITIES
Price (US$/lt) Price ratio Protection Special
Tax
 Pisco Pisco Whisky Whis ky/ Whisky/ Whisky/ Whisky/
35º 40º 43º Pisco 35º Pisco 40º Pisco 35º Pisco 40º
CIF/ex-
factory
2.60 3.60 5.70 2.19 1.58
Price after duty
Spain 2.86 3.89 5.70 1.99 1.47
United
Kingdom
2.86 3.89 5.70 1.99 1.47
France 2.86 3.89 5.70 1.99 1.47
Germany 2.86 3.89 5.70 1.99 1.47

Price after duties and special tax
Spain 5.51 6.93 8.96 1.63 1.29 23% 13%
United
Kingdom
14.23 16.89 19.67 1.38 1.16 44% 26%
France 9.20 10.94 13.17 1.43 1.20 39% 22%
Germany 8.46 10.29 12.58 1.49 1.22 34% 20%

227 Chile Rebuttal Submission, Annex B, p.13.

Table 35
228
DEGREE OF PROTECTION OF PISCO WITH REGARD TO
WHISKY IN CHILE
 Price (US$/lt) Price ratio Protection Special
Tax
Pisco Pisco Whisky Whisky / Whisky/ Whisky/ Whisky/
35º 40º 43º Pisco 35º Pisco 40º Pisco 35º Pisco 40º
CIF/ex-
factory
2.30 3.30 6.00 2.61 1.82
Price after duties
Chile 2.30 3.30 6.66 2.90 2.02
Price after duties and special tax
Chile 2.92 4.85 9.79 3.35 2.02 16% 0%

4.434 The European Communities notes that Chile raised the argument that the EC system of
taxation of spirits affords protection to the EC domestic production because, on an ad valorem basis,
pisco is taxed more than the EC spirits. Chile explained that its intention in making this argument was
not to question the compatibility of the EC system w ith Article III:2, but rather to illustrate the point
that "neutral" tax distinctions may nevertheless have an incidental protective effect.
4.435 The European Communities goes on to state that Chile's argument is not only irrelevant for
this dispute, but also wrong, both as a matter of law and of fact. First and foremost, the EC system is
based on the application of a uniform specific tax per hectolitre of pure alcohol to all the products
containing ethyl alcohol.229 Thus, unlike in the Chilean system, in the EC system all ethyl alcohol is
equally taxed, irrespective of the product in which it is contained. Therefore, the question whether
protection is afforded to domestic production through "dissimilar" taxation does not even arise.
4.436 The European Communities maintains that in an y event, the EC system does not have the
effect alleged by Chile. EC produced spirits are of ten less expensive than imported spirits. This can
be easily demonstrated with the help of Chile's ow n price data. Table 15 above shows that Canadian
whisky, US whisky and Mexican tequila are mo re expensive (and, therefore, less taxed in ad valorem
terms under the EC system) than a relatively expe nsive brand of Scotch whisky such as Johnnie
Walker Red Label.

228 Chile Rebuttal Submission, Annex B, p. 14.
229 Council Directive 92/83/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92) and Council
Directive 92/84/EEC, of 19 October 1992 (OJ No L 316 of 31.10.92).

4.437 The European Communities further argues that wh en sold in the EC market, Chilean pisco
may be as expensive as good quality EC spirits. Tabl es 34 and 35 above compare the producer's ex-
factory price of pisco in Chile with the retail prices of some EC spirits (including insurance, freight
and distribution expenses) charged by a duty-free s upplier (presumably, also in Chile). Given the
differences in level of trade, it would have been surprising if Chilean pisco was not less expensive
than the EC spirits. The table below compares the actual retail prices in a supermarket in Brussels of
pisco especial Capel of 35 (a relatively inexpensive brand in Chile) and a sample of well-known (and
relatively up-market) brands of EC produced spirits. It shows that, contrary to Chile's claims, pisco is
taxed in ad valorem terms at a similar rate as the EC spirits.

Brand
(all bottles are 70 cl)
Price
(BEF)
Tax
(BEF)
Equivalent
Ad valorem rate
Pisco Capel 35 410 155.6 37.95 %
Vodka Smirnoff 415 166.7 40.17 %
Gin Gordon's 409 166.7 40.76 %
Brandy Veterano 477 160 33.54 %
J. Walker Red Label 494 177.8 35.99 %
Source: Retail prices at the supermarket Delhaize Chazal, Brussels, on 28/10/98. See EC Exhibit 64.

4.438 With regard to the eff ect of specific taxes, Chile maintains that Tables 34 and 35 above are
accurate. In those tables, the calculations indicated in the first 3 columns (labelled pisco 35º, pisco
40º and whisky 43º) are based on after customs price for pisco in Europe, and producers prices for
whisky.230 From those tables it can easily be seen th at a specific tax levied on alcohol content
produces a dissimilar taxation, if the comparison is made on an ad valorem base. Chile asks the Panel
to note that this dissimilarity is much larger that the dissimilarity generated by the Chilean system
alleged by the European Communities. For clarity purposes, Table 35 above is summarized below:

230 Chile adds that after customs price of Pisco was estimated considering producers price in Chile,
transportation to Europe and related insurance costs and customs duties in Europe. Producers price of whisky,
was estimated in US$ 5.70.

SPECIFIC TAX ON ALCOHOLIC BEVERAGES IN SOME EC MEMBER STATES
MEASURED IN AD VALOREM TERMS (%)
Member State
Estimated Price
Pisco 35º
US$ 2.90
Pisco 40º
US$ 3.90
Whisky 43º
US$ 5.70
Spain 92.9 78.1 57.3
Great Britain 397.9 334.2 245.1
France 221.9 181.2 131.0
Germany 195.9 164.6 120.7

(b) Legislative Objective
4.439 The European Communities maintains that the tax distinctions in dispute do not serve any
legitimate purpose. They are simply a subterfuge to replicate the protective effects of the preceding
system. Alcohol content has been chosen as a taxation criterion me rely because it allows Chile to
distinguish indirectly between the majority of pisco, on the one hand, and the majority of imported
spirits, on the other hand, and not because the ILA purports to discourage the consumption of alcohol.
4.440 In support, the European Communities goes on to state that the New Chilean System is a
rather unusual method of taxing alcoholic beverages. In fact, that method does not correspond to any
of the three methods commonly applied by most countries, and which are: a) specific taxes based on
the alcohol content (e.g. , x pesos per litre of pure alcohol or per degree of alcohol); b) specific taxes
based on the volume of beverage (e.g. , x pesos per litre of pisco); and c) ad valorem taxes on the
price of the beverage.
4.441 According to the European Co mmunities, instead, the method devised by Chile is a hybrid
one in which ad valorem rates vary according to alcohol content. The rationality of that method in
terms of fiscal policy is questionable. The price of distilled spirits is not correlated to their alcohol
content. Indeed, if there was such a direct corre lation, high strength ethyl alcohol would be more
expensive than any other distilled spirit. The ab sence of a direct correlation between price and
alcohol content means that the goal of ad valorem taxation (imposing a higher burden on the more
valuable products) and the goal of taxing alcohol content (discouraging the consumption of alcohol)
may conflict and ultimately cancel each other.
4.442 The European Communities also ar gues that the absence of any legitimate policy purpose is
further evidenced by the lack of internal coherenc e of the ILA, and in particular by the following
aspects of its "design, structure and architecture".
4.443 First, the European Communities points out that all liquors of 35 or less are taxed at the same
ad valorem rate. As a result, low strength liquors (e.g ., light liqueurs) are taxed more heavily per
degree of alcohol than pisco of 35 . Thus, contrary to Chile's claims, the ILA actually encourages the
consumption of alcohol, rather than discourages it.
4.444 Second, the European Communities notes that there is no objective reason that can explain
why the ad valorem rate starts to increase from precisely 35 . The only reason for choosing that
strength level as the starting point is simply that 35  is the most usual alcohol content of pisco
especial, which together with pisco corriente of less than 35 accounts for 90 % of the sales of pisco.

4.445 The European Communities explains that if the rate had started to increase from 0  instead of
35, the applicable rate on pisco of 35  would have been much higher (140 %) unless, of course, the
rate increased by smaller increments than the current 4 percentage points per degree of alcohol. But if
Chile had applied a smaller increment per degree of alcohol, the applicable ad valorem rate on spirits
of 40 would have also been lower, a result unacceptable to Chile's pisco industry.
4.446 Third, the European Communities notes that between 35  and 40, the tax rate increases very
rapidly, by no less than 4 percentage points for each additional degree of alcohol. As a result, a
difference of merely 5 degrees of alcohol content leads to the application of a tax on spirits of 40 
which is 74 % higher than the tax on spirits of 35 . Such a tax differential is disproportionate to the
additional damage to human health or other undesirable social effects (if any at all) which may result
from drinking spirits of 40  instead of spirits of 35 . The magnitude of that tax differential is even
more arbitrary in view of the fact that sim ilar differences in alcohol content outside the 35 - 40 
bracket do not entail any difference in taxation at all. For instance, pisco corriente is typically bottled
at 30, five degrees less than pisco especial. Yet, both pisco especial and pisco corriente are taxed at
the same rate.
4.447 Fourth, the European Communities states that all spirits above 39  are taxed at the same rate.
Again, this has the paradoxical result that the alc ohol contained in very high strength liquors such as
gran pisco of 46 or even 50 is taxed less than the alcohol contained in spirits of 40.
4.448 The European Communities adds that in the 1995 Proposal, the rate continued to increase
until 42. As shown in Table 5, all the main types of imported spirits can be legally sold in Chile (and
are usually bottled in their countries of origin) at 40 . Thus, in practice the imposition of higher tax
rates above 40 would have had little impact on imports. For instance, the exporters of whisky would
have reacted to the imposition of a much higher tax on whisky of 43 than on whisky of 40 simply by
replacing current exports of whisky of 43  by shipments of whisky of 40 
. This development was
anticipated by the pisco industry, which explains its quiet acquiescence to what in practice was but a
purely "cosmetic" amendment of the 1995 Proposal. Thus, according to press reports, when
presenting the 1996 Gemines study, Mr Peñafiel (general manager of Capel) noted that:
[A]lthough nowadays, the largest part of [whisky] imported [into Chile] has 43 , so
that the tax will decrease only to 65 %, in the future the product will arrive at 40 ,
something which, [Mr Peñafiel] underlined, is already a characteristic of all whisky
sold in Europe.231
4.449 In rebuttal, Chile points out that it has explained to the European Communities that the
Chilean tax system serves legitimate revenue, health and social purposes, primarily by taxing more
heavily products that are more costly and higher in alcohol content. It is not for the European
Communities to second guess those purposes. While ther e are trade-offs in fulfilling these objectives,
the relevant point is that the system is indeed neutral and objective. One might indeed question the
motivation and effectiveness of countless internal measures of the European Communities or any
other WTO Member, but Article III was not established so that the WTO could sit in judgement on
the "legitimacy" of the policy objectives of its Members, so long as the measures themselves
objectively conform with the WTO Agreement.

4.450 Chile alleges that in amending its laws, it had had in mind several objectives, including:
(i) maintaining fiscal revenue;
(ii) eliminating type distinctions such as tho se that had existed in Japan (which also
would eliminate the alleged discrimination against whisky in the previous system);
(iii) discouraging alcohol consumption; and
(iv) minimizing the potential regressive aspects of reforming the tax system.
4.451 Chile points out that because the New Chilean System will change the rate of tax paid with
respect to various products, there is the Trans ition System, under which the whisky tax is phased
down immediately, but the remainder of the system takes full effect on 1 December 2000. In the
intervening time, whisky producers will enjoy con tinuing tax reductions, wh ile other producers can
decide how they wish to approach the Chilean market under the New Chilean System.
4.452 Chile argues that the new Chilean law comple tely reforms Chilean taxation of alcoholic
beverages and advances the objectives noted above, while conforming to Article III.
4.453 Chile goes on to explain that in November 1997 it enacted new legislation substantially
reforming the Chilean system of taxation of distilled sp irits. Within this new system, spirits of 35° or
less will be taxed at 27% ad valorem . The ad valorem tax will rise 4 percentage points for each
additional degree of alcohol content above 35°, but with the rate capped at 47% for spirits above 39°
of alcohol content. Therefore, lower alcohol c ontent products have a lower tax rate, while those
having a higher alcohol content have a higher tax rate. The new Chilean system will make no tax
distinction by type of distilled beverage or origin. (i.e., domestic or imported). The same ad valorem
tax rate is applied to all distilled spirits having the same alcohol content.
4.454 Chile further argues that, concerning tax differentials, there is no difference in that all distilled
spirits of the same alcohol strength are subject to an identical ad valorem tax. The European system is
the same, in that all distilled spirits of the same al cohol strength face the same rate of tax, except that
the EC tax is a specific one, which, of course, fa lls more heavily on lower priced products than on
higher priced products. Both tax systems use iden tical scales for all distilled spirits (except beer and
wine, which are taxed less in the European Communiti es and more in Chile), but the EC's system is
more distortive because of the use of specific taxes per degree of alcohol.
4.455 Chile further explains that within this contex t, the new system is built around objective and
non-discriminatory criteria has the effect inter alia of reducing the present tax rate applied to some
products, as is the case for whisky, and of increasing it for others, as is the case for pisco in all its
categories (i.e., pisco of high and low alcohol content).
4.456 According to Chile, the new Chilean System is based on two objective criteria: alcohol
content and price (i.e., ad valorem ) of the product, regardless of its type, origin and labeling.
Taxation based on alcohol content and on an ad valorem basis is not against Article III of GATT or
any other provision of the multilateral trading system and both are widely used.
4.457 Chile notes that the ad valorem taxation system does not distort competitive attributes of
products (i.e., price relationships), as opposed to those which an ab solute value is imposed according
to alcohol content. Such specific tax systems in troduce a distortion biased in favor of products of
higher price since a fixed tax will be a smaller percentage of the value of a high priced product.

4.458 Chile poses a question: why did the Europ ean Communities insist on pursuing the WTO
challenge against the New Chilean System? Chile cons iders that is not so hard to understand. The
major exporters of distilled spirits want to mini mize their tax burdens in all markets, and such
exporters would prefer not to have to adapt their products to individual markets. Chilean exporters,
similarly would prefer not to have to adapt their products to individual markets.
4.459 Chile goes on to state that, in this sense, it can understand why European exporters of distilled
spirits would be willing to take a chance on conti nuing their old GATT challenge against the Chilean
system even after its reform, since failure woul d leave them no worse off while the possibility of
success might reduce their taxes.
4.460 Chile further notes that the European Commun ities continues its attacks on the motivations
for Chile's tax laws. For example, Chile is accu sed both of hiding its motivations and failing to
achieve the objectives in a fashion that the Europ ean Communities finds sufficiently coherent. Chile
has freely conceded that its objectives required a measure of compromise between different objectives,
but not a compromise on GATT compliance.
4.461 Further, Chile claims that it is not reveali ng a secret that WTO member governments all over
the world tax alcoholic beverages at higher rates th an most products, partly for revenue reasons that
contradict to some extent the health reasons. If that establishes a violation of GATT obligations, then
the European Communities will have much policing and self-policing to do in the world and at home.
4.462 Chile indicates that it is not critical of the European Communities for having their system,
because a multiplicity of motivations is common for all kinds of taxes in every country. It is not Chile
who is attacking objective systems that have diffe rential results. Nevertheless, the European
Communities should see that objective tax systems can have uneven results when measured by a
subjective categorization system. Chile also cannot help being bemused by the EC's diligent efforts to
find a justification for its specific tax on ethyl alcohol. Neither the Chilean nor the EC system appears
to qualify under the Article XX exception. At l east, Chile believes that the European Communities
would have a difficult time explaining the necessity of this tax to discourage consumption of ethyl
alcohol in distilled spirits (does wine or beer al cohol not impair the senses?). Chile also wonders
what scientific analysis produced the varying scales of taxation, and how the EC's health goals are
reconciled with the EC's minimum alcohol requirements for various sp irits and with its socialisation
objectives for distilled spirits.
4.463 In the view of Chile, like nearly all tax me asures in nearly all countries, the New Chilean
System serves various objectives, and to some extent is a compromise among these objectives. Chile
understands that the issue before this Panel is the conformity of the New Chilean System with
Article III:2 rather than the various policy objectiv es that may have been considered by different
legislators and government agencies involved in de veloping that law. Nevertheless, Chile provided
some explanations in order to understand the Chilean legislation.
4.464 Chile explains that in Chile, as in many countri es, the Finance Ministry has a significant role
in tax policy. In providing its input into the development of the New Chilean System, the Chilean
Finance Ministry sought to achieve two broad objec tives: tax revenues that would be approximately
equivalent to those obtained under the Old Chilean System; and a distribution of the burden of the
taxes that would not be more regressive than that of the Old Chilean System, i.e., that would not
increase the relative tax burden on the poorer income-earners relative to the wealthier income-earners.

In its support, Chile puts forward Tables 36 and 37.
Table 36
232
Weighting Factors for Expenditure on Alcoholic Beverages Per Quintile

 Overall Q1 (<Income) Q2 Q3 Q4 Q5 (>Income)
Total 100.000 100.000 100.000 100.000 100.000 100.000
Alcoholic
Beverages
0.930 0.985 1.124 1.107 1.061 0.781
Wine 0.301 0.362 0.350 0.328 0.318 0.269
Champagne 0.025 0.033 0.017 0.019 0.035 0.023
Chicha 0.010 0.005 0.024 0.020 0.010 0.006
Beer 0.295 0.384 0.488 0.467 0.352 0.172
Pisco 0.172 0.166 0. 185 0.194 0.213 0.147
Whisky 0.050 0.000 0.011 0.026 0.050 0.072
Other spirits 0.077 0.035 0.049 0.053 0.083 0.092

Number of
households

1,363,706

272,741

272,741

272,741

272,741

272,741
Total
expenditure

607,718

38,728

60,757

83,591

123,755

300,888

Percentage Distribution of Expenditure Per Quintile

 Overall Q1 (<Income) Q2 Q3 Q4 Q5 (>Income)
Alcoholic
beverages
100% 6.7% 12.1% 16.4% 23.2% 41.6%
Wine 100% 7.7% 11.6% 15.0% 21.5% 44.2%
Champagne 100% 8.4% 6.8% 10.5% 28.5% 45.6%
Chicha 100% 3.2% 24.0% 27.5% 20.4% 29.7%
Beer 100% 8.3% 16.5% 21.8% 24.3% 28.9%
Pisco 100% 6.2% 10.8% 15.5% 25.2% 42.3%
Whisky 100% 0.0% 2.2% 7.2% 20.4% 71.3%
Other liqueurs 100% 2.9% 6.4% 9.5% 22.0% 59.2%
Source: Survey of household budgets 1996/1997 (National Institute of Statistics) (to be published).

Q = Quintile.

232 Chile Response to Questions asked at the First Substantive Meeting, p. 35.

Table 37
233

Distribution of Revenue by Income Quintile

Additional Tax on Alcoholic Beverages

Millions of Chilean Pesos ($), May 1997234

Case 1: Former System vs. Law No. 19,534 (1997)

 Weighting factors for expenditure Revenue Revenue under new system
 Q: I, II, III Q: IV, V 1996 e=0 e=1
Pisco 32.4% 67.5% 12,012 14,512 13,799
Whisky 9.4% 91.7% 7,090 4,760 5,505
Spirits 18.7% 81.1% 4,844 5,998 5,617
Burden 1996 5,464 18,540 24,004
Burden under new
system e=0
6,273 19,028 25,301
Burden under new
system e= 1
6,040 18,920 24,960
Change e=0 14.8% 2.6% 5.4%
Change e=1 10.5% 2.1% 4.0%

Case 2: Former System vs. Uniform Ad Valorem Rate (34%)

 Weighting factors for expenditure Revenue Revenue under new system
 Q: I, II, III Q: IV, V 1996 e=0 e=1
Pisco 32.4% 67.5% 12,012 16,337 15,240
Whisky 9.4% 91.7% 7,090 3,444 4,369
Spirits 18.7% 81.1% 4,844 5,490 5,326
Burden 1996 5,464 18,540 24,004
Burden under new
system e=0
6,646 18,642 25,289
Burden under new
system e= 1
6,346 18,616 24,963
Change e=0 21.6% 0.6% 5.4%
Change e=1 16.1% 0.4% 4.0%
Source: Survey of household budgets 1996/1997 (National Institute of Statistics) Ministry of Finance model.

Q = Quintile

4.465 Chile indicates that Table 36 sets forth the weigh ting factors for expenditure by the different
income quintiles of the population on the most commonly consumed alcoholic beverages. By
analysing the distribution of expe nditure on each type of beverage according to income quintile, it is
easy to appreciate that in the case of both whisky and the other non-pisco beverages, it is the higher
income groups that account proportionally for the gr eatest consumption. Whisky, in particular, has
always been considered as a luxury good consumed for the most part (92 per cent) by the high income
groups. The source of this information is the Survey of Household Budgets 1996/1997 by the
National Institute of Statistics.

233 Chile Response to Questions asked at the First Substantive Meeting, p. 36.
234 Chile explains that the measurement can be made u nder two hypothetical elasticity scenarios: e=0:
constant consumption, and e=1: constant expenditure.

4.466 Chile further claims that Table 37 shows the im pact of different tax structures on different
socio-economic groups. Quintiles I, II and III (low er income), and quintiles IV and V (higher
income), have been grouped together. With th e revenue obtained from the model described above
(Section I) and the distribution of expenditure according to the above table it is possible to estimate
the change in the tax burden on the different so cio-economic groups, for the products concerned,
under the new tax structure and under the flat stru cture (both having the same effect on aggregate
revenue). The results show that the flat structure involves a greater change in the tax burden (16-22
per cent) than under the new structure (11-15 per cent) for the lower income groups. For the higher
income groups, the tax burden under the flat rate remains practically unchanged (<1 per cent) in
relation to the new structure (2-3 per cent).
4.467 According to Chile, the first of these Finance Ministry objectives -- approximate equality of
tax revenues -- could have been achieved through a flat ad valorem tax. However, such a tax would
have been materially more regressive in its effect s than the Old Chilean System in terms of income
distribution. In Chile, with the exception of certain specialty liqueurs primarily imported from Europe
(such as Campari), there tends to be a correlation between higher prices and higher alcohol strength.
Thus, by having the ad valorem tax rise with alcohol content, the progressive distribution of tax
revenues is enhanced.
4.468 Chile states that two further points should be not ed in this regard. First, notwithstanding the
objective not to have a more regressive inciden ce of taxation on the different quintiles of the
population, the New Chilean System is slightly more regressive than the Old Chilean System. That is
primarily because of the drastic reduction in tax on whisky, which is a relative luxury good in Chile,
and the increase in tax on the cheapest grades of pi sco, the most common drink for poorer Chileans.
(Ironically, in light of Europe's current complaint, the only motivation for this regressive step of
reducing the tax on whisky was to respond to the trade complaint of the European Communities).
4.469 Chile further notes that the second point that should be noted is that the Finance Ministry
assessment was a static analysis, based on two arbitrary assumptions:
(i) that there would be no adjustment by consum ers in their spending patterns as a result
of the changed tax system; and
(ii) that there would be no adjustment of the alcohol strength of their products by
producers to try to take advantage of the lower ad valorem rates applied to lower
alcohol strength products.
4.470 Chile also notes that as to whether producers will adjust the alcohol strength of their products,
that is difficult to tell. Chile would guess that, if the United States adopted the Chilean Tax System
tomorrow, within weeks Chile would see distilled sp irits producers of the world undertaking the
simple dilution that is required to qualify for lo wer taxes. Thus would be born "Johnny Walker
Light," "Beef Eaters Lean," etc., all marketed at lower alcohol strength. The highest quality producers
(like producers of gran pisco) might not wish to adjust their products, but those wishing to compete
on price at the low end of the market might well decide to adapt their products.
4.471 Chile further explains that consumer health is one of the considerations that led to higher
taxation of higher alcohol strength beverages in Chile , as Chile assumes is the case in other countries,
including the European Communities and the United States. Health is not the only objective however,
or Chile would have imposed still higher taxes on be verages over 40º alcohol, a step that would have
led to even higher taxation of European whisky.
4.472 Chile then maintains that increasing the ad valorem tax rate as alcohol content increases has
both health benefits (by discouraging consumption of high alcohol products) and "social" benefits

(because it makes the tax system more progressive). Chile points out these considerations to enhance
the Panel's understanding of the Chilean law, but Chile does not claim an Article XX exception,
which in any case is unnecessary given the conformity of Chile's law with Article III.
4.473 Chile states that doubtless, different beginning a nd ending points for the tax might have been
chosen, especially if health had been the only motivating factor for the New Chilean System.
However, Chile was also seeking to reduce the tax on whisky in response to the trade complaints of
the European Communities, to reform the old system based on type of distilled spirits and to maintain
both gross tax revenues, and to a void making the system more regressive in the distribution of the
relative tax burden on different income groups in Chile.
4.474 Chile further explains that the system fina lly enacted addressed all these objectives. Most
importantly for purposes of this pr oceeding, the New Chilean System al so conforms with Article III.
The New Chilean System does not discriminate between domestic and foreign products. The identical
scale of taxation, based entirely on objective criteria is applied to all products, whether or not those
products are like, directly competitive, or substitutable.
4.475 The European Communities contends that Chile's manifest inability to reconcile the tax
distinctions with the stated policy objectives of the New Chilean System provides further
confirmation that, in reality, those distinctions are applied with the excl usive purpose to afford
protection to its domestic production.
4.476 In the view of the European Communities, in essence, Chile argues that the policy objectives
of its New Chilean System are none of the EC's busi ness and should not be examined by this Panel.
The European Communities has acknowledged that it is for each Member to choose its own taxation
objectives. At the same time, it is obvious that th e inadequacy of a tax system to achieve its self-
stated objectives is highly probative that the system is in fact being applied so as to afford protection
to domestic production. This type of analysis is part of the examination of the "design, the
architecture and the revealing structure" of tax m easures which panels have been enjoined to conduct
by the Appellate Body.
235
4.477 The European Communities explains that its inte ntion in making this argument was simply to
demonstrate that the New Chilean System is objectiv ely inapt to serve the taxation goals stated by
Chile itself. Additional confirmation of this is pr ovided by the fact that, to the EC's best knowledge,
no other country in the world applies the same system, even though many countries pursue similar
taxation objectives. The inadequacy of the New Ch ilean System to achieve Chile's purported policy
goals evidences that, in reality, that tax system has been designed with the exclusive purpose to
continue to afford protection to Chile's domestic production of spirits. The European Communities
does not exclude, however, that there may be othe r taxation methods which permit Members to attain
the policy goals stated by Chile without affording protection to Chile's domestic production.
4.478 The European Communities further claims that it is only in response to a question from the
Panel that Chile has eventually acceded to explain in some detail its purported taxation objectives.
The response furnished by Chile fully explains its reluctance to let the Panel address this question.
4.479 The European Communities goes on to state that Chile acknowledges that the tax differentials
cannot be explained by health protection reasons, because in that case the tax rate should have
continued to increase above 40 . To this, it should be added that, if health considerations played a
genuine role, alcohol contained in pisco would no t be taxed less than alcohol contained in low
strength liqueurs. Furthermore, health considerations cannot explain the huge tax differential between
spirits of 35 and spirits of 39.

235 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 29.

4.480 In the view of the European Communities, Chile also admits that the tax distinctions are not
necessary in order to preserve the previous level of tax revenues. That objective could have been
achieved as well by applying a flat ad valorem rate at an appropriate leve l on all alcoholic beverages.
Or, in case the concern with health protection was r eal, by applying a flat specific rate on alcohol
content, also at an appropriate level.
4.481 According to the European Communities, in view of the above, it must be concluded that the
very peculiar features of the New Chilean System are considered necessary by Chile in order to
achieve the third policy objective mentioned in its r esponse to the Panel, namely the objective that the
new system should not be more "regressive" than the previous one. As shown below, this justification
is spurious.
4.482 The European Communities then argues that the only alternative to the New Chilean System
which appears to have been considered by Chile's Ministry of Finance is the application of a pure ad
valorem rate at 34% (hereafter, the "Alternative System "). Chile does not argue that the Alternative
System would be "regressive", in the sense that the poor would pay a higher share of their income
than the rich. Rather, Chile's c ontention is that the Alternative System would be less "progressive"
than the New Chilean System, because the poor would contribute a larger portion of the tax proceeds.
The difference, nevertheless, is very small. Accord ing to the estimates of the Ministry of Finance,
under the New Chilean System th e three lowest income quintil es would pay between 24.2 % and
24.8 % of the total tax revenue. Under the Alte rnative System, those quintiles would contribute
between 25.4 % and 26.2 % of the total tax revenue.
236
4.483 The European Communities further argues that at any rate, Chile's contention that the chosen
system is less "progressive" is based on two erroneous assumptions.
4.484 The European Communities first explains that Ch ile assumes that there is a direct correlation
between alcohol content and price. Yet the Eur opean Communities has already demonstrated that
there is no such correlation. Chile's own data provide further confirmation of this. Contrary to Chile's
claims, it is not only certain imported "speciality liqueurs" which are more expensive than high
strength spirits. One of the tables given by Chile shows that, for example, pisco of 35  is more
expensive than aguardiente of 50, brandy of 38 and rum of 40 and as expensive as gin of 40.
4.485 The European Communities goes on to state that on Chile's own construction, even if there
existed now a correlation between alcohol content and price ( quod non), such correlation would be
broken as a result of the systematic dilution of high strength spirits in order to escape the highest tax
rates (unless Chile is arguing that diluted premium Sc otch will be sold at the same price as cheap
pisco corriente ). Thus, eventually the New Chilean System would be as "regressive" as a pure ad
valorem system. Further, if imported high strength spirits were diluted to 35 , the New Chilean
System could not, unlike the Alternative System, ach ieve the objective of maintaining the same level
of tax revenues.
4.486 In the view of the European Communities, the second mistaken assumption is that the
consumption patterns of the different income groups ar e not affected by the level of the taxes applied
to each type of spirit, and therefore, by their leve l of prices. In other words, Chile assumes that the
tastes of the poor will remain forever different from th e tastes of the rich. As admitted by Chile itself,
that assumption is "arbitrary".

236 The European Communities notes that the analysis made by Chile's Ministry of Finance obscures
how small is the difference by focu sing on the differences in the percentage by which the tax burden on the
three lowest income quintiles increases in the New Chilean System and the Alternative System, compared to the
old system.

4.487 The European Communities explains that if th e Alternative System appears to be more
"regressive" than the New Chilean System in the an alysis made by the Ministry of Finance, it is
simply because the burdens on each income group are calculated on the basis of their spending
patterns under the old tax system in force in 1996, when whisky was taxed at 70 % and pisco at 25 %.
In view of that tax differential, it is hardly surprising if in 1996 the two top income quintiles
accounted for a large portion of the consumption of whisky. If in 1996 the taxes on whisky (and
consequently the prices) had been lower, consumpt ion of whisky by the remaining income quintiles
would have accounted for a higher percentage.
4.488 The European Communities concludes that, in su m, Chile's attempted justification rests on
purely circular reasoning. Whisky is taxed at a highe r rate because it is considered to be the drink of
the rich. Yet, the reason why it is assumed to be the drink of the rich is because in the past the poor
drank less whisky compared to pisco than the rich . But one of the reasons why the poor drank less
whisky compared to pisco than the rich was pr ecisely because whisky was taxed much more heavily
than pisco.
4.489 The European Communities furt her argues that the same type of argument now made by
Chile was raised by Japan in Japan – Taxes on Alcoholic Beverages I . It was rejected by the panel in
categorical terms:
The Panel noted the Japanese submission th at … generally "taxes on liquors are
levied according to the tax bearing ability on the part of consumers of each category
of liquor". The Panel was of the view that the use of product and tax differentiations
with the view of maintaining or prom oting certain production and consumption
patterns could easily distort price compe tition among like or directly competitive
products by creating price differences and pr ice-related differences which would not
exist in case of non-discriminatory internal ta xation consistent with Article III:2. The
Panel noted that the General Agreement does not make provision for such a far-
reaching exception to Article III:2 and that the concept of "taxation according to tax-
bearing ability of prospective consumers" of a product did not offer an objective
criterion because it relied on unnecessarily subjective assumptions about future
competition and inevitably uncertain consumer responses.
237
4.490 In conclusion, the European Communities states that, in sum, the New Chilean System that
has the clear effect of favouring pisco, the local spirit, over other types of spirits imported from the
European Communities and other Members. Furthe rmore, the "structure", the "design" and the
"architecture" of the system cannot be rationally explained except as being pre-ordained to achieve
precisely that protective effect. The inescapable conclusion is that the New Chilean System is applied
"so as to afford protection to domestic productio n", contrary to Chile's obligations under GATT
Article III:2.
(c) Percentage of Less Taxed Products in Domestic Products
4.491 The European Communities claims that as shown in Table 3 above, approximately 90 % of
pisco is bottled at 35  or less and is therefore eligible for the lowest applicable tax rate of 27 % ad
valorem. Furthermore, there is nothing that preven ts Chile's pisco manufacturers from replacing their
current production of pisco of more than 35  by pisco bottled at a lower strength so as to benefit from
the lowest tax rate.
4.492 In the view of the European Communities, th e only other spirit types with a significant
volume of sales that may qualify for the lowest tax rate are liqueurs and aguardiente, virtually all of

237 Panel Report on Japan - Taxes on Alcoholic Beverages I, supra., para. 5.13.

which are domestically produced. It can be estimated that, together, pisco, liqueurs and aguardiente
of 35 or less may account for as much as 75 % to 85 % of Chile's total production of distilled spirits.
Thus, the New Chilean System will continue to fa vour a large majority of Chile's production of
distilled spirits.
4.493 The European Communities argues that finally, Chile has failed to rebut the EC's evidence
showing that the New Chilean System is applied "s o as to afford protection to domestic production".
Under the New Chilean System, more than 95 % of im ports will be taxed at the highest tax rate. In
contrast, between 75 and 85 % of domestic spirits (i ncluding 90 % of pisco) will be taxed at the
lowest rate. Moreover, sales of domestic spirits with a minimum alcohol content of more than 35 
represent only 6 % of domestic production.
238 Thus, potentially nearly all domestic production
qualifies for the lowest tax rate. The mere fact that some domestic products fall within the more
taxed category is not sufficient, in light of previ ous panel reports, to exclude a finding of protective
application. What really matters is that the vast majority of Chile's domestic production falls within
the most favoured category.
4.494 The European Communities notes that Chile claims that domestic production accounts for
70 % of the spirits subject to the highest tax rate. That figure, however, is deceptive. The supporting
tables239 shows that only 26 % of domestic production c onsists of spirits with a minimum alcohol
content of more than 39 . Furthermore, domestic brands of hi gh strength spirits of more than 39 
such as gin, vodka, rum or whisky are generally lo w quality products positioned at the low end of the
market. So-called "Chilean whisky" is a case in point. According to the International Wine and
Spirits Record, the largest part of Chile's "whisky" production is used for re-filling bottles of imported
brands.240 This is not the type of "domestic productio n" which a Government may be interested in
protecting.
4.495 Chile replies that in assessing effects of the New Chilean System, the European Communities
asks the Panel to look only at existing EC productio n that would face high taxes and existing Chilean
production that would face relatively lower taxes. As just noted, that ignores both the EC production
that would face low taxes if exported to Chile a nd the substantial Chilean production that will face
relatively high taxes. 241 The European Communities already pr oduces grappa, for example, a spirit
distilled from grapes that is quite similar to pisco, a nd it could readily be marketed in Chile, if the EC
producers so chose. In addition, nothing under Chil ean law prevents the EC producers of spirits from
diluting their products to a lower alcohol strength and commercializing them in Chile provided that
they comply with the provisions of the Chilean law re garding health and food. In that very real sense,
the European Communities has the equality of competitive opportuniti es which it claims to seek.
Very simply, the New Chilean Law applies to and af fects domestic producers of spirits in the same
manner as it applies to and affects importers of alc oholic beverages. It in no way prevents foreign
producers of spirits from importing any low alcohol content spirits benefiting from a lower level of
taxation on the basis of their alcohol content.
4.496 The European Communities further responds that Chile also argues that the New Chilean
System is "neutral" because there are some imports in the less taxed category. The actual fact,
however, is that imports of spirits with a minimum alcohol content of 40 account for 95 % of imports.

238 Ibid.
239 Chile First Submission, Annex III.
240 EC Exhibit 19, p.43.
241 Chile argues that local production accounts for 71.6% of the alcoholic beverages with alcohol
content of more than 39° in 1995, which will be subject to the highest rate of taxation under the New Chilean
System.

In practice, the only imported products which coul d benefit from the lowest tax rate in the New
Chilean System are certain types of low strength liqueurs.
242
4.497 In the view of the European Communities, Chile 's assertions to the effect that in previous
cases the favoured product was always one that "cou ld be only domestic" misrepresent the findings of
those reports. For example, just like Chile in this case, Japan claimed that its tax system was "neutral"
because shochu was not an "inherently" Japanese product. 243 Indeed, there were imports of shochu
into Japan.244 Furthermore, the panel accepted the evid ence submitted by Japan according to which
shochu was produced in substantial quantities outsi de Japan, in countries su ch as Korea, China,
Singapore and even the United States. 245 Similarly, in Korea – Taxes on Alcoholic Beverages , the
panel based its conclusion that the measures were protective on the fact that the current volume of
imports of soju were very small, and not on the fact that soju was an "inherently" Korean product.246
4.498 The European Communities continu es to state that in the same vein, Chile argues that in
United States – Malt Beverages , the small breweries exception was found to violate Article III:2
because "only small US breweries could qualify". This is a gross misrepresentation of the panel's
findings. The panel did not condemn the small brewery exception because it was not available to
foreign products, but because beer from small brewer ies is "like" beer from large breweries, and
Article III:2, first sentence, does not tolerate any tax differential between "like" products:
The Panel further noted that the parties disagreed as to whether or not the tax credit in
Minnesota were available in the case of impor ted beer from small foreign breweries.
The Panel considered that beer produced by large breweries is not unlike beer
produced by small breweries …. Therefore, in the view of the Panel, even if
Minnesota were to grant the tax credits on a non-discriminatory basis ... there would
still be an inconsistency with Article III:2, first sentence.
 247
4.499 In the view of the European Communities, Chile's argument turns upside down the well-
established principle that Article III is concerned with the protection of competitive opportunities and
not of actual trade flows. 248 The thrust of that principle is th at in order to establish a violation of
Article III:2, it is not necessary to show that a measu re has actually restricted imports. A violation of
Article III:2 may be found even if there are no imports at all. It is sufficient to show that the measure
may limit potential imports. Chile subverts this princi ple by arguing that the fact that actual imports
are restricted is irrelevant, if potential imports of a different product are not.
4.500 Further, the European Commun ities states that Chile's argume nt does not take into account
the specific nature of the products at issue. Sp irits are not commodities. Spirits are "experience
goods"249, whose consumption is largely based on habit. For that reason, market penetration tends to
be slow and requires considerable marketing effo rts. It may require some time and advertising
expenditure to convince a hardened pisco drinker to switch to whisky, just as it may require some
time and advertising to convince a smoker of Camel to try Marlboro. Even though all distilled spirits
and liqueurs are, by reason of their physical characteristics and potential end-uses, "directly
competitive or substitutable" products, currently the main competitive threat to pisco comes from

242 The European Communities notes as regards grappa that it should be noted that in the European
Communities its minimum alcohol content is 37.5 % vol. Therefore, it woul d have to be diluted in order to
benefit from the lowest tax rate in Chile.
243 See Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., paras. 4.19 and 4.175-4.179.
244 Ibid., para. 4.177.
245 Ibid., para. 6.35.
246 Panel Report on Korea - Taxes on Alcoholic Beverages, supra., para. 10.102.
247 Panel Report on United States - Malt Beverages, supra., para. 5.19.
248 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p.16.
249 See Panel Report on Korea - Taxes on Alcoholic Beverages, supra., para. 10.75.

whisky and the other high strength spirits which are already present in the Chilean market. It could
take many years before other (low strength) spirits which are currently not exported to Chile, or only
so in small quantities, could represent a comparable threat for pisco. Thus, the New Chilean System
does afford effective protection to pisco even if it does not protect pisco against potential imports of
low strength spirits.
4.501 Chile further responds that the European Communities itself has made an analogy between
type names such as whisky, vodka, shochu, etc, and brandnames, such as Camel or Marlboro
cigarettes. The analogy is correct, at least insofa r as the laws would prevent a whisky producer from
calling his product vodka, just as the intellectual property laws of most countries would prevent
Camel from calling its cigarettes Marlboros, or, for that matter, a sparkling wine producer from Italy
or Chile calling its product Champagne in the European Communities.
4.502 According to Chile, the panels in the Korean and Japanese cases decided that tax distinctions
based on such type distinctions are not permissi ble, if the two types of product are directly
competitive or substitutable and if they are dissimilarl y taxed, and if that dissimilar taxation creates a
favoured group that is essentially all produced domestica lly. In other words, a distinction that may be
perfectly acceptable, indeed mandated for purpo ses of marketing products under a certain name,
cannot be used to justify tax or regulatory distin ctions under Article III if the named products are
otherwise directly competitive or substitutable and the other tests of an Article III violation are met.
4.503 Chile states that it does not contest that thesi s. Indeed, distinctions based on intellectual
property, or subjective classification systems could be very harmful to a developing country such as
Chile if used to discriminate against Chilean pr oducts. Products that may qualify to be treated
differently for intellectual property or similar purposes may still be directly competitive or
substitutable for Article III purposes.
4.504 Chile claims that in this dispute, however, the European Communities is not simply asking
the Panel to prohibit tax distinctions based on type names. Indeed, Chile has done that, eliminating all
distinctions based on types of distilled spirits. The European Communities is asking this Panel to take
the interpretation of Article III significantly farthe r so as to create an affirmative obligation for WTO
members to ensure that their inte rnal taxes accommodate precisely the same marketing standards that
the European Communities insists ar e insufficient to make the products not directly competitive or
substitutable. For the European Communities, it is no t sufficient to abandon tax distinctions that are
based on concepts such as types or brands. The European Communities argues that the tax laws and
regulations must not have the effect of diminishi ng whatever marketing or intellectual property value
is thought to be associated with the name or brand.
4.505 Chile further contends that this theory woul d go too far as a matter of interpretation of
Article III. It is one thing to say that qualitative di stinctions, even though sought by the industry and
mandated by law or regulation, are not necessarily su fficient to justify tax or regulatory distinctions
that otherwise would violate Article III. It is qu ite another thing to say that Article III carries an
implicit obligation affirmatively to protect or enhance such an intellectual property right or subjective
classification system.
4.506 In the view of Chile, primarily at the ur ging of the European Communities and other
developed countries, the WTO now includes the TR IPS Agreement. The Eu ropean Communities is
free, if it wishes, to seek to negotiate further in tellectual property rights and protections, such as a
right to market under type names like whisky with high minimum alcohol requirements and immunity
from adverse tax consequences flowing from that hi gh alcohol content. But there is no basis for
attributing such an obligation to Article III of GATT 1994.

4.507 Chile reiterates that in the meantime, under the New Chilean System, EC producers will have
the same choice as Chilean producers and all third-c ountry producers of alcoholic beverages. They
can sell products that already are of low alcohol strengt h at the lowest rate of taxation. They can sell
high alcohol products without dilution, but al so without discrimination between domestic and
imported product and, in the case of whisky, at a s ubstantially lower tax rate than has prevailed.
They can also elect to dilute their high alcohol products with a relatively small amount of water and
similarly benefit from low taxation. Despite the EC's protestations. Chile cannot fail to note that
dilution with water is hardly an onerous process for a product that, in the EC's words, is already "99%
water and alcohol" and whose last stage of production is already dilution with water to the desired
alcohol strength. Further, the European Comm unities itself has noted the large tendency for
consumers themselves to dilute their product with water, ice, or various mixers.
4.508 Chile notes that, even after dilution, Chile's in tellectual property laws will protect the EC's
trademarks in Chile, whether those producers market their brands as whisky or some other product.
Chile has a chart demonstrating various diluted al coholic beverages on sale in Chilean supermarkets,
using their brandnames and the al coholic beverage with which they are mixed, as indicated in
Table 38.
Table 38
250

Diluted Alcoholic Beverages

Beverage

Alcohol Content Brandname Origin
Margarita

13 Careye's Mexico
Vodka and peach 25 Artic Italy
Vodka and coconut 25 Artic Italy
Vodka and melon 25 Artic Italy
Vodka and apple 25 Artic Italy
Vodka and pineapple 30 Artic Italy
Vodka and cranberry

30 Artic Italy
Lemon rum

35 Finlandia Finland
Pisco sour 22 Capel Chile
Pisco sour 22 Control Chile
Pina colada 20 Mitjans Chile
Whisky and cola 8 Jack Daniel's U.S.A.
Cola de mono 16 Vina Mendoza Chile

(d) Percentage of More Taxed Products in Imported Products
4.509 The European Communities further points out that in contrast, nearly all imports of spirits
will be taxed at the highest rate. As shown in Table 19 above, imports of whisky, gin, vodka, rum and
tequila (all of which will be taxed at the rate of 47 % ad valorem ) account for more than 95 % of
imports of spirits into Chile.

250 Chile Oral Statement at the Second Substantive Meeting, Table I-A.

4.510 The European Communities contests the Chile ar gument that the New Chilean System is
"neutral" because some domestic production will be taxe d at the highest rate. In reality, however, the
share of current domestic production falling within the most taxed category is relatively small:
between 15 % and 25 %. Furthermore, sales of do mestic spirits with a minimum alcohol content of
more than 35 represent as little as 6 % of total domestic pr oduction. In turn, domestic spirits with a
minimum alcohol content above 39  account for barely 2.7 % of to tal domestic production, based on
the data shown in Table 19 above. Thus, potentially nearly all domestic production of spirits qualifies
for the lowest or the intermediate tax rate. For comparison, in Japan – Taxes on Alcoholic Beverages
I and II
251, the share of domestic production falling within the less taxed category was 80 %.
4.511 The European Communities also considers that in any event, as Chile itself has acknowledged,
previous panel reports confirm that the presence of some domestic production in the most taxed
category does not exclude a violation of Article III:2, second sentence. Thus, for example, in Japan –
Taxes on Alcoholic Beverages II 252, domestic production accounted for no less than 75 % of the sales
of whisky, 72 % of the sales of brandy, 82 % of the sales of spirits and 97 % of the sales of liqueurs.
In Korea – Taxes on Alcoholic Beverages , 80% of gin, 50 % of rum and 30 % vodka were
imported.253 What really matters is whether the majori ty of domestic production falls within the
favoured category.
4.512 The European Communities further claims that unlike pisco those spirits do not have the
flexibility to move down the scale in order to benef it from the lowest tax rate. In conformity with
Chilean regulations, all of them must be bottled at a minimum alcohol content of 40  and, therefore,
are automatically locked in to the highest rate of 47 %.
4.513 In rebuttal, Chile contests the EC complaint that Chilean Law 18,455 will prevent producers
of distilled spirits such as whisky, gin and rum from marketing their products at the lowest rate of
taxation, because Chilean regulations under that la w established minimum alcohol standards for those
products that preclude sale at less than 40  of alcohol. That misstates the requirements of Chilean
Law 18,455 and regulations thereunder, which in any even t are not at issue in this dispute. It is true
that products cannot be marketed, for example, as "whisky" unless the product contains at least 40 
alcohol. However, there is nothing in Chilean la w or regulations that preclude a whisky producer
from adding water to the product to reduce its strength to 35  before bottling, so long as the product is
not marketed as whisky.
4.514 In the view of Chile, while producers of whisky (or rum, gin, etc.) might prefer to market
their products under the traditional type name, those producers cannot have it both ways when seeking
the benefits of Article III. The distilled spirits indus try cannot insist when taxation is at issue that all
distilled spirits products be treated in the iden tical way as measured by whatever standards of
equivalency best suit the commercial interests of th e large export industries, but then claim at the
same time that fine distinctions between essentially identical products, often based almost exclusively
on origin or minute differences of process or ingredients, be vigorously enforced and accommodated.
4.515 Chile goes on to state that whisky producers in Europe, like whisky producers in Chile,
cannot market their product as whisky in Chile unless it is at least 40  alcohol by strength. That is a
requirement of both European Communities and Ch ilean regulations, and in both cases it is applied

251 Panel Report on Japan - Taxes on Alcoholic Beverages II, supra., para 4.95.
252 Ibid., Annex IV.
253 See Panel Report on Korea - Taxes on Alcoholic Beverages, supra., para. 3.17.

equally to imported and domestic pr oducts. That is, a product that is "like" whisky in every way but
its alcohol strength cannot be marketed as whisky.
254
4.516 Chile states that it is ironic that the Europ ean Communities also re quires minimum alcohol
levels in order to be able to market products in the Community as different kinds of spirits. For
example, the commercially desirable name of Scotch whisky can only be applied to a product that
meets the minimum alcohol standard imposed by the European Communities 255, as also confirmed by
the ECJ.256 An imported product that is identical in ev ery other way cannot use this desirable term
Scotch whisky if it has one percent less alcohol th an the minimum -- yet, such distinctions have not
been considered to violate Article III:4 requirement s for no less favorable treatment with respect to
internal laws, regulations and requirements.
4.517 According to Chile, the EC's own practice under the national treatment provisions of the
Treaty of Rome has developed in such a way that, according to the European Communities,
"Article III:2 of GATT contains provisions broadly corresponding to Article 95 [EEC]". 257 In
interpreting the national treatment rules of Article 95 of the Treaty of Rome, the European Court of
Justice stated that:
In the present state of Community law Article 95 EEC does not prohibit Member-
States, in the pursuit of legitimate ec onomic or social aims, from granting tax
advantages, in the form of exemptions from or reduction of taxes, to certain types of
spirits or to certain classes of producers, provided that such preferential systems are
extended without discrimination to impor ted products conforming to the same
conditions as the preferred domestic products.258
4.518 Chile states that it is interesting to note that the European Court of Justice decided that:
A system does not favor domestic producers if a significant proportion of domestic
production of alcoholic beverages falls within each of the relevant tax categories.259
4.519 Chile goes on to state that the same can be inferred from a contrario analysis of the European
Court of Justice ruling that:
[A] criterion for the charging of higher taxation which by definition can never be
fulfilled by similar domestic products cannot be considered to be compatible with the
prohibition of discrimination laid down in Article 95 of the Treaty ...260
4.520 Thus, Chile mentions that the European Communities recognizes that "Article III:2 is
concerned with the protection of competitive opportunities and not of actual competition". (emphasis

254 Council Regulation 1576/89 of 29 May 1989 Establishing General Rules on the Definition,
Description and Presentation of Spirits, Art. 5, 1989 J.O. (L160) 1.
255 Ibid.
256 Case C-136/96, Scotch Whisky Association v Compagnie Financiere Europeenne de Prises de
Participation, 696J0136, 1998 ECJ Celex Lexis 1211 (16 July 1998).
257 Case 148/77, H. Hansen jun. & O. C. Balle GmbH & Co. v Hauptzollamt Flensburg , 1978 E.C.R.
1787, 1 C.M.L.R. 604 (1979).
258 Case 196/85, Natural Sweet Wines: Commission v. France , 1987 E.C.R. 1597, 2 C.M.L.R. 851
(1988); See also, Case 127/75, Bobie Getrankevertrieb GmbH v Hauptzollamt Aachen-Nord, 1976 E.C.R. 1079;
and Case 148/77, H. Hansen jun. & O.C. Balle GmbH & Co. v. Hauptzollamt Flensburg 1978 E.C.R. 1787,
1 C.M.L.R. 604 (1979).
259 Case 243/84, John Walker & Sons Ltd v. Ministeriet for Skatter og Afgifter, 1986 E.C.R. 875,
2 C.M.L.R. 278.
260 Case 319/81, Commission v Italy, 1983 E.C.R. 601, 2 C.M.L.R. 517, para. 17.

supplied by Chile) It is clear from the preceding ar guments that EC producers of alcoholic beverages
have the same competitive opportunities as domestic producers of spirits and it is up to EC producers
to seize the opportunities that the New Chilean System offers them.
4.521 Chile contests the objection of the European Communities that the New Chilean System
results in relatively high taxes on many imports a nd relatively lower taxes on many domestic products.
That may be true, assuming that the current conf iguration of EC (and Chilean) production continue.
But it is equally true that the New Chilean System results in relatively high taxes of high alcohol
premium domestic products, which constitute a substantial and growing segment of Chilean
production, a pattern of consumption which is consistent with the level of distribution and income of a
developing country. In fact the New Chilean System is biased in tax terms against relatively high
alcohol products and against rela tively expensive products, but that does not constitute a violation of
the "so as to afford protection to domestic production" standard.
4.522 Chile argues that it is also essential to note in this regard that, unlike systems based on
distinctions between different types of distilled spir its, it is a relatively simple matter for foreign and
domestic producers to adapt to the neutral and objec tive standards of the Chilean system. A whisky
producer cannot readily become a pisco producer, but a producer of any spirit of 40  alcohol can
readily dilute the product to 35 . The European Communities already produces many products
(grappa, fruit liqueurs, etc.) that qualify for the lo west taxes and even more products that would
qualify if only, as the European Communities suggests be done for pisco,
261 some water is added to
the current high alcohol products before bottling. Article III simply does not obligate sovereign
Member governments to harmonize their neutral ta xation system to the convenience of foreign
producers in the way sought by the European Co mmunities in this case. The New Chilean System
affects domestic producers of spirits in the same manner as it affects importers of alcoholic beverages,
and does not prevent foreign producers of spirits from importing any low alcohol content spirits
benefiting from a lower level of taxation on the basis of their alcohol content.
4.523 In the view of Chile, the overriding requirement of Article III:2 is not to discriminate in favor
of domestic goods and against imported goods on the basis of national origin of a product. Almost all
cases brought to GATT and WTO panels under Article III:2 have involved measures that, on their
face, afforded more favorable treatment to some or all domestic goods than to imported goods.
4.524 Chile states that a legislator should also be aware that a measure th at formally does not
discriminate based on nationality may nevertheless be found to contravene Article III:2, second
sentence, if the effect of the measure is to make more favorable treatment available exclusively or
virtually exclusively to domestic products to the disadvantage of imported products. GATT and WTO
panels have gone furthest in extending the concept of de facto discrimination based on national origin
of a product in the recent alcoholic beverage taxa tion cases against Japan and Korea. Both of those
countries had tax systems in which one type of distille d spirit was taxed at a far lower rate than other
distilled spirits. Further, in each case, domestic producers accounted for virtually all domestic
consumption of shochu or soju, because vari ous measures effectively prevented imports of
shochu/soju from competing in the domestic market . In these circumstances, where there was no
possibility for foreign producers to obtain the benef its of the low tax accorded to shochu/soju, and
where the panel found that the favoured product was like or directly competitive or substitutable with
other types of distilled spirits, these systems were held to contravene Article III:2.
4.525 Chile goes on to state that on the other hand, laws and regulations based on objective criteria
such as those used in the New Chilean System ha ve rarely been challenged in the GATT and have

261 Chile notes that producers of pisco reservado or gran pisco might choose not to dilute, because they
would then lose the right to market under those more pr estigious names, which are al so associated with more
elaborated processes and select ingredients.

never been successfully challenged, even when the tax system may result in less favorable treatment
for some or many imported goods than for some or many domestic goods. For example, in the United
States - Taxes on Automobiles case, the panel found that the United States had not breached
Article III:2 by imposing a luxury tax on ve hicles above a certain threshold value.
262 The U.S. tax
resulted in far higher taxes on certain European prod ucts, which dominated the U.S. market for cars
priced significantly above the threshold price and thus the vast majority of the revenue collected from
the tax on European cars. However, far more im ports, including a significant number of imports in
the price categories most directly competitive with U.S. "luxury cars," paid a minimal tax or no tax at
all.
4.526 Chile states that while the reasoning of the United States - Taxes on Automobiles Panel (the
so-called "aims and effects" test) was not followed subsequently by the Appellate Body, Chile
believes that the result would have been the sa me under the three part test applied by the Japan –
Taxes on Alcoholic Beverages II Appellate Body.263 The luxury tax imposed by the United States was
based on objective criteria (a tax on the value of cars in excess of a fixed luxury level) that applied to
both domestic and imported cars, and imported cars could and did benefit from the tax exemption
granted to all cars below the exemption.
4.527 Chile further argues that comparing that system to the Chilean system of taxation of alcoholic
beverages, it might be noted that it is easier as a practical matter for foreign producers to adapt the
alcohol strength of their product than for car producers to reduce their prices.
4.528 Also, Chile maintains that similarly, even though specific taxes such as those imposed on
alcoholic beverages in several EC Member States ha ve a marked discriminatory effect on low priced
imported products relative to high priced domestic products such as Scotch whisky or even imported
high priced products such as U.S. or Canadian whisky, Chile has believed that a challenge of such tax
systems under Article III (or Article I which requires most favoured nation treatment with respect to
matters covered by Article III:2) would probably not be successful because the tax standard is
objective, even if its effect disfavours low price products.
4.529 Chile notes that it is likewise inconceivable that members of the WTO, particularly
developing country members, thought or think that, in joining the WTO and accepting thereby the
obligations of Article II:2, they were foregoing the right to use fiscal policy tools such as luxury taxes
or exemptions or reduced taxes for goods purchased primarily by poor consumers, even if such
policies result in higher taxes on many imports than on many like or directly competitive products.
4.530 Chile believes that the Europ ean Communities errs in the fo llowing principal ways chiefly
because the European Communities ignores signifi cant differences between the Chilean law and
market and those of Japan and Korea or becau se the European Communities tries to equate
differences between the Chilean and EC systems of taxation with a violation of Article III:2.
4.531 Chile argues that the Europ ean Communities ignores that, unlike the situation under the
Japanese and Korean Systems, imported products can readily benefit from the lowest rates of taxation
in Chile.
4.532 In the view of Chile, the European Communiti es accepts taxation based on alcohol content,
but tries to argue that such taxes must be both sp ecific and strictly proportional to alcohol content,
when such a test is not required by Article III, not equitable by many standards, and not consistent
with wine tax policies and policies such as luxury taxes.

262 Panel Report on United States - Taxes on Automobiles, supra.
263 See Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra.

4.533 According to Chile, the European Communities asks this Panel to assess the Chilean objective
tax system in terms of its effect on precisely the su bjective categorisation system that is abandoned in
the New Chilean System.
4.534 Chile maintains that having successfully argued in the Japan and Korea cases that a subjective
system for typing and naming products cannot necessarily justify different treatment of those products
under Article III:2, the European Communities now tries to argue that there is an affirmative duty to
ensure even objective criteria -- such as those employed by Ch ile -- accommodate the subjective
marketing system. This is tantamount to creating a new intellectual property right and insisting that
Article III affirmatively protect that right.
4.535 Chile considers that panels a nd the Appellate Body applied the broadest interpretation of
Article III:2 in the recent cases against Japanese and Korean alcoholic beverage taxes. In those cases,
the measures in question were held inconsistent with Article III:2, second sentence, even though:
(i) there was no explicit discrimination based on nationality; and
(ii) at least in the case of Japan, there w as very substantial domestic production of
unfavourably taxed products that the pane l found to be directly competitive or
substitutable.
4.536 Then Chile argues that though those elements might suggest a non-discriminatory system,
there were critical additional aspects to both system s. In those cases, the ta x systems of Japan and
Korea discriminated according to type of distilled spirit, and the type that was most favorably taxed
was virtually entirely insulated from import competition. That is the element that does not exist in the
New Chilean System.
4.537 In the view of Chile, the European Commun ities criticised Chile because it mis-described
shochu and soju as "inherently" domestic products. I ndeed, that was not the panel finding in either
case. Instead the panel found that those particular types of distilled spirits in those countries were
essentially insulated from import competition by Japan ese and Korean measures. Thus imports could
not benefit from the lower rate of taxation. Th ey could not benefit by producing shochu or soju,
because those products effectively c ould not be imported. They coul d not benefit otherwise, because
only the product named shochu or soju could benef it, and the criteria for using those names did not
allow adaptation of other products to qualify as shochu/soju.
4.538 Chile notes that the European Communities also seems to imply that there was an opportunity
for imports to take advantage of the low tax cate gory in the Korean and Japanese systems, when in
fact the panels found quite the contrary. Notwithstanding the existence of productive capacity abroad,
the panel found that domestic producti on of shochu and soju were insu lated from that competition.
Foreign shochu/soju producers could not enter the re levant markets because of trade restrictions, and
foreign producers of other distilled spirits could not a lter their products to make them into shochu or
soju. Whisky could not be diluted into soju or shochu, and Vodka could not simply rename itself
without changing its production method and becoming subject to essentially insuperable trade barriers.
4.539 Chile argues that by contrast, the Chilean system, using alcohol content without type
distinctions, allows imports to take advantage of the low tax category of Chile.
4.540 Chile thus concludes that the Japanese and Kor ean systems employed subjective distinctions,
while the Chilean System is objective. Use of type names to make tax categories had the effect in
Japan and Korea of excluding from the lowest tax ca tegory distilled spirits not meeting the standards
to be called shochu or soju. At the same time, import restrictions prevented products that could
qualify as soju or shochu from entering. Thus, on ce the panel determined that shochu and soju were

competitive or substitutable with other products, th e panel could also conclude that a virtually
exclusively domestic product was being afforded protection by dissimilar taxation.
4.541 In rebuttal, the European Communities stresses the unequal impact of the measure on
imported as compared to domestic products. The me asure's structure ensures that between 75 % and
85 % of Chile's domestic production of spirits (inclu ding more than 90 % of all pisco sales) will be
eligible for the lowest tax rate possible. In contr ast, 95 % of imported products (including all imports
of whisky, vodka, rum, gin and tequila) will be taxed at the highest rate possible.
4.542 In the view of the European Communities, Chile has not challenged those figures. Still, Chile
pretends that the measure affords the same competitive opportunities to the EC exporters than to the
Chilean producers of pisco. According to Chile, the EC exporters of whisky could take advantage of
the lowest rate simply by diluting their whisky to 35 . Yet, that diluted be verage would no longer be
considered as whisky in most countries. In Chile its elf, the law prescribes that whisky must have no
less than 40 . This means that if the EC producers diluted whisky to 35 , the resulting product could
not be sold under the term "whisky". As men tioned before, the same minimum alcohol content
requirement applies also to gin, rum, vodka and tequila.
4.543 The European Communities notes that likewise, th e fact that a few imports of low strength
liqueurs will benefit from the lowest tax rate do es not exclude a violation of Article III:2, second
sentence. The possibility to dilute high strength spirits to 35  is not a real option for the EC spirits
producers. To begin with, because by doing so the EC producers of spirits would forfeit the right to
sell their products under their traditional, well re puted names. Moreover, the degree of alcohol
content is one of the essential features which defi ne the identity of each type of spirit. Whisky
drinkers would simply not consider diluted whisky as real whisky.
4.544 The European Communities states that it seems al most unnecessary to state that this is not
really an option for the EC producers of spirits. In the first place, as acknowledged by Chile, whisky,
vodka, gin, rum and tequila (which together account for 95 % of imports) simply could not be
lawfully marketed at 35 or less, unless at the price of losing their names.
4.545 The European Communities notes that Chile seems to consider as an obvious fact that foreign
producers "could not hope to sell something called s hochu in the Japanese or Korean market". On the
other hand, it pretends that selling in Chile something called " aguardiente de cereales" would be no
more difficult than selling something called "whisky". This is incorrect. "Whisky", "rum", "gin",
"vodka" and "tequila" are all well-established product names which enjoy worldwide consumer
recognition. In order to build up a totally new pr oduct name with the same reputation as "whisky",
the EC producers would have to invest considerable financial resources over a long a period of time.
Asking the EC producers to forfeit the prestigious na me "whisky" in order to qualify for the lowest
tax rate amounts to asking them to write off all thei r previous marketing efforts in Chile. If Chile is
truly convinced that the use of a well-known a nd reputed name does not improve the "competitive
opportunities" of a spirit, why does it insist on reser ving the name "pisco" exclusively for domestic
pisco?
4.546 The European Communities further notes that Ch ile quotes the following passage of the ECJ
decision in the Case 319/81, Commission v. Italy, as supporting a contrario Chile's argument that the
presence of domestic products in the more taxed category excludes protective application:
... a criterion for the charging of higher ta xation which by definition can never be
fulfilled by similar domestic products cannot be considered to be compatible with the
prohibition laid down in Article 95 of the Treaty ...

4.547 In the view of the European Communities, Ch ile's argument provides an excellent illustration
of the well-known fact that a contrario inferences are often wrong. It is obvious that from the fact
that a condition which cannot be fu lfilled by domestic production is contrary to Article 95 ECT, it
cannot be logically inferred that all other conditions are always compatible with Article 95. By now,
it is a well-established principle of both EC law and GATT law that de facto discrimination (as
opposed to de jure discrimination, including indirect de jure discrimination such as the one at issue in
Case 319/81) is contrary to Article 95 of the Treaty of Rome and Article III GATT, respectively.
4.548 The European Communities further argues that on the other hand, it is worth noting that this
ECJ judgement refutes Chile's dilution argument. The measure in dispute in case 319/81 was the
application by Italy of the VAT at a higher rate on spirits which benefited from a designation of origin
(e.g., Cognac). This condition could not be met by domestic production, because Italian law does not
recognise designations of origin for spirits. If one fo llows Chile's logic, there would be no violation
of Article 95, because foreign producers could avoid paying the higher tax simply by selling their
products under a generic name. For instance, the exporters of cognac would have qualified for the
lowest rate simply by selling its product under the name "wine brandy", something which according
to Chile would not have impaired their competitive opportunities.
4.549 According to the European Communities, more over, even if Chilean regulations were
amended so that whisky, gin, rum, vodka and tequila could be lawfully marketed at 30 -35 without
forfeiting their name, the New Chilean System woul d still fail to afford "equality of competitive
opportunities". Contrary to Chile's argument, minimum alcohol standards are not a capricious
invention of some wicked multinationals. The level of alcohol content is one of the essential
characteristics which define the identity of each type of spirit. Consumers associate each type of spirit
with a certain range of alcohol content. For many whisky consumers, whisky of 30  would simply
not be "real" whisky, irrespective of the name written on the label. It is in recognition of this fact that
the regulations of both Chile and the European Communities, and of many other countries, prescribe a
minimum alcohol content for whisky of 40.
264
4.550 The European Communities also argues that in practice, by putting forward its dilution
suggestion Chile admits that its New Chilean Sy stem places foreign producers in the following
dilemma. Those producers can either choose to preserve their products' name, as well as the
properties with which they are traditionally known in Chile and worldwide at the cost of being
subjected to higher tax rates. Or they can obtain a more favourable tax treatment, but at the price of
losing both the product's name and the product's identity.
4.551 The European Communities further claims that that sacrifice is not required of the producers
of pisco. Indeed, pisco does not need to forfeit its name or suffer any alteration of its traditional
characters in order to benefit from the lowest tax rate and thus can "have it both ways".
4.552 According to the European Communities, already more than 90% of pisco is 35  or less and,
therefore, qualifies for the lowest tax rate. Mo reover, pisco producers could dilute the remaining
production to 35, without losing the right to use the name "pi sco". All they would lose is the right to
use the names "gran pisco" and "pisco reservado" . Those names enjoy less consumer recognition
than names such as "whisky" and have only a limited commercial value.
4.553 In the view of the European Communities, moreover, unlike in the case of whisky and the
other main types of imported spirits, a relativel y high alcohol content is not one of the essential
features that define the identity of pisco. To the contrary, traditional pisco is 30-35 (recall that pisco
of 30  to 35  is called precisely "tradicional"). Thus, consumers of pisco, unlike consumers of

264 See US Exhibit 1.

whisky, would be neither surprised nor disappointed by pisco diluted to 35 . Chile's argument to the
effect that sales of high strength pisco have grown rapidly over the last decade only serves to
underscore that high strength is not one of the traditional characteristics of pisco. The growth of high
strength pisco is the result of a relatively recent ma rketing strategy which could be easily reversed so
as to take advantage of the lowest tax rate.
4.554 Further, the European Communities maintains th at the positions taken by the pisco industry
during the process leading to the ad option of the New Chilean System confirms beyond any possible
doubt that, for the pisco industry, the "sacrifice" of gran pisco and pisco reservado is indeed a small
one, compared to the benefit they derive from the a pplication of a higher tax rate to whisky. As
explained below, the pisco industry petitioned the Chilean Parliament to increase the tax rate on
spirits of 40  (including pisco reservado) to 50% (instead of 45%, as proposed by the Government)
and the rate on spirits of 43  (including gran pisco ) to 73% (instead of 65%). Later on, the pisco
industry opposed an amendment of the Government proposal that would have lowered the rate on
both pisco reservado and gran pisco to 40-45% (instead of 50 % and 65 %, respectively, as proposed
originally by the Government).
4.555 In the view of the European Communities, th e truth of the matter is that the Chilean
Government does not really believe that dilution is a realistic option for the EC spirits producers. The
"dilution" argument is but an ex-post facto rationalisation. When estimating the impact on the level of
tax revenue of the New Chilean System, the experts of the Chilean Ministry of Finance assumed that
all whisky would continue to be sold at the same strength as before. Chile now describes that
assumption as "arbitrary". However, given that mainta ining the level of tax revenues is one of Chile's
paramount objectives, making that assumption would have been not only "arbitrary" but also
irresponsible.
4.556 Chile replies that as can be seen in the EC's own Table 8 above, the last stage of production
of distilled spirits of virtually every kind is to ad d water to achieve the desired alcohol strength. EC
producers have themselves produced lower alcohol versi ons of virtually all types of spirits sold in the
European Communities, and could do so again.
4.557 Chile notes that the European Communities and the intervening parties have objected that
they do not want to have to dilute their products further in order to qualify for a lower tax rate in Chile,
and that EC and Chilean regulations would precl ude marketing their products under certain type
names unless minimum alcohol strength requireme nts for those types are observed. Chilean
producers of Pisco Reservado and Gran Pisco have ma de the same objection. However, neither the
Chilean nor the EC regulations governing minimum al cohol contents for marketing distilled spirits
under particular type names are at issue in this Pa nel proceeding. Further, Article III does not require
WTO members to design their laws and regulations to accommodate the manner or name under which
foreign producers might prefer to market their pr oducts. The benefit of marketing under particular
type names such as Gran Pisco or whisky is sim ilar to the benefits from marketing under marks of
origin or trademarks. Article III does not re quire protection or accommodation of rights or
regulations, so long as the law does not impose discriminatory restrictions.
4.558 In the view of Chile, some producers also comp lain that dilution with water will affect the
taste of their products. However, most products ar e consumed diluted by the consumer. Producers of
the few products that are most often consumed undi luted (such as cognac or Gran Pisco), may decide
not to lower their alcohol content, but these products tend all to be taxed with one another at the
highest tax level in any case. In its support, Chile refers to Table 38 above.

(e) Position of Domestic Industry toward New Chilean System
4.559 The European Communities claims that the terms of Law 19,354 were negotiated and
agreed formally by the Government with the pisco industry and are largely responsive to the interests
and demands of that industry. As discussed belo w, those demands were by no means circumscribed
to the level of the taxes applied to pisco.
4.560 Chile replies that the European Communities devotes ma ny pages to an entirely irrelevant
description of past taxation of alcoholic beverages in Chile and an even longer and also irrelevant
purported "drafting history of Law 19,534," in wh ich the European Commun ities claims to know the
Chilean legislative process and even motivations of elected officials and industry groups. The
"drafting history" is particularly curious, in that the European Communities apparently intended to try
to establish protectionist motivations, but even the se lective and partial record to which the European
Communities refers includes ample demonstration th at the motivation of many legislators was to
remove discrimination and protectionism in the old system that the European Communities had
previously attacked.
4.561 In the view of Chile, in any event, the previ ous tax system of Chile and the motivations of
Chilean legislators and industries are not at issue in this dispute, nor are they relevant to the
interpretation of Article III:2.
4.562 The European Communities alleges that Law 19,534 was adopted in an attempt to address
longstanding complaints from the European Commun ities and other WTO members to the effect that
the ILA was contrary to GATT Article III:2. The European Communities had requested formal
consultations with Chile under GATT Article XXIII with respect to the ILA already in 1989.
265
Following the conclusion of the Uruguay Round, th e European Communities renewed its requests to
Chile to bring the ILA in conformity with its GA TT obligations. The EC complaints were expressly
mentioned in the message of the President of the Republic attached to the first of the Executive's
proposals for amending the ILA 266 and were extensively discussed dur ing the subsequent debate by
the Chilean Congress.
4.563 In the view of the European Communities, at first, the pisco industry and the representatives
of the zona pisquera in Congress were opposed to any modification of the ILA. Eventually, however,
even the pisco industry accepted that an amendment of the ILA was in evitable in order to avoid an
outright condemnation of Chile in the WTO. The Foreign Relations Minister Mr Insulza summed up
accurately the prevailing view in Chile when, fo llowing a meeting with representatives of the pisco
industry, he declared that "consensus exists that the current legislation is discriminatory and a change
must be made
267 ". Similarly, during the debate by Congress of Law 19,534, many legislators
(including the representatives of the zona pisquera ) admitted openly that a reform of the ILA was
necessary because the existing legislation was "discriminatory" and "favoured" the pisco industry.268
4.564 The European Communities then argues that although the pisco industry realised that it was
no longer possible to maintain the formal discrimin ation between pisco and other spirits, it had no
intention to renounce the protection which it had enjoyed for decades. Rather, according to the
European Communities, the objective of the pisco i ndustry was to perpetuate the tax differentials
between pisco and other spirits in a less conspic uous manner. The European Communities argues that
the process of amendment of the ILA was driven by the purpose to find a formula that, whilst being

265 Gatt doc. DS9/1.
266 Presidential Message No 78-332, 26 October 1995 (EC Exhibit 14).
268 See the Minutes of the debate by the Chamber of Deputies of 27 July 1997, EC Exhibit 16 and Las
Ultimas Noticias, 7 November 1996, EC Exhibit 37, and El Diario, 13 February 1997 (EC Exhibit 41).

ostensibly less inconsistent with GATT Article III:2, allowed Chile to preserve to the largest extent
possible the tax differentials between pisco and whisky.
4.565 The European Communities goes on to claim that in the course of that process, the Chilean
Executive submitted two formal proposals for amendi ng the ILA. The first proposal was tabled as
early as October 1995
269 (the "1995 Proposal"). That proposal was even more favourable to the
interests of the pisco industry than the amendment eventually adopted in November 1997. As shown
in Table 39, the 1995 proposal differed from Law 19,534 in three respects:
(i) the rate on spirits of 35 or less was 25 % instead of 27 %;
(ii) from that base, the rate in creased in increments of 5 percentage points per each
additional degree of alcohol content instead of 4 percentage points per degree;
(iii) the tax rate continued to increase until 42 instead of peaking at 39.

Table 39270
1995 Proposal for amending the ILA

Alcohol strength Tax rate ad valorem
Less or equal to 35 25 %
Less or equal to 36 30 %
Less or equal to 37 35 %
Less or equal to 38 40 %
Less or equal to 39 45 %
Less or equal to 40 50 %
Less or equal to 41 55 %
Less or equal to 42 60 %
Over 42 65 %

4.566 According to the European Communities, in addition, the 1995 Proposal differed from Law
19,534 in that it did not envisage any transitional period. Instead, the new tax rates would have
become applicable immediately after the entry into force of the amendment.

269 Presidential Message No. 78-332, 26 October 1995 (EC Exhibit 14).
270 EC First Submission, Table 8.

4.567 The European Communities argu es that the 1995 Proposal was strongly supported by the
pisco industry. That support was expressed at the hearing of interested parties hold by the Committee
on Foreign Relations of the Chamber of Deputies. On that occasion, the only request made by the
pisco industry was that, between 35  and 42, the tax rate should increase by 6 percentage points per
each additional degree of alcohol instead of by 5 percentage points.
271 Had this demand been
accepted, the applicable rate on pisco reservado would have been 55 % instead of 50 %, and the rate
on gran pisco 73 % instead of 65 %. According to the European Communities, this request shows
that Chile's pisco industry was more concerned by the reduction of the taxes applied to whisky than
by the increase of the taxes on high strength pisco.
4.568 The European Communities further argues that, significantly, the 1995 Proposal was
vigorously opposed by all the other interested par ties that expressed their opinion before the Foreign
Relations Committee. The opponents to the bill included not only the importers of spirits (represented
by the Asociación Nacional de Importadores ) but also the Sociedad de Fomento Fabril (the "SFF",
Chile's federation of industrialists) and the Asociación Gremial de Licoristas (a trade association of
liquor producers), as well as Chile Vid (the association of producers of fine export wines) and the
Asociación de Exportadores y Embotelladores de Vino (the association of exporters and bottlers of
wine).272
4.569 The European Communities further claims that according to the SFF, the 1995 Proposal was
still contrary to GATT Article III:2 because although it "eliminate[d] the explicit discrimination
against whisky … it replace[d] it by disguised discrimination". 273 Furthermore, both the SFF and the
Asociación Gremial de Licoristas noted that the 1995 Proposal would give pisco even a greater
advantage with respect to other spirits. 274 Similar views were expressed by the producers and
exporters of wine.275
4.570 According to the European Communities, the 1995 Proposal failed to attract sufficient support
within the Foreign Relations Committee due to its perceived incompatibility with Chile's WTO
obligations. According to the chairman of the Committee, Mr Renán Fuentealba, the 1995 Proposal:
… does not resolve the problem for Great Britain nor the WTO. We are not giving a
voluntary political signal of eliminating the [tax] discrimination and we are running
the risk that they will take us to a panel and we will lose.276
4.571 The European Communities goes on to argue that , confronted with the opposition of the
Foreign Relations Committee, the Government announced that it would present to Congress an
amendment ("indicación") to the 1995 Proposal providing for a la rger reduction of the tax differential
between pisco and whisky. According to press repor ts, the Government was envisaging to set the tax
rate on whisky of 40  in the range of 40 % to 45 %, instead of at 50 %, as provided by the 1995
Proposal.277

271 See the Report of the Committee on Foreign Rela tions, Inter Parliamentary Affairs and Latin
American Integration, Bulletin No L732-05, dated 6 August 1996 (hereafter, "Report of the Committee on
Foreign Relations"), p. 5. A translation into English is attached as EC Exhibit 17. See also Minutes, p. 16 (p. 2
of the English translation) (EC Exhibit 16).
272 Report of the Committee on Foreign Relations, pp. 5-7 (EC Exhibit 17).
273 SFF's submission to the Committee on Foreign Relations, p. 6 (EC Exhibit 18).
274 Ibid., p. 7. See also the Report of the Committee on Foreign Relations, p. 6 (EC Exhibit 17).
275 Ibid., pp. 6-7 (EC Exhibit 17).
277 El Diario, 23 de Julio 1996 (EC Exhibit 32).

4.572 The European Communities further contends that the pisco industry and the representatives in
Congress of the zona pisquera
278 staunchly resisted any such modification of the 1995 Proposal. In
order to pre-empt the Government from presenting the announced amendment, the opposition parties
forced a vote on the 1995 Proposal by the Foreign Relations Committee on 30 July 1996. This
strategy failed because the members of the governme ntal coalition voted against the Government's
own proposal.279
4.573 According to the European Communities, th e support of the pisco industry to the 1995
Proposal was reiterated at a seminar of pisco prod ucers organised by APICH (the national association
of pisco producers) in La Sere na in June 1996. Significantly, the seminar was entitled: "Pisco
industry: challenges and threats". According to pr ess reports, one of the main conclusions of that
seminar was that :
[T]he pisco producers … rejected any [m odification by the Government] to its
proposal to amend Article 42 of Decree Law No 825 now under the discussion, even
if that proposal is not totally satisfactory for the industry, [since such a modification]
could leave pisco in an even more disadvantageous position with respect to whisky.
280
According to the same reports, the seminar was attended by Mr A. Gutiérrez Ortega, Under-Secretary
of Agriculture.
4.574 The European Communities emphasizes that the reduction of the tax on whisky to 40%-45 %
envisaged by the Government would have benefited not only whisky, but also all other spirits over
39, including pisco reservado and gran pisco . The European Communities claims that the
opposition of the pisco industry to that reduction constitutes additional proof that its overriding
concern was to preserve a large tax differential betwee n whisky and a large majority of pisco, even if
that required "sacrificing" high strength pisco.
4.575 The European Communities also contends that , as soon as it became apparent that the 1995
Proposal would not be approved by Congress, the G overnment entered into negotiations with the
pisco industry to try and agree on a new proposal that was (or, at least, appeared to be) less plainly
inconsistent with Chile's obliga tions under the GATT. Those discussions led to the signature in
September 1996 of a "protocol" by representatives of the Chilean Government and of the pisco
industry. During the consultations with the European Communities, the Chilean Government
described the contents of that protocol in the following terms:
The so-called protocol contains the summi ng up of the consultations held with the
private sector as normally done in matters of public interest. It contains three distinct
parts: the first simply reflects the ac quiescence of the private sector with the
Government's proposal to send a bill to Congress with the tax scale and transition
period that later became law. The second and third part refer to other unrelated

278 See, e.g., the statements made by Representative Encina to La Epoca, 12 June 1996 (EC Exhibit
28); by Representative Pizarro to El Diario, 23 July 1996 (EC Exhibit 32) and El Mercurio, 24 July 1996 (EC
Exhibit 33); and by Representative Munizaga (of the opposition party Renovación Nacional) to Estrategia, 31
July 1996 (EC Exhibit (36).
279 See El Diario, 31 July 1996 (EC Exhibit 34); El Mercurio, 31 July 1996 (EC Exhibit 35); Estrategia,
31 July 1996 (EC Exhibit 36); and La Epoca, 31 July 1996 (EC Exhibit 37).

matters such as the agreement to initiate e fforts at promoting exports of pisco through
the governmental agency Pro - Chile.
281
4.576 The European Communities further argues that, despite its carefully chosen terms, this
statement constitutes a recognition that the sec ond proposal submitted by the Executive to Congress
had been previously agreed with the pisco industry and, therefore, reflected the interests of that
industry. According to the European Communities, the terms of that agreement were that in exchange
for its acceptance of a marginal in crease in the rate applied to pisco corriente and pisco especial and
of a greater reduction of the tax rate on whisky than had originally been proposed (from 70 % to 47 %,
instead of 50 %), the pisco industry would obtain financial "compensation" for the reduction of the
level of protection.
4.577 According to the European Communities, in a ddition, the pisco industry would benefit from a
long transitional period to adapt itself to the new situation. At the insistence of the pisco industry, that
transitional period would apply not only with respect to the increase of the taxes in pisco but also with
respect to the decrease of the taxes on whisky. The European Communities argues that this
demonstrates, once again, that it was the reduction of the taxes on whisky, and not the increase of the
taxes on pisco, which worried most the pisco industry.
4.578 The European Communities further claims that, following the signature of the protocol, the
Chilean Government appears to have had second th oughts with respect to the WTO compatibility of
the terms agreed with the pisco industry. Indeed, although the protocol was signed in September 1996,
the Chilean Government failed to act upon it for nearly one year, which caused considerable alarm
among the pisco producers.282
4.579 The European Communities argues that, following insistent calls by the pisco industry and the
representatives of regions III and IV in Congress 283, a new proposal embodying the terms of the
protocol was eventually presented by the Governme nt to Congress on 9 June 1997. This bill was
approved by the Chamber of Deputies on 30 September 1997, and by the Senate (without debate) on 4
November 1997.
4.580 According to the European Communities, the minut es of the Chamber of Deputies' debate on
17 July 1997284 provide an extensive record of the objectives pursued by its proponents, among whom
the representatives of regions III and IV figured very prominently. While declaring their support for
the amendment, the representatives of those regions emphasised its negative impact for the pisco
producers in their constituencies. The European Co mmunities argues that, in doing so they were led
to admit openly that pisco is directly competitive and substitutable with other distilled spirits (and in
particular with whisky) and that the ILA had been effective in providing protection to the pisco
industry.
4.581 The European Communities claims that the positio ns taken by the pisco industry during the
amendment process of the ILA show that its ov erriding concern was to preserve a large tax
differential between low strength pisco and whisky, even at the expense of increasing the tax on high
strength pisco. According to the European Comm unities, this concern would have been totally
irrational unless maintaining a tax differential between low strength pisco and whisky served to afford
protection to the pisco industry.

281 The European Communities notes that to the best of the EC's knowledge, the Chilean Government
did not sign similar "protocols" with an y other interested party of the "private sector", such as the importers of
whisky.
282 See El Mercurio, 10 April 1997 (EC Exhibit 45).
283 Ibid. See also Las Ultimas Noticias, 7 November 1996 (EC Exhibit 38); La Segunda, 12 February
1997 (EC Exhibit 41); and El Diario, 13 February 1997 (EC Exhibit 43).
284 Attached as EC Exhibit 16.

4.582 The European Communities goes on to state that the pisco industry requested that the 1995
Proposal be amended so that, between 35  and 42 , the tax rate increased by 6 percentage points per
each additional degree of alcohol instead of by 5 percentage points. This request would have
increased the rate on pisco reservado from 50 % to 55 % and the rate on gran pisco from 65 % to
73 %. The European Communities cl aims that, for the pisco industry it would have been senseless to
make such a demand unless it had been convinced th at increasing the tax on whisky would afford
additional protection to the pisco industry as a whole.
4.583 The European Communities further states that la ter in the legislative process, the pisco
industry opposed an amendment of the 1995 Proposal that would have lowered the tax rate on spirits
above 39  to 40-45 % (instead of 50 %). This amendment would have benefited not only whisky and
other imported spirits above 39 , but also pisco reservado and gran pisco. Again, according to the
European Communities, the pisco industry's position would have been irrational unless it was
premised on the conviction that, overall, a larger tax differential between low strength pisco and
whisky would afford additional protection to pisco, despite the "sacrifice" of high strength pisco.
4.584 The European Communities also cl aims that according to the official reports of the Foreign
Relations Committee of Chile's Chamber of Deputi es, Capel and Control submitted two requests to
that Chamber in the course of the parliamentary de bate of the New Chilean System. Specifically, the
Committee's reports read in relevant part as follows:
[Capel and Control] point out that in acco rdance with the wording of the draft, pisco
is withdrawn as a taxed substance since the draft refers to spirits, in which category
pisco is not included; the same holds for pisco which is excluded from the regulation
as a specific concept.
They propose that the rate should vary by 6 % for each degree in alcohol instead of
the 5 % proposed by the single article of the draft. They also suggest editorial
changes to avoid confusion arising from vagueness in concepts used.
285
4.585 In the view of the European Communities, in any event, a document provided by Chile in
response to questions deals exclusively with the first of the two requests above mentioned. The
reasons which led the pisco industry to demand an increase of the taxes on high strength pisco (the
second of the above mentioned requests) still await an explanation by Chile. According to the
European Communities, the only rational explanati on for such an unusual demand is that the pisco
industry was seeking to increase the tax differen tial between whisky and low strength pisco, which
accounts for the vast majority of pisco sales.
4.586 In rebuttal, Chile argues that such points argued by the European Communities are simply
an attempt to impugn the New Chilean System becau se, in Chile's democracy, a domestic industry
seeks to have the tax or trade system be as favorab le to it as possible, and the Chilean Government
tried to obtain an understanding of a domestic indus try that faced a wrenching change to the tax
system that had been in effect for many years.
4.587 In the view of Chile, in the same vein, th e European Communities devotes many pages listing
excerpts from Chile's legislative debate about the new taxation system. Some of these examples show
that legislative representatives of the regions that produce pisco in Chile were seeking to minimize the
adverse effects of a New Chilean System on pisco producers and, because adverse effects could not be
avoided, also sought other gove rnment help for their constituents . At least in the case of the
legislative history, the European Communities, while presenting a distorted picture, did note many
remarks from legislators who announced that the ne w system was eliminating discrimination against

285 See EC Exhibit 17, p.5.

foreign products. Chile submits that if such deve lopments infringe Article III or are even evidence of
such infringement, then all WTO Members are in deep peril, not least the European Communities.
4.588 Chile contends that the Memo No. 5886 was pr epared in connection with the first bill
submitted to Congress in November 1995, for amending the tax system on alcoholic beverages. As
the Panel and the European Communities are awar e, this bill was eventually replaced by the
Government and some time later an amendment bill was introduced which eventually became actual
Law No. 19.534. The memo is therefore completely irrelevant to this case. In addition, this Memo
was originally an internal document prepared by a lawyer of Cooperativa Control for his General
Manager, whereby he gives certain explanations abou t the system apparently used in the bill before
Congress for taxing different alcoholic beverages, a ccording to the definitions of the same contained
in several Chilean Regulations.
4.589 Chile argues that it appears worth pointing out to the Panel, that any motivation the industry
or other sectors in Chile may have had during the ra ther lengthy discussing process that eventually led
to the inacting of Law 19,534, are at this stage comp letely irrelevant. It has already been ruled in
GATT-WTO dispute settlement system, that panels should concentrate on the results and effects of
the prevailing governmental measure or piece of legi slation, and not on their possible aims. Such
rulings are perfectly appropriate and understandable, even more in a Civil Law system, where the text
of the law – particularly when it is crystal clear as in this case – will always prevail over any
interpretation.
4.590 Chile reiterates that the issue before this Pa nel is not the objectives of the Chilean pisco
industry (or those of the Scotch Whisky Association) . It is curious that the European Communities,
which laboured so hard in Japan – Taxes on Alcoholic Beverages II to discredit the "aims and effects"
test, now seems to want to revive the test for private industry. Chile has no doubt that private industry
associations want to do well by their private member s, and be seen to have been successful on behalf
of their members.
4.591 In the view of Chile, the issue is not the motive of the different private distillers of Chile or
Scotland; both doubtless would like to make as much money as possible. That is not surprising, nor
does it constitute a violation of the GATT. Howe ver, the issue before the Panel is whether the
European Communities has demonstr ated the three elements of a violation of Article III:2, second
sentence.
4.592 Chile indicates that the Appellate Body has already cautioned against this kind of subjective
effort to discern motivation. In Japan - Taxes on Alcoholic Beverages II , the Appellate Body stated
that the issue of "affording protection to dom estic production" is an objective question of effect, not a
subjective question of the intent of legislators.
286
4.593 Chile further argues that the European Commun ities likewise has not demonstrated that the
New Chilean System operates so as to afford protec tion to domestic production. It is true that the
result of the application of Chile's uniform, objective system of taxation may be that the majority of
domestic distilled spirits will be taxed at a relatively low tax rate and the majority of imports will be
taxed at a relatively high tax rate (if foreign pro ducers or importers choose not to adapt their products
in the simple manner required to benefit from the lo west tax category). However, that result does not
constitute a violation of Article III:2. As to the EC's claims that the New Chilean System is GATT –
illegal as evidenced by political stat ements and the ultimate acceptance of the pisco industry of the
need for this change in Chile's law, such "evide nce" has about the same value as a claim that the
European Communities must be violating its obligat ions because politicians claim to have done well
by domestic farmers or because EC farmers ceas e demonstrating after the European Communities

286 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., pp. 27-28.

makes a change in farm policy. Finally, Chile h as explained that there are multiple considerations
behind the legislation, including significantly minimizing the regressive effects of a flat tax rate.
4.594 Chile also claims that it, in an attempt to avoid a burdensome and costly dispute settlement
procedure and to address EU complaints, did not wait for a panel to decide on whether or not it ought
to modify its legislation regarding its tax regi me for alcoholic beverages. Chile after much
consideration adopted a new final regime that Chile believes both fully complies with the GATT 1994
rules and provides immediate commercial benefit to the European Communities.
4.595 According to Chile, the Chilean legislature promulgated Law No. 19.534 on taxes on
alcoholic beverages on 13 November 1997. This law provides a transitional period from 1997 to 2000
in order to permit a progressive and orderly change of the taxation regime applicable to alcoholic
beverages in Chile. However, under the Old Chil ean System whisky had been subject to a tax
significantly higher than any other distilled spirit, which was the primary complaint of the European
Union concerning the old law. To respond to those complaints, it was considered important to begin
immediate phased reductions of the tax on whisky.
4.596 Chile states that it is worth recalling that the European Communities originally challenged in
the WTO the Old Chilean System, which imposed tax es according to type of distilled spirits, with
pisco taxed at 25%, whisky at 70% and all other spirits at 30%. Chile believed – and still does believe
– that the old Chilean law was de fensible because pisco is not directly competitive or substitutable
with other distilled spirits in the Chilean market.
4.597 According to Chile, Chile amended its tax laws, in large part b ecause of the complaints of the
European Communities, especially in regard to wh isky. In addition, the decision of the Appellate
Body in the Japan – Taxes on Alcoholic Beverages II case suggested that, if the European
Communities were able to show that pisco is dir ectly competitive or substitutable with other distilled
spirits, then a tax system that differentiated by type was likely to be fo und inconsistent with
Article III:2.
4.598 In the view of Chile, pisco has not been s hown to be directly competitive or substitutable
with other distilled spirits. Nevertheless Chile enacted fundamental changes in this law.
4.599 Chile claims that in amending its laws, Chile had in mind several objectives, including:
(i) maintaining fiscal revenue;
(ii) eliminating type distinctions such as those that had existed in Japan (which also
would eliminate the alleged discrimination against whisky in the previous system);
(iii) discouraging alcohol consumption; and
(iv) minimizing the potential regressive aspects of reforming the tax system.
(f) Low Import Duty on Alcoholic Beverages
4.600 Chile claims that a second point worth noting is that Chile is not protecting its industry as the
European Communities claims. If that would have been the case Chile would have concentrated its
"protectionist battery" on the tariff rate. A truly e ffective protectionist approach would have been to
increase its applied tariff from 11 % up to 25 % (its own bound rate). Chile argues that it is moving in
an opposite direction than that suggested by the Eu ropean Communities: Chile is about to reducing its
tariff to an a-cross-the-board rate of 6% (certain ly including the most diverse spirits). Instead of
protecting its producers, Chile is liberalizing unilaterally.

4.601 According to Chile, products of some c ountries like Mexico and Canada, face no duty
because they have signed free trade agreement with Chile. The European Communities can also do
the same if they decide to accept its invitation to begin negotiations for a free trade agreement early
next year.
4.602 In rebuttal, the European Communities claims that this argument of Chile conceals the
fact that since the 1970s Chile has applied a single flat rate to imports of all products. This is
considered as one of the basic principles of Chile 's trade policy. If the Chilean authorities were to
make now an exception to that principle in favour of the pisco industry, it would be difficult for them
to resist similar requests from other domestic industries.
4.603 The European Communities further notes that, as noted by Chile itself, two of the main
producers of spirits (Mexico and Canada) have al ready concluded Free Trade Agreements ("FTAs")
with Chile, while the EC Commission has formally proposed to the EC Council the opening of
negotiations with Chile for the conclusion of an Association agreement comprising the establishment
of an FTA. Similarly, the US Executive has request ed fast-track authority to negotiate a FTA with
Chile. It is clear, therefore, that in the long term tariffs could not afford to Chile's pisco industry the
desired level of protection. In fact, the pers pective of concluding an FTA with the European
Communities was precisely one of the reasons invoked by the pisco industry during the process of
adoption of the New Chilean System in order to ju stify its request for limiting the reduction of the
taxes on whisky.
287
V. THIRD-PARTY ARGUMENTS
A. CANADA
1. Introduction
5.1 Canada indicates that it has a substantial interest in this dispute. According to Canada, Chile's
tax regime imposes a much higher tax burden on impor ted distilled spirits than that imposed on the
directly competitive or substitutable domestic distilled spirit, pisco. The taxes afford protection to the
domestic pisco industry by denying imported di stilled spirits, including Canadian whisky, the
competitive opportunities available to pisco. This h as an adverse impact on the ability of Canadian
distilled spirits to compete effectively with pisco ; this situation discourages efforts by Canadian
exporters, and thus serves to frustrate penetration of the Chilean market. Canada restates that it was a
complainant in the Japan - Taxes on Alcoholic Beverages II 288 case, and as a consequence, has an
active interest in the legal issues which arise from a very similar dispute.
5.2 Canada has reviewed the submissions of th e European Communities and Chile, and supports
the EC position in this proceeding.
2. Legal Arguments
5.3 Canada welcomed the outcome of the Japan – Taxes on Alcoholic Beverages II case and was
pleased with the principles set out by the Appellate Body for the interpretation and application of
Article III:2 of GATT 1994. Canada notes that the issues which arise in the context of the Chilean
liquor tax regime bear strong resemblance to matters which were under dispute in Japan – Taxes on
Alcoholic Beverages II 289, and accordingly, the panel's disposition of the present dispute should be

287 See EC Exhibit 30.
288Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra.
289Ibid., p. 27 [sic], in which the Appellate Body set out the issues:

guided by the principles established in the panel and Appellate Body Reports
290 in that case. These
principles were followed recently in a panel decision in another dispute, Korea - Taxes on Alcoholic
Beverages.291
(a) "directly competitive or substitutable"
5.4 Canada notes that the European Communities correctly points out that Article III:2, second
sentence, applies not only to products that are actua lly competitive or substitutable in a particular
market, but also to those that are potentially competitive or substitutable. 292 However, in Canada's
view this should not be a central issue in this dispute.
5.5 Canada believes that the Eur opean Communities has adduced c onclusive evidence of existing
competition between pisco and imported di stilled spirits in the Chilean market. 293 The reaction of the
pisco industry in Chile to proposed reductions in the taxes on whisky (and increases in taxes on pisco)
provides compelling evidence for the panel to deduce that there is direct competition between pisco
and imported distilled spirits.

 Unlike that of Article III:2, first senten ce, the language of Ar ticle III:2, second
sentence, specifically invokes Article III:1. The significance of this distinction lies in the fact
that whereas Article III:1 acts implicitly in addre ssing the two issues that must be considered
in applying the first sentence, it acts explicitly as an entirely separate issue that must be
addressed along with two other issues that are raised in applying the second sentence. Giving
full meaning to the text and to its context, three separate issues must be addressed to
determine whether an internal tax measure is inco nsistent with Article III:2, second sentence.
These three issues are whether:
(1) the imported products and the domestic products are "directly competitive or
substitutable products" which are in competition with each other;
(2) the directly competitive or substitutable imported and domestic products are "not
similarly taxed"; and
(3) the dissimilar taxation of the directly competitive or substitutable imported domestic
products is "applied ... so as to afford protection to domestic production".
 Canada notes that these are three separate issues. Each must be established separately by the
complainant for a panel to find that a tax measure imposed by a Member of the WTO is inconsistent
with Article III:2, second sentence.
290Panel Report on India - Patent Protection for Pharmaceutical and Agricultural Chemical Products ,
adopted on 2 September 1998, WT/DS79/R, para. 7.30, the panel indicated that panels:
….should give significant weight to both Article 3.2 of the DSU, which stresses the role of the
WTO dispute settlement system in providing se curity and predictability to the multilateral
trading system, and to the need to avoid inconsistent rulings.
291Panel Report on Korea - Taxes on Alcoholic Beverages, supra.
292Canada states that imported products that ma y only be potentially competitive with a domestic
product should not be categorically ex cluded from the scope of Article II I:2, second sentence. Otherwise,
internal regulatory regimes that favour domestic prod uction to such an extent that imported products are
effectively barred from entering the domestic market could be rendered beyond challenge.
293According to Canada, the products at issue share si milar physical characteristics, the same end-uses,
the same HS heading, the same sales outlets, and even share the same shelf space (see, for example, subsections
IV.D.3-6 of the EC's first written submission). There is also eviden ce of significant cross-price elasticity and
elasticity of substitution (see, for exam ple, subsection IV.D.7. of the EC's first written submission). Of course
the ultimate corroboration for this view is that both Chilean authorities an d the pisco industry have expressly
and implicitly recognized that pisco and other distilled spirits are directly competitive and substitutable (See, for
example, subsection IV.D.8 of the EC's first written submission).

5.6 With respect to potential competition, Canada notes that the Appellate Body in Japan – Taxes
on Alcoholic Beverages II held that GATT Article III:
[p]rotects potential competition ... of the equal competitive relationship between
imported and domestic products.
294
5.7 Also in connection with the issue of poten tial competition, Canada supports the arguments
made by the European Communities, and s ubmits that the reasoning of the panel in Korea - Taxes on
Alcoholic Beverages295 is compelling for the resolution of the present dispute.
5.8 Moreover, the imported products, such as Canadi an whisky, unquestionably fall within the
meaning of "substitutable" products. From Canada's perspective, it is particularly noteworthy that
Chilean whisky and pisco drinkers "each pref er the other spirit as a first alternative". 296 Thus, it is
submitted that the products at issue are both directly competitive and substitutable.
(b) "not similarly taxed"
5.9 In Canada's view, there is no doubt that pisco a nd the imported spirits are not similarly taxed.
The Panel should reject Chile's attempt to divert attention away from the fundamental question of
whether this particular measure in this particular set of circumstances constitutes dissimilar taxation.
All aspects of the measure, from its transitional phase through to its final form, involve more than a de
minimis differential in the taxation of directly competitive or substitutable products.
5.10 For example, under the transitional phase whisky is currently taxed at 65% ad valorem, while
pisco is taxed at only 25% ad valorem. Although the rate for whisky will be reduced over the next
few years, the lowest rate it will achieve during the transition phase is 53%, while pisco remains at
25%. It is indisputable that this constitutes dissimilar taxation.
5.11 Canada further argues that, even in its fina l form (i.e., the "New Chilean System") the
measure taxes the products dissimilarly. Chile app ears to take the position that the products are taxed
similarly because the differences in taxation correspond to differences in alcohol content. Such an
argument is untenable for several reasons. First, th e measure is not purely a tax on alcohol content.
The tax is calculated on the value of the beverage as a whole. Second, if it were purely a tax on
alcohol content one would expect a uniform rate pe r degree of alcohol. However, the rate per degree
of alcohol for pisco at 35 o is 0.771%, while whisky at 40 o is taxed at 1.175% per degree of alcohol, a
level which is 50% higher. Third, if it were purel y a tax on alcohol content one would not expect the
same rate of tax to be applied to beverages with different alcohol st rengths. However, the tax rate for
whisky at 40 o (47% ad valorem) is the same as that applicable to gran pisco at 50 o, despite the ten
degree difference in alcohol content.297
5.12 Canada states that in any event, the measure is a tax on the value of the beverage, not the
value of that which is purportedly being taxed - alc ohol content. Viewed from this perspective, the
tax of 47% of the value of a bottle of whisky at 40 o alcohol content, is dissimilar to the 27% ad
valorem tax on a directly competitive or substitutable bottle of pisco with 35o alcohol content.298

294Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 16.
295Panel Report on Korea - Taxes on Alcoholic Beverages, supra., paras. 10.47 - 10.50.
2961997 SM survey (referenced at para. 130, and EC Exhibit 21at page iv).
297The measure provides that the tax ra te applicable to spirits with an alcohol content over 39° is 47%.
See paragraph 52 and Table 5 of the EC's first written submission.
298Canada points out, that as noted by the EC (at paragraph 173 of EC First Submission), such a tax
differential is greater than de minimis.

5.13 In short, according to Canada, Chile is attemp ting to hide a discriminatory regime behind the
facade of a purportedly "objective" product differe nce. However, dissimilar taxation is evident
irrespective of whether the tax is viewed as tied to the value of the beverage, or to alcohol content. If
Chile's transitional and new tax regimes on spirits are accepted by the Panel, this would provide WTO
Members with a blueprint for circumventing thei r Article III:2 second sentence obligation simply by
establishing spurious product categories. The Chil ean regime is a thinly disguised discriminatory
measure that maintains the protection of the domestic pisco industry. If this regime were to be found
consistent with GATT Article III:2, other Members may be tempted to implement similar regimes in
order to protect domestic production, with the ulti mate effect that Article III could be seriously
undermined.
5.14 Canada concludes, that the Chilean argument th at there is no jurisprudence establishing that
taxes must be proportional, should not cloud the issue whether Chile's taxes are dissimilar. In
Canada's view, an examination of the taxation rate per degree of alcohol or of the taxation rate per
bottle, demonstrates that the taxes applicable to the majority of domestic pisco are not similar to the
taxes for the majority of the directly competitive or substitutable imported distilled spirits.
(c) "so as to afford protection"
5.15 Canada recognises that an ad valorem tax is not inherently inc onsistent with Article III:2,
second sentence. Rather, it is the manner in which Chile is applying this particular ad valorem tax
that is contrary to Article III:2, second sentence. As previous panels have found, and the Appellate
Body has affirmed:
Article III:2 does not prescribe the use of any specific method or system of
taxation. ... Since Article III:2 prohib ited only discriminatory or protective tax
burdens on imported products, what mattered w as, in the view of the Panel, whether
the application of the different taxation methods actually had a discriminatory or
protective effect against imported products.
299
5.16 Canada argues that several aspects of the desi gn, architecture and structure of Chile's tax
regime establish its protective application. First, the sheer magnitude of the tax rate differential in this
case is sufficient to establish that the measure is applied so as to afford protection to the domestic
pisco industry in Chile. Second, the measure's stru cture ensures that the vast majority of Chile's
production of distilled spirits (primarily pisco) will con tinue to be eligible for the lowest possible tax
rate (27%), while almost all imported distilled spirits will continue to be taxed at the highest rate
(47%). Protection for pisco is further ensured by legislation requiring certain imported distilled spirits
(notably those that appear to be most competitive with and substitutable for pisco, such as whisky) to
have a minimum alcohol strength of 40 o. As applied, the tax rates would create a wide, protective
buffer zone for domestic pisco in relation to imported distilled spirits.
5.17 Canada argues that the combination of these and the other factors identified by the European
Communities is to deny imported distilled spirits the competitive opportunities available to Chilean
pisco. Canada notes that, similar to the situation in Japan – Taxes on Alcoholic Beverages II ,300 the

299Appellate Body Report on Japan - Taxes on Alcoholic Beverages II , supra., p. 32 [ sic], citing the
Panel Report on Japan – Taxes on Alcoholic Beverages I, supra., para. 5.9 c).
300 Ibid., p. 34 [sic], where the Appellate Body, in discussing the protective application of the measure,
quotes paragraph 6.35 of the Panel Report as follows:
[W]e conclude that [the panel] reasoned correctly that in this case, th e Liquor Tax Law is not
in compliance with Article III:2. As the Panel did, we note that:

[t]he combination of customs du ties 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

Chilean measure fails to guarantee equality of competitive conditions between the imported and
domestic products, and makes it difficult for imported distilled spirits to penetrate the Chilean market.
In effect, it "isolates" pisco from foreign competition by imported distilled spirits.
5.18 Canada notes, that while the European Comm unities correctly challenges the absence of a
legitimate policy purpose, it is important that its assertion not be interpreted to suggest that the
existence of such a purpose would make the regime consistent with Article III:2. The fact that a
measure may have a non-protectionist policy objectiv e does not make that measure consistent with
Article III:2, second sentence.
301 As noted by the Appellate Body in Japan – Taxes on Alcoholic
Beverages II :
If the measure is applied to imported or dom estic products so as to afford protection
to domestic production, then it does not matter that there may not have been any
desire to engage in protectionism in the minds of the legislators or the regulators who
imposed the measure. It is irrelevant that protectionism was not an intended objective
if the particular tax measure in question is nevertheless, to echo Article III:1, "applied
to imported or domestic products so as to afford protection to domestic
production".302
5.19 Canada further notes that it is equally important to remember that the Appellate Body has
made it clear that it is not necessary to provide eviden ce of protectionist intent in order to prove that a
measure affords protection to domestic production.303 However, this does not mean that the statements
of Chilean officials and the Chilean pisco industry ar e irrelevant. Their statements regarding the need
and means to protect the pisco industry help to confirm the protective design, architecture and
structure of the measure.
5.20 Canada argues that, in any event, claims a bout the protection of public health are not
supported by the facts. Such claims can only be viewed as ex post facto justification, in the light of
statements by Chilean officials and pisco industry re presentatives, to the e ffect that the taxation
regime is designed to protect the pisco industry from competition by imported distilled spirits.
5.21 Canada stresses that Chile cannot justify the di ssimilar taxes on the basi s that certain Chilean
products may be subject to the higher tax rates, wh ile certain imported products may benefit from the
lower tax rates. There is nothing in Article III: 2, nor any of the GATT or WTO panel or Appellate
Body reports, that can be used to justify a taxati on measure that benefits the majority of a domestic
industry's production, and places the majority of the di rectly competitive or substitutable products at a
competitive disadvantage to the domestic products. To the contrary, following the reasoning of the
Appellate Body in the Japan – Taxes on Alcoholic Beverages II case, if there is dissimilar taxation of

market and, on the other, it does not gua rantee 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 ...
301 Canada notes that if a WTO Member wants to ma intain a measure that is inconsistent with
Article III:2, it must meet the conditions set out in GATT Article XX.
302Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p. 31 [sic].
303In Japan - Taxes on Alcoholic Beverages II, supra. , p. 31), in describing what must be shown in
order to establish that a tax is "protective", the Appellate Body stated:
This is not an issue of intent. It is not nece ssary for a panel to sort through the many reasons
legislators and regulators often have for what they do and weigh the relative significance of
those reasons to establish legislative or regulatory intent.

some imported products in comparison with direc tly competitive or substitutable domestic products,
this is sufficient to meet the test of "not similarly taxed".
304
5.22 Canada concludes that Chile misconstru es the concept of equality of competitive
opportunities, by suggesting that foreign producers can adapt their production to benefit from lower
taxes. In Canada's view, the converse is true, i.e. if foreign producers must adapt their production and
thereby lose the value of their product name in or der to benefit from the lower tax, their imported
products would be at a competitive disadvantage to th e vast majority of pisco, which would not have
to meet these burdens.
B. MEXICO
1. Introduction
5.23 Mexico does not agree with Chile that the Transitio nal System is not at issue in this dispute.
On the contrary, Mexico considers that since the system has been in corporated into the transitional
period, it corresponds to "the matter referred to th e DSB", and that the Panel must determine whether
the two systems i.e. the Transitional and New Chilean Systems are inconsistent with Article III.2 of
the GATT 1994.
5.24 As mentioned by the European communities in th eir submission, the products at issue are, on
the one hand, pisco, and, on the other hand, all th e other distilled spirits falling within the heading
HS 22:08 of the Harmonized System (HS) nomenclature. The European Communities provided an
illustrative list of these products, expressly including tequila.
5.25 Mexico insists that tequila and pisco are "like products" in the sense of Article III.2, first
sentence, of the GATT 1994, but is merely requesti ng the Panel to find that tequila and pisco are
directly competitive or substitutable products 305 in the sense of Article III. 2, second sentence, of the
GATT 1994.
5.26 In this connection, Mexico agrees with the par ties to the dispute in their endorsement of the
conclusions of the Appellate Body in Japan – Taxes on Alcoholic Beverages II 306 according to which
the following rules must be applied to determine th e inconsistency of an internal tax measure with
Article III.2, second sentence:
(i) The imported products and the domestic products must be "directly competitive or
substitutable products" which are in competition with each other;
(ii) the directly competitive or substitutable im ported and domestic products must not be
"similarly taxed"; and

 304Ibid., p. 27. Moreover, it is noteworthy that in United States - Section 337, the panel found:
... that the "no less favourable" treatment requirement of Article III:4 has to be understood as
applicable to each individual case of imported products. The Panel rejected any notion of
balancing more favourable treatment of some imported products against less favourable
treatment of other imported products.
Panel Report on United States – Section 337, supra., para. 5.14.
305 Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.38, agrees with the
statement by the Appellate Body in Japan – Taxes on Alcoholic Beverages II, supra., that the category of
"directly competitive or substitutable products" is broad.
306Appellate Body Report Japan - Taxes on Alcoholic Beverages II, supra., p. 24.

(iii) the dissimilar taxation of the directly competitive or substitutable imported and
domestic products must be applied "… so as to afford protection to domestic
production".
2. Legal Arguments
(a) "directly competitive or substitutable"
5.27 In order to determine which products belong to this category, the following criteria should be
applied
307:
(i) Physical characteristics;
(ii) common end-uses;
(iii) tariff classification;
(iv) the "market-place".
(i) Physical Characteristics
5.28 Mexico disagrees with Chile's assertion that th e products under consider ation have virtually
no characteristics in common. The two charact eristics mentioned in the Panel Report on Korea –
Taxes on Alcoholic Beverages 308 are fully applicable to the comp arison between pisco and tequila as
well: they are both distilled spirits, bottled and labelled in a similar manner.
5.29 Mexico notes that the Panel Report on Japan – Taxes on Alcoholic Beverages II states that the
physical characteristics are not the decisive cr iterion for determining whether products are
competitive or substitutable. 309 However, Mexico agrees with the European Communities when it
asserts that "if two products have sufficiently simila r physical characteristics, such similarity may of
itself be sufficient to conclude that the products in question are apt to serve for the same end-uses".310
(ii) End-uses
5.30 Mexico notes that the European Communities, in their submission, refers to the findings of
the Panel in Japan – Taxes on Alcoholic Beverages II according to which the end-uses are the
"decisive criterion" for establishing whether two products are directly competitive or substitutable.
5.31 Mexico further notes that the 1997 SM Survey 311 shows that tequila and pisco have the same
end-uses in at least the following respects:
(i) drinking styles: both spirits are most likely to be consumed with a mixer beverage
(such as cola);
(ii) drinking occasions: Chilean consumers of spirits considered "parties", "with friends",
"family meetings" and "weekends" to be the most common occasions for the

307These criteria were established by the panel and adopted by the Appellate Body in Japan - Taxes on
Alcoholic Beverages II , supra., p. 25.
308Panel Report on Korea – Taxes on Alcoholic Beverages, para. 10.67.
309Panel Report on Japan – Taxes on Alcoholic Beverages II, para. 6.22.
310See EC First submission, para. 109.
311 See EC Exhibit 21.

consumption of pisco or tequila, while the cat egories "after work", "aperitif", "during
week" and "digestive" were considered less common;
(iii) drinking places: both spirits are mainly consumed "at home" or at a "friend's house";
(iv) availability in sales channels: the most common sales channels for both beverages
are "supermarkets" and "liquor stores", while "gift shops", "duty-free", "others" and
"airlines" are uncommon as sales channels in both cases; and
(v) types of consumers: in the Chilean mark et, women tend to drink more pisco and/or
tequila than men.
5.32 Furthermore, the recipe brochures mentioned by the European Communities
312 suggest that
the producers of pisco themselves perceive pisco and tequila as products with a common final use, i.e.
the preparation of "margaritas".
(iii) Tariff Classification
5.33 Mexico notes that both beverages come under HS subheading 2208.90, i.e. they are at the
same six-digit level, which is the Harmonized System 's most advanced and specific classification. In
Mexico's view, it is also worth noting that the Appellate Body in Japan – Taxes on Alcoholic
Beverages II pointed out that if "sufficiently detailed, tariff classification can be a helpful sign of
product similarity".313
5.34 Regarding the mutual substitutability of tequila and pisco in the Chilean market, Mexico
refers to the EC's Exhibit 22, Table 4.1.2, whic h purportedly shows that 17 per cent of consumers of
Chilean spirits would buy tequila if they intended to buy pisco and did not find it, while 56 per cent
would buy pisco if they could not find tequila.
5.35 As regards cross-price elasticity, the anal ysis submitted by the European Communities 314
shows a 44.8 per cent change in response to a 27 per cent tax on all spirits instead of the tax currently
applied. The table shows a considerable price elasticity.
(iv) Recognition of Government of Chile
5.36 Mexico points out that in add ition to the evidence presented by Mexico, it should be noted
that Chile implicitly accepted that pisco and the ot her spirits at issue in this case are directly
competitive or substitutable. More specifically, Chile states that the examples provided by the
European Communities concerning the background to the new law "show that legislative
representatives of the regions that produce pisco in Chile were seeking to minimize the adverse effects
of a New Chilean System on pisco producers and, because adverse effects could not be avoided, also
sought other government he lp for their constituents". 315 Mexico asks rhetorically, what adverse
effects would the new system have if the products were not "directly competitive or substitutable"?

312See EC First submission, para. 140.
313Appellate Body Report on Japan – Taxes on Alcoholic Beverages II , supra., p. 21. Various panels
shared that opinion, such as EEC – Measures on Animal Feed Proteins, supra., Japan – Taxes on Alcoholic
Beverages I, supra., and United States – Standards for Reformulated and Conventional Gasoline, supra.
314See Table 4.2.2, EC Exhibit 22.
315See Chile First submission, para. 71.

(b) "not similarly taxed"
5.37 As can be seen in Table I of Mexico's submis sion, the tax differentials show a margin of
discrimination of 120 per cent and 174.4 per cent be tween pisco and tequila under the "Old Chilean
System" and the "New Chilean System" respectively.
5.38 Moreover, Mexico agrees with the panel and the Appellate Body in Japan – Taxes on
Alcoholic Beverages II when they argue that the amount of differential taxation must be more than de
minimis, as determined on a case-by-case basis.
316 In the case at issue, the differentials in the rate of
taxation suffice to establish that they are in excess of any de minimis criterion.
(c) "so as to afford protection"
5.39 Mexico notes that the panel in Korea – Taxes on Alcoholic Beverages 317 endorses the
conclusion of the Appellate Body in Japan – Taxes on Alcoholic Beverages II, focussing on the
objective factors underlying the tax measure in que stion including its design, architecture and the
revealing structure.
5.40 In the case at issue, the following elements show that Chile imposed its tax scheme in order to
afford protection to its domestic industry:
(i) the amount of the differential taxation (see Table I);
(ii) the structure of the Chilean tax system;
(iii) the fact that the great majority of dis tilled spirits produced on the Chilean market
have an alcohol strength of 35° or less;
(iv) the fact that most imported distilled spirits have an alcohol strength of more than 35°
and, in many cases, more than 39°.
5.41 Mexico notes that as regards design, architectur e and the revealing structure of the measure,
Chile accepted that its new system was "biased" ag ainst relatively higher alcohol products. Chile
denied however, that this was a means of affording protection to domestic production 318 on the
grounds that the producers of other spirits could benefit from the system by diluting their products
with water or switching their exports to beverages benefiting from a lower level of taxation.319
5.42 According to Mexico, Chile's proposals are obviously not only unworkable, but also
irrelevant. The product that Mexico is interested in exporting to Chile is tequila. Apart from the fact
that under Chilean law, tequila must have a minimum alcohol strength of 40° 320, and that it must
comply with the corresponding Mexican Official Standard to be marketed under that name, it is
obvious that the consumer of tequila wants tequila and not water. Mexico points out that if its
intention had been to export spir its with a strength of 35° or less, it would not have bothered to
participate as a third-party in this dispute. In Mexico's view, these arguments by Chile simply
confirm that the protection afforded to national produ ction is so high that the only way of competing

316Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 27. This same
argument was used by the Panel in Korea – Taxes on Alcoholic Beverages, supra., para. 10.100.
317Panel Report on Korea – Taxes on Alcoholic Beverages, para. 10.101.
318Chile First submission, para. 68.
319Ibid., para. 73.
320See Article 12 of the Regulation Implementing Law No. 18455, published in the Official Journal of
23 October 1986 and appearing as Appendix 2.2 of EC Exhibit 12.

on an equal footing with Chilean beverages would be to change the quality of the imported products
or the products themselves.
5.43 Mexico further notes that Chile agrees with the European Communities that in its system,
different levels of alcohol stre ngth are taxed differently, but argues that Article III:2 of the GATT
1994 has never been interpreted to require a direct pr oportionality rule. It points out that the Panel in
Japan – Taxes on Alcoholic Beverages I , only suggested that taxation must be based on objective
criteria. The Chilean system of taxation is not, nor can it be considered to be, based on "objective
criteria". Chile gives no satisfactory explanation of how a margin of discrimination of 174.07 per
cent
321 applied to the difference of little more than 4° in alcohol strength under the Chilean tax
structure (between 35° and 39°) can be seen as bei ng based on "objective criteria". Mexico is not
challenging the fact that the Chilean tax varies according to the alcohol strength of the beverages: it is
challenging the way in which that tax is applied. Mexico further argues that, the purpose and effect of
the Chilean system is to protect national production against imports of products that are directly
competitive with or substitutable for Chilean beverages.
5.44 Mexico argues that in considering the fact that the national production of spirits in Chile is
dominated by pisco with an alcohol strength of 35° or less, it is interesting to refer to Table II below.
Mexico points out this table was prepared on the b asis of Table 8 which forms part of Annex III of
Chile's written submission, and shows, in terms of volume, the share of pisco with a strength of 30°
and 35° in the Chilean market. Moreover, acco rding to the European Communities, with the
exception of 1992, the share of pisco in the Chilean spirits market grew constantly from 44.1 per cent
in 1982 to 73.8 per cent in 1996.
5.45 Mexico notes that Chile, in its own written submission, 322 reveals the substantial share of
imports of spirits with a strength of 40° or more in the Chilean market. It should be observed that
tequila is not expressly mentioned 323, so that the percentage shares are in fact higher than those
shown.324
5.46 Mexico further notes that according to the Eu ropean Communities, imports of whisky and
tequila (the two most popular beverages after pisco) account for 93.6 per cent and 100 per cent
respectively of the Chilean market for those spirits. 325 It is curious that under the New Chilean
System, these two products are taxed the most heav ily; and, the tax applied to tequila will now
increase from 30 per cent to 47 per cent. This in itself should be sufficient evidence that the Chilean
system is designed to protect domestic production.
5.47 Mexico concludes that it has proved that the Ch ilean tax system is contrary to the provisions
of Article III.2, second sentence, of the GATT 1994, and therefore requests that the Panel:
(a) find that the Chilean system for the taxati on of spirits violates the second sentence of
Article III.2 of the GATT 1994 in order to help the DSB in making the
recommendations or issuing the resolutions provided for under the GATT 1994;
(b) find that the measure at issue nullifies or impairs benefits under the GATT 1994 by
favouring pisco in a manner contrary to that Agreement.

321 See Table I.
322Ibid., Annex III, Tables 1-7.
323 The table provided by Chile only mentions the following spirits as having a strength of 40° or more:
whisky, rum and other white spirits, gin and geneva, and, for 1996 and 1997, vodka as well.
324 See Table III.
325Tables 9.A and 9.B of EC First submission, p. 36

Table I
Margins of Discrimination

 Pisco Tequila Margin of
discrimination
Tax applied under the
"old system"
25% 30% 120%
Tax applied under the
"new system"
27% 47% 174.07%

Table II

Share of Pisco with a Strength of 35° or Less in the Chilean Spirits Market

 1991 1992 1993 1994 1995
Pisco 30° 64.51% 60.50% 52.29% 41.57% 33.53%
Pisco 35° 5.27% 8.45% 17.56% 26.69% 35.57%
Total of the
two piscos
69.78% 68.95% 69.85% 68.26% 69.10%

Table III

Market Share of Spirits with a Minimum Strength of 40°

 1991 1992 1993 1994 1995 1996 1997
Volume 82.65% 81.31% 76.37% 66.81% 60.00% 50.83% 54.37%
Value 86.57% 84.69% 79.38% 78.02% 71.09% 59.5% 59.63%

C. P
ERU
5.48 Peru briefly stated that it considers that the Ch ilean system of taxation of alcoholic beverages
is discriminatory, contrary to Article III:2 of GATT 1994, and causes harm to Peruvian exports of
alcoholic beverages to Chile.
5.49 Peru also referred to an issue it has raised in two DSB meetings, regarding the propriety of the
use of the term pisco by Chile. 326 Peru stated that it was an exporter of pisco to Chile and since the
Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS) would only enter into
force in Chile and Peru in the year 2000, Peru wished to reserve its rights to invoke Article 22.1 of the
TRIPS Agreement and other provisions related ther eto. Peru considered that the geographical
indication "Pisco" was Peruvian and as such gave Peru exclusive rights.

326 Peru has previously expressed its position at two DSB meetings on 18 November 1997, and
25 March 1998 (see WT/DSB/M38 & WT/DSB/M/44).

D. U
NITED STATES
1. Introduction
5.50 The United States asserts that Latin America is a key growth market for its distilled spirits
producers, who have undertaken significant efforts to promote U.S. products in the region. U.S.
exports of distilled spirits to Peru and Venezuel a have grown by 52% and 116% respectively over the
past two years, following the elimination of discriminatory measures. 327 However, despite significant
economic growth in Chile, U.S. distilled spirits exports have not witnessed similar growth, due to
Chile's history of discriminatory taxation.
5.51 The United States further asserts that in 1996, it exported approximately $1.1 million in
distilled spirits to Chile.328 Whiskey, which includes Bourbon and Tennessee whiskey, two distinctive
types of American whiskies produced from fermente d grains, accounted for 29.7% of the total U.S.
exports of the distilled spirits at issue in this dispute. 329 Other traditional spirits at issue are rum, gin
and vodka, which accounted for 61.4% of these exports. The remaining 9% of U.S. exports to Chile
include liqueurs (3.3%) and pre-mixed cocktails.330
5.52 The facts developed by the European Communitie s conform to the experience of the U.S.
exporting industry. Chile’s measures at issue cons ist of two elements: (1) the current Transitional
System, which applies different tax rates for par ticular product categories, and (2) the New Chilean
System, which will tax on the basis of alcohol c ontent (through Law 19.534, an amendment to its
Decree-Law 825/1974).
5.53 As a legal matter, the United States considers that:
(i) The Transitional System on distilled spirits , applicable until 30 November 2000, is
inconsistent with the second sentence of Article III:2 of GATT 1994 because it
provides for lower internal taxes on the domestic spirit "pisco" than on directly
competitive or substitutable imported spirits falling into the tax categories of
"whisky" and "other spirits", and is applie d so as to afford protection to Chile's
domestic production of pisco; and
(ii) The New Chilean System on distilled spirits , applicable as of 1 December 2000, is
inconsistent with the second sentence of Article III:2 of GATT 1994 because it results
in the imposition of lower taxes on domestic spirits with an alcohol content of 35
degrees or less than on directly competitive or substitutable imported spirits that have
a higher alcohol content, and is applied so as to afford protection to Chile's domestic
production.

327 According to the United States, in June 1993 Peru replaced its discriminatory selective consumption
tax (10% for pisco and 50% for other spirits) with a single ad valorem tax of 10%. Similarly, Venezuela
presently assesses a rate of Bs.10 per liter for all alcoholic beverages.
328 See U.S. Exhibit 1, the 1996 data on U.S. distilled spirits exports to Chile (by class). The 1996 data
are the most recent and most complete available.
329 See 27 CFR Sec. 5.21.
330 The United States notes that the majority of the 5.7% of the "other" category in U.S. Exhibit 1
consists of ethyl alcohol, a product used for industrial purposes and as a primary input for the production of
other distilled spirits; ethyl alcohol is not at issue in this dispute. A de minimis portion of the "other" category
includes pre-mixed cocktails.

2. Legal Arguments
(a) General
5.54 As the European Communities notes in its submis sion, the Appellate Body has clarified the
interpretation of Article III:2, second sentence in Japan - Taxes on Alcoholic Beverages II . The
Appellate Body stated that in order to find an internal tax measure inconsistent with the second
sentence of Article III:2, three separate elements must be satisfied:
(i) the imported products and the domestic prod ucts must be "directly competitive or
substitutable products" which are in competition with each other;
(ii) the directly competitive or substitutable imported and domestic products must be "not
similarly taxed"; and
(iii) the dissimilar taxation of the directly co mpetitive or substitutable imported domestic
products must be "applied ... so as to a fford protection to domestic production",
331
which requires an examination of "the underlying criteria used in a particular tax
measure, its structure, and its overall application..."
332 These underlying criteria
include the "design, the architecture, and th e revealing structure of a measure", the
"magnitude of the dissimilar taxation", and "a ll the relevant facts and all the relevant
circumstances in any given case".333
5.55 The United States notes that, with respect to th e first element -- whether two products are
"directly competitive or substitutable" -- the Eu ropean Communities argues convincingly that all
types of pisco, regardless of alcohol content, are the same product; that pisco and all other distilled
spirits share the same basic physical characteristics; that pisco and all other distilled spirits have the
same end-uses; that pisco and all other distilled spirits fall within the same HS heading, HS 22.08; that
pisco and all other distilled spirits are sold in the same sales channels; and that there is significant
cross-price elasticity between pisco and the all other distilled spirits. In fact, the European
Communities establishes that not only is there a close competitive relationship between imported
spirits and domestic pisco, but that all distilled spirits at issue are directly competitive or substitutable
with each other.
5.56 According to the United States, there is also ample evidence that both the Transitional System
and the New Chilean System involve dissimilar tax treatment as between domestic and imported
products, and afford protection to domestic production.
(b) Old Chilean System: Background
5.57 The United States argues that an examination of the tax system immediately preceding the
present Transitional System helps to show the prot ective structure of both the present regime and the
regime to take effect in the year 2000. The EC ’s account of the debate in the Chilean government
concerning the Old Chilean System and the process of adopting the Transitional System and the New
Chilean System demonstrates that protectionist forces prevailed in their effort to ensure that the new

331 Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra. The three elements
approach was most recently us ed in the Panel Report on Korea - Taxes on Alcoholic Beverages , supra, paras.
10.34-10.102.
332 Ibid., p. 29.
333 Ibid., p. 29.

systems would create the same protective effect as th e Old Chilean System they were introduced to
replace.
334
5.58 The "Old" Chilean System, established by D ecree-Law 825/1974, was in effect from June
1979 to 30 November 1997. It explicitly classified all distilled spirits into three particular product
categories: pisco, whisky, and "other spirits". Prior to its termination it applied an ad valorem tax rate
of 25% to pisco, 70% to whisky, and 30% to all other spirits.335
5.59 According to the United States, the Old Chilean System taxed imports and domestic products
in a dissimilar fashion, thus satisfying the second element of the Appellate Body’s approach to the
second sentence of Article III:2. The magnitude of the difference between the rates for whisky and
pisco speaks for itself; the 5% differential in the ta x rates applied to pisco and other imported distilled
spirits is also beyond de minimis. Given the tight competition between distilled spirits, for example
those that are used with mixers (e.g., pisco and Pu erto Rican rum), even a small variation in price
such as a 5% difference in taxation can sufficiently skew purchasing decisions.
5.60 Turning to the third element of the Appellate B ody’s analysis, that of protective application,
the United States argues that because pisco has a 73.8% share of the Chilean distilled spirits market as
of 1996,336 the higher relative taxes on all other distilled sp irits could be expected to afford protection
to pisco. Furthermore, all pisco is by definiti on domestic. According to Chilean Law No. 18,455/85
and Law-Decree 78/1986, "pisco" is a protected geogr aphical indication that can only be used for
Chilean-made pisco. Therefore, the dissimilar taxa tion of the Old Chilean System was applied so as
to afford protection to domestic production.

5.61 The United States argues that the Old Chilean System resulted in the taxation of 89.1% of all
domestic spirits at the lowest rate, 10.6% of all domestic spirits at the median rate, and a mere 0.3% of
all domestic spirits at the highest rate. In turn, the Old Chilean System taxed 53.8% of all imported

334 See EC First Submission, paras. 61-78.
335 Throughout the existence of Decr ee-Law 825/1974, the tax rates for whisky and for other distilled
spirits fluctuated repeatedly; however, the tax rate for pisco remained steady at 25%.
336 See Table 9A in EC First Submission.

spirits at the highest rate, 46.2% of all imported sp irits at the median rate, and no imported spirits at
the lowest rate.
337
5.62 The highest tax rate, applied almost exclusively to imports, was 180% greater than the lowest
rate. In the Japan – Taxes on Alcoholic Beverages II and Korea – Taxes on Alcoholic Beverages
cases, the differences in the arb itrary rates and their relative effects on imports and domestic products
were themselves evidence of a protective structur e; in the case of the Old Chilean System, the
structure was also arbitrary in that it established different tax rates for the three product categories,
with no discernible rationale.
(c) Transitional System
5.63 The United States notes that the present tax system is a transition from the old to the new one.
Established by Law 19,534, it will remain in place until 30 November 2000. Even Chilean
government officials recognized the discriminatory nature of the Old Chilean System, and the features
duplicated in the transitional regime permit a similar conclusion with respect to this substitute.
5.64 According to the United States, an examination of the Transitional System reveals that pisco
and directly competitive or substitutable imported dis tilled spirits are also not “similarly taxed”. The
Transitional System maintains the same, distinct product categories as the Old Chilean System for
pisco, whisky and other spirits. And although the Tr ansitional System reduces the tax rate for whisky
from 70% to 53% over a span of three years, the tax discrimination remains, since whisky is still
taxed much more than pisco (25%) and other spirits (30%).

5.65 With respect to the third element of the analysis, the Transitional System's design,
architecture and structure reveals a measure that again taxes 89.1% of all domestic spirits at the lowest
rate, 10.6% of all domestic spirits at the median rate , and a mere 0.3% of all domestic spirits at the
highest rate. Similarly, it taxes 53.8% of all importe d spirits at the highest rate, 46.2% of all imported
spirits at the median rate, and no imported spirits at the lowest rate. In fact, the only difference

337 See Graph 1. To calculate the Chilean market shares of domestic and imported products in each tax
regime (Graphs 1, 2 and 3), the United States utilises the 1996 sales data from the ISWR report, as provided in
EC Exhibit 19, and Tables 1, 9A and 9B of EC First Submission. The 1996 data are the most recent and most
complete available. Furthermore, the submission excl udes from these calculations the "other" spirits category
from the ISWR report, because the report is silent as to the identity and the alcohol c ontent of the vast majority
of these spirits. See EC Exhibit 19, p. 97. (Also, see U.S. Exhibit 2 for details of these calculations).

between the Old Chilean System and the Transitional System is the magnitude of the dissimilar
taxation: While the medium tax rate remains 20% greater than the lowest tax rate, the highest tax rate
is reduced from 180% greater than the lowest rate to 112% greater than the lowest rate. Yet despite
this reduction, the tax differential remains grossly disproportional. As with the Old Chilean System,
the application of taxes based solely on the iden tification of directly competitive or substitutable
products, the fact that the protected product is ex clusively domestic, and the magnitude of the tax
differentials between imports and domestic products, together establish a protective structure.
(d) New Chilean System
5.66 The United States notes that the New Chilean System, also established by Law 19,534, is
scheduled to take effect on 1 December 2000. While th is regime is not yet in effect, it is nevertheless
the proper subject of these proceedings as it is a manda tory measure the details of which have already
been determined.
338
5.67 The New Tax System will differ from the Old an d Transitional Systems in that it will tax on
the basis of alcohol content. Distilled spirits with an alcohol content of 35 degrees or less will be
taxed at 27% ad valorem. Yet for distilled spirits with an alcohol content of over 35 degrees, the rate
will escalate in 4 percent increments for each additiona l degree of alcohol, topping off at the 47% rate
for spirits bottled at over 39 degrees alcohol content.
5.68 The United States notes that the EC submission demonstrates that despite eliminating the
explicit product categories found in the two previous regimes, the New Chilean System will maintain
dissimilar taxation between domestic and imported dis tilled spirits: 89.6% of all pisco sold is bottled
at 35 degrees or lower, whereas whisky, vodka, rum, gin and tequila by law must all be bottled at 40
degrees or higher. The New Chilean System thus will continue to ensure that a tax rate of 27% is to be
applied to most domestic spirits, while a 47% rate be applied to most imported spirits.
5.69 As for protective application, the United States notes that the New Chilean System will differ
from past systems by relying on apparently neutral cr iteria, i.e. alcohol content and value. However,
these criteria will continue to afford protection to domestic production. The vast majority of products
to which the lowest tax rate will apply will still be pisco, an inherently domestic product which is also
the major distilled spirit sold in Chile, while the highest tax rate will still apply to most imported
products.
5.70 The United States argues that in the context of the facts and circumstances of this case,
Chile’s use of alcohol content for taxation purposes is an effort to perpetuate the relatively higher
rates applied to imports. The alcohol content of mo st imported spirits is well known, and in fact fixed
by Chilean law. By statute, Chile requires that whisky, rum, vodka, gin and tequila be at least 40
degrees in alcohol content. The same law dictat es that brandy must be a minimum of 38 degrees,
pisco must be a minimum of 30 degrees, and liqueurs can range from 25 degrees and upwards,
depending on the type of liqueur. 339 Thus, for example, whisky can only be sold as "whisky" in Chile
if it is subject to the maximum tax rate possible.
5.71 The United States further argues that, as a resu lt of well-established industry practices and
legal standards required by many of the major di stilled spirits markets, most international whisky
producers bottle their product at a minimum alcohol content of 40 degrees. Similarly, most
international producers of rum, vodka, gin and te quila bottle their products at around 40 degrees

338 See Panel Report on United States - Taxes on Petroleum and Certain Imported Substances , supra.,
para. 5.2.2.
339 Chilean Decree 78/1986, implementing Law No. 18,455/85.

(typically no lower than 37.5 degrees).
340 Producers generally prefer to maintain the same alcohol
content, regardless of market requirements, because of the fact that alcohol strength contributes to
each product’s characteristics and taste. Thus, by pegging the tax rates to alcohol content, the Chilean
regime will apply its rates on the basis of a well- known, inherent attribut e of each product and will
thereby continue to protect pisco from competition from whisky and other imports.
5.72 According to the United States, further evidence of the Chilean law’s protective structure is
the arbitrary choice of 35 degrees as the dividing line between a straight ad valorem rate of 27% and
rates that increase considerably. Very few im ported spirits are bottled under 35 degrees alcohol
content; indeed, most imported spirits are legally required to be over this 35 degree threshold. As
pisco is the only major distilled spirits category with the flexibility to fall below the threshold, and in
fact most are bottled at an alcohol content of 35 degrees or less, pisco will once again be effectively
singled out for preferential tax treatment.
5.73 The United States argues that the steeply increasing tax rates on imports of over 35 degrees
alcohol content, compared to the flat rate applied to pisco below that threshold, can only be explained
as taxation applied to afford protection to pisco . Although one GATT panel properly found that
gradual increases in rates may support the determ ination that a progressive tax structure is non-
protectionist in its structure, 341 in this case the four percent tax increase for each additional degree of
alcohol content will create a disproportionate in crease in tax for spirits with 40 degrees alcohol
content or more. Thus when comparing two bottl es of spirits with equal value, the tax on the 40
degrees spirit will be 74% greater than the tax on th e 35 degrees spirit. Moreover, the EC submission
describes evidence of the anticipated discriminatory effect of the new tax regime and the protective
purpose of the threshold, as revealed from the drafting process of the new legislation.342
5.74 The United States further argues that the protec tionist structure is further evidenced by the
overall relative impact of the new regime on im ports and domestic products. The New Chilean
System will tax the vast majority, 83.9%, of all dom estic spirits at the lowest possible rate, and only
12.3% of all domestic spirits at the highest possibl e rate. Conversely, the new regime will tax 94.5%
of all imported spirits (a share higher than the prev ious two regimes) at the highest possible rate, but
only a mere 4.5% of all imported spirits at the lowest possible rate.343

340 See U.S. Exhibit 3.
341 See Panel Report on United States - Taxes on Automobiles, supra., para. 5.14.
342 See EC First Submission, paras. 61-78.
343 The United States notes that these calculations for the new tax regime are made with the assumption
that all liqueurs are taxed at the lowest rate possible, given their ability to be bottled at 35 degrees alcohol
content or less (in reality, while mo st domestically produced liqueurs ( e.g., creme de menthe, flavoured
brandies) are bottled at below 35 degrees, most imported liqueurs ( e.g., Drambuie, B&B) are bottled at above
the threshold). Furthermore, these calculations exclude brandy because, with an ability to be bottled at 38
degrees alcohol content, it can be taxed at 39%, a median tax rate.

 Domestic Imported

5.75 The United States observes that the 12.3% of all domestic spirits to be taxed at the highest
possible rate, stated above, will consist mostly of pisco reservado and gran pisco , two brands of
pisco.344 However, one must bear in mind that pisco is the only major distilled spirits category given
the flexibility by law to be bottled at 35 degrees alco hol content or below. Thus, while the domestic
producers of pisco may purport to bottle a small portion of their production (10.4%) at 40 degrees or
more, they can at any time choose to reduce the al cohol content of these brands and still retain the
identity of "pisco". On the other hand, Chile do es not provide this freedom to the producers of the
major imported spirits, therefore ensuring that in the New Chilean System, whisky, rum, gin, vodka
and tequila will all be "locked" into the highest tax rate imposed.
5.76 According to the United States, the New Chilean System is promulgated to provide continued
protection to domestic spirits. In the US view, Ch ile would have the Panel conclude that its New
Chilean System is non-discriminatory simply because it will allow some imported spirits to enjoy the
lowest tax rate possible while imposing the highest tax rate on a few of its domestic products.
However, the products in these circumstances are fe w and far between, and act as no more than mere
token gestures. In short, Chile will again fail to provide non-discriminatory treatment for its distilled
spirits market.
5.77 The United States concludes that Old Chilean System applied its lowest tax rate to 89.1% of
all domestic spirits and its highest tax rate to 53.8% of all imported spirits. This uncontested
discriminatory treatment between domestic and impor ted spirits continues in the transitional tax
regime which, while lowering the magnitude of the tax differential (between the highest tax rate and
the lowest tax rate) from 180% to 112%, is a mirror image of the Old Chilean System. Then in the
year 2000, the New Chilean System will further fo rward this tradition of dissimilar treatment by
providing its lowest tax rate to 83. 9% of all domestic spirits, whil e imposing its highest tax rate on
94.5% of all imported spirits. Furthermore, the New Chilean System will effectively increase the ad
valorem tax for most U.S. imports from 30% to 47%.
345 It is obvious that all three tax regimes
operate with the same practical effect. 346 And in all cases, the exclusive carve-out of preferential tax
treatment for domestic production is clear.

344 See U.S. Exhibit 2.
345 According to the United States, in the old and transitional regimes, approximately 61.4% of all U.S.
exports to Chile (rum, gin and vodka) are categorized as "other distilled sp irits", and taxed at the 30% rate.
However, in the new regime, these spirits will be taxed at the maximum 47%, an increase in tax rate of 56.7%.
346 See Table 1 and U.S. Exhibit 4.

Table 1

OLD REGIME
TRANSITIONAL
REGIME

NEW REGIME

 Domestic

Imported Domestic Imported

Domestic Imported

Low Tax Rate 89.1%

0.0% 89.1% 0.0%

83.9% 4.5%

Median Tax Rate 10.6%

46.2% 10.6% 46.2%

3.8% 1.0%

High Tax Rate 0.3%

53.8% 0.3% 53.8%

12.3% 94.5%

TOTAL 100.0%

100.0% 100.0% 100.0%

100.0% 100.0%

VI. INTERIM REVIEW
6.1 In letters dated 25 February 1999, the Europ ean Communities and Chile requested an Interim
Review by the Panel of certain aspects of the Interim Report issued to the parties on 15 February 1999.
The parties did not request an Interim Review meeting.
6.2 The European Communities has argued that paragr aphs 2.1 and 2.3 and footnote 1 should be
amended to reflect the fact that Chilean Law No. 19.534 did not repeal and replace Decree 825/74, but
instead amended it. We changed the Descriptive Part of the Report in this regard to reflect Chile's
legal characterization of its own law. While the EC has pointed out that the title of Law No. 19.534
refers to it as a modification, we will accept Chile's characterization of its legislation in this regard.
As we noted in footnote 1, we do not find the characterization of whether the law is a replacement or a
modification to be of any substantive importance to our Findings.
6.3 With respect to the Findings, the Europ ean Communities has made suggestions for
clarifications with respect to paragraph 7.46 and footnotes 370, 390 and 407. We generally agree with
these points and have made changes accordingly.
6.4 With respect to paragraph 7.35, the European Communities argues that the proper reference is
to the 1998 SM Survey rather than to the 1997 SM Survey and that this paragraph and the following
one should be moved. However, th ese paragraphs refer to Chile's di sagreement with both surveys.
One of the references in paragraph 7.35 was inco rrect and we have changed it. Otherwise the
paragraphs are accurate and have not been amended.
6.5 The European Communities claims that the st atements in paragraph 7.60 were not in
reference to the 1998 SM Survey, bu t instead referred to another section of the EC's First Submission.
The references in paragraph 7.60 et seq., are take n from the section of the EC's first submission
beginning at paragraph 145 and we re direct references to the 1998 SM Market Survey. The Tables
referred to therein are derived from that survey. Up on further consideration, we decided that it would
be helpful to reverse the data references in pa ragraphs 7.60 and 7.61 and modify the language of
these paragraphs in order to further clarify this point.
6.6 With respect to paragraphs 7.71 and 7.77, the European Communities strongly objects to the
characterization of the cross-price elasticity s hown in the 1995 Gemines study as being "low". We
continue to be of the view that a cross-price elasticity of .26 is low. However, we also note our
extensive discussion of the reasons why this estimated cross-price elasticity is lower than the actual

ratio would be, which is also the conclusion reached by the authors of the study. Therefore, we
decline to change the paragraphs.
6.7 The European Communities argues that paragr aph 7.100 does not accurately reflect their
argument. After reviewing their statement and s ubmissions to the Panel, we have made some
modifications to this paragraph.
6.8 The European Communities states that the third sentence of paragraph 7.105 is not accurate in
that an ad valorem system would not provide similar taxation unless it applied the same rates or rates
with less than de minimis differences. This is what we intended when referring to "purely" ad
valorem systems. Nonetheless, we will clarify the re ference. We consider the remainder of the
paragraph accurate and appropriate in its qualifications and decline to further modify it.
6.9 The European Communities request s that we eliminate footnote 420 because reference to
other taxation systems is not relevant to this dis pute. Furthermore, the European Communities argues
that the discussion is beyond the Panel's Terms of Reference. As the European Communities
correctly notes, we stated in footnote 430 that inqu iry into other tax systems for alleged inconsistency
with GATT rules is not relevant. However, Chile of fered this argument by analogy and, in our view,
it is worth noting some of the specific problems that can arise from such arguments. In our view, this
fuller explanation serves a useful purpose in this regard. We specifically noted in the footnote that the
examination required to determine the accuracy of the analogy would in fact be beyond the Panel's
terms of reference. Accordingly, we decline to delete this footnote.
6.10 The European Communities objects to paragraph 7.109 for the same reasons described above
in regard to footnote 420. We decline to make the requested change for the same reasons discussed in
regard to that footnote.
6.11 The European Communities argues that paragr aph 7.121 mis-characterizes their position on
the question of the Chilean legislative process. In our view, the language requested by the European
Communities is merely a more in-depth descripti on of their position than what is contained in
paragraph 7.121. We note that a full description of the EC position can be found in the Descriptive
Part of the report at paragraphs 4.559-4.585. In our view, paragraph 7.121 is accurate and we decline
to make the requested change.
6.12 The European Communities argues that paragraph 7.122 does not address the EC argument.
In its interim review request, the European Communities states that:
The Pisco industry was not trying to "push a tax burden onto another" but, rather to
attract upon itself an additional tax burden. Neither Chile, nor now the Panel, have
given any satisfactory explanation for that unusual request.
6.13 The European Communities then goes on to argue that we should draw inferences from the
alleged willingness of the Chilean government to nego tiate certain benefits with one constituent but
not another. In our view, there is no basis for th e EC's demand that the Panel provide it with a
"satisfactory explanation" of the Chilean legislativ e process. Indeed, the in ferences that it wishes us
to draw are precisely the sort of delving into dome stic politics that previous panels and the Appellate
Body have declined to do. The European Co mmunities does not provide direct evidence of the
Chilean government position. Rather it wishes us to conduct an investigation to draw inferences from
a series of policy negotiations. It is manifestly uncle ar what standards we should use to evaluate such
discussions and negotiations or what the authority is for conducting such an investigation of the
Chilean legislative processes. We agree with the guidance provided by the Appellate Body in this
regard and decline to make the changes requested by the European Communities.

6.14 The European Communities requests that we change subparagraph 7.131(iv) for the reasons it
requested we change paragraph 7.121. We decline to make this change for the same reasons we
declined to change paragraph 7.121.
6.15 The European Communities has asked us to revi se the summary of its argument in paragraph
7.137 to better reflect its argument. We have made some changes to that paragraph to better reflect its
argument.
6.16 With respect to paragraph 7.146, the Europ ean Communities suggests that it is inaccurate to
state that "to a certain extent both parties are correct in their arguments" because the Panels
conclusions in the following two paragraphs accord with the EC position. We noted that Chile argued
that we should not review the legitimacy of its polic y objectives. We agree. However, we also agree
with the EC's argument that the lack of a rati onal connection between the stated objectives and the
measure was evidence of protective design, struct ure and architecture. Thus, we consider our
summary in paragraph 7.146 accurate and decline to make the requested change.
6.17 Chile notes its disappointment in and disagreem ent with the Panel's conclusions in this
dispute.
6.18 In its specific comments, Chile disagrees with our characterization of their position in
paragraph 7.28. Chile states that it provided arguments against the determination that HS 2208 is the
"relevant market". However, this paragraph is not concerned with a dete rmination of "relevant
markets" and we did not use that term. Rather it deals on the one hand, with the identification of the
appropriate category of certain im ports and, on the other, with the appropriate categorization of
certain domestic products. We ha ve reviewed the record once again and do not find where Chile
argued that the list of distilled alcoholic beverag es identified by HS 2208 was not the appropriate
category of imported products. Chile also never argued that particular sub-categories of HS 2208
should be excluded, as was done, for example, in the panel findings in Korea –Taxes on Alcoholic
Beverages.
6.19 While Chile did argue that various distinctions between products undercut the EC's arguments
with respect to the question of directly competitiv e or substitutable products, this does not go to the
question of whether certain distilled alcoholic beverages contained within HS 2208 should be grouped
separately or excluded from the Findings. Furthe rmore, we discussed various sub-categories of
products at various points in the Findings when th ere were differences in products that we felt
warranted further examination (see, for example, paragraph 7.54). Had such examination revealed
differences that justified finding certain products not within the groupings utilised or not directly
competitive or substitutable, we would have made su ch a determination. Finally, in discussing this
question in paragraph 7.28, we specifically di scussed why such grouping of products would not
prejudge the substantive discussion of the question of whether the imported and domestic products are
directly competitive or substitutable.
6.20 Chile also made the following argument in regard to paragraph 7.28:
Chile also provided information proving that the different kinds of pisco are marketed
in different markets and are produced using different technology. If it is later argued
that a diluted whisky is not whisky, why should a 43° pisco diluted to 30° continue to
be a Gran Pisco.
6.21 We note again that this argument really goes elsewhere; namely, to the substantive Findings
on "dissimilar taxation" or "so as to afford protec tion" relating to Chile's argument that products can
easily be diluted to achieve tax parity. However, we note that it is a matter of Chilean law that all
pisco is grouped together regard less of its strength in the Old Chilean System and the Transitional

System and that the geographic denomination under Chilean law of "pisco" does not refer to alcohol
strength. We also note that it is a matter of Chil ean regulation that whisky and other products lose
their generic names if they are diluted. Thus, the term pisco is available to spir its at various levels of
alcohol content while the term whisky is available only at 40° of alcohol content and above. We are
not convinced to change paragraph 7.28.
6.22 Chile further argued that it showed that "when wine is included in the regression, for example
the coefficient ceases to become statistically significant". This argument also does not really go to the
point of the discussion in paragraph 7.28. Noneth eless, we note that Chile supplied a new regression
analysis, so it is not accurate to state that the results change when wine is added to the regression. We
discussed the methodological problems with the new Ch ilean analysis as well as the others submitted.
We also discussed the question of including wine (and beer) in our overall analysis. Our conclusion
was that it was possible that wine and beer are al so directly competitive or substitutable with pisco.
However, that does not refute the extensive evidence that pisco is directly competitive or substitutable
with the other distilled spirits. This also appears to be the conclusion recently reached by the Chilean
competition authorities.
6.23 With respect to paragraph 7.41, Chile disagr ees with our use of the Adimark Survey as
relevant evidence. We recognized its limitations b ased on sample size and we specifically stated that
we did not wish to make too much of the survey. However, we found it both relevant and useful in
that it was a study presented to the Chilean legislature and not one developed for purposes of this
dispute. Chile states that we should not draw any conclusions about its value "without proper
knowledge of the market". However, we specifically stated that we took note of the survey because
of its consistency with other market information.
6.24 Chile also argued with respect to the Adimark su rvey that the panel attached greater validity
to one segment of the market than another. Chile's criticism implies that there must be high degree of
current substitutability among all portions of Chilean society for products to be considered directly
competitive or substitutable. That is not correct. We found it to be relevant evidence that a focus
group representing a significant portion of Chilean so ciety (the portion with the highest disposable
income and therefore a proportionally greater share of domestic consumption) showed a high level of
willingness to substitute whisky for pisco. We also noted that another segment would be interested in
trying whisky although the second group of respondent s thought they would revert to consumption of
pisco later. Complainants do not have to show that all consumers would shift all consumption; rather,
that some portion would under some circumstances. There is then a question which we have
addressed at length as to whether such amount of substitu tability is sufficient. In our view, the weight
we have accorded to the Adimark survey is consiste nt with its limitations and its conclusions. We
decline to make the changes requested by Chile.
6.25 Chile disagrees with footnote 393 regarding its inability to provide the 1996 Gemines Study
pursuant to requests by the European Communities and the Panel. In Chile's view this footnote mis-
allocates the burden of proof and implies an uncoope rative position by Chile. Chile further notes that
it is not obligated to provide evidence contrary to its own arguments. Chile also states that the Panel
should have given more credence to the fact that the study was the property of a private party. First,
the question here is not one of allocation of the burden of proof. The European Communities is
required to present evidence to establish its claims. W ith respect to this piece of its overall evidence,
the European Communities presented st atements made in the Chilean pr ess to the effect that the 1996
Gemines Study showed a high degree of substitutabil ity between whisky and pisco. Our statement in
footnote 393 was that Chile (and its industry) had foregone the opportunity to rebut this evidence by
not presenting the study for examination. Second, we made no statement about Chile being
uncooperative. Chile adopted a fully cooperative po sition during the whole period of the proceeding,
of which we are appreciative. Third, we specifica lly noted that the study was in the pisco industry's
hands and the industry had refused to provide it. As we noted, it would be an artificial distinction to

state that we would refuse to accept the unreb utted information provided by the European
Communities as it referred to a study that we c ould not see ourselves because it was retained in the
hands of the directly interested domestic Chilean industry.
6.26 Finally, we specifically noted that there is no compulsory discovery under the DSU.
However, we do find it regrettable that any indu stry (or any Member, whether complainant or
respondent) would not submit requested relevant eviden ce for consideration by a panel. We note that
we are troubled by Chile's statement that its only duty is in "not obstructing the work of the panel".
Article 13 of the DSU states that:
A Member should respond promptly and fully to any request by a panel for such
information as the panel considers necessary and appropriate.
6.27 We think this treaty obligation calls for somethi ng more than a lack of obstruction. And, in
fact, Chile's approach throughout the proceedings was constructive. Our only conclusion here was
that, given that the Chilean industry had refused the repeated requests to produce the report, we would
accept the EC's unrebutted evidence about the report's conclusions. Accordingly, we decline to make
the requested changes.
6.28 With respect to paragraph 7.74, Chile notes th at its initial basis for comparing prices was
mistaken but was later corrected. We agree and will change the paragraph accordingly.
6.29 Chile claims that, with respect to paragraph 7. 76, the conclusions on cross-price elasticity of
pisco and imported distilled spirits is not based on any evidence and notes that only two products were
involved: whisky and pisco. As we noted, pisco an d whisky are two of the most dissimilar products
involved. It follows that the evidence for the inte rmediate products would be supportive of the same
conclusions. We must also note that we discus sed at great lengths the weaknesses of the studies
submitted, but found them useful supportive evidence to be considered along with other factors also
discussed at length. We decline to make the change requested.
6.30 Chile has requested that in paragraph 7.105 we not state that specific tax systems are not
generally considered to be applying dissimilar ta xation. While not necessarily agreeing with some of
Chile's reasoning in its comments, we note that we have found that the New Chilean System is an ad
valorem system qualified by reference to alcohol cont ent and that it is not a specific tax system.
Therefore, the statement is irrelevant and we agree to remove it.
6.31 Chile disagrees with our statements in para graph 7.109 regarding luxury tax systems and
claims that the New Chilean System is a type of l uxury tax system. As pointed out in this paragraph,
we disagree. A system where ad valorem rates change according to alc ohol content rather than value
is not a luxury tax system. The paragraph illustrates our conclusion and we decline to change it in this
regard.
6.32 Chile objects to footnote 430 claiming that it did not attempt to justify its own measures by
reference to other Member's policies. It is the case that Chile did not admit that its measures were
GATT-inconsistent and then attempt to defend them by reference to other Members' laws. However,
as Chile again acknowledges, it did argue at great le ngth that, in its view, to find Chile's measures
GATT-inconsistent would compel a finding that other Members' laws were also inconsistent. Either
way, the other Members' laws are irrelevant to our analysis. We will amend this footnote to further
clarify Chile's position and our conclusions on this matter.
6.33
Chile argues that paragraph 7.143 is not corr ect because Chile disagrees that the products
discussed are directly competitive or substitutable. Chile states in its Interim Review comments that
such competitive conditions exist only with respect to directly correlat ed alcoholic content beverages.

Chile did not present its arguments in this fashion dur ing the meetings or in its submissions. We are
unaware of any evidence that supports an argument that distilled alcoholic beverages are directly
competitive or substitutable only with those that cont ain the same alcohol content. Nonetheless, we
will amend the paragraph to more clearly reflect that the statements are our conclusions and not
Chilean arguments.
6.34 Chile disagrees with paragraph 7.149 and clai ms that we have confused two different
concepts. According to Chile "revenue neutrality" does not refer to maintaining the same tax revenue
but also takes into account issues of progressivity or regressiveness of application. We disagree. It is
quite obvious that "revenue neutrality" refers to just what it says: achieving the same amount of
revenue. In our view, it is not correct to conclude th at "revenue neutrality" also includes an element
of social impact neutrality. To so argue ignores the plain meaning of the word "revenue" and is
unsupported by either logic or the evidence. We decline to change paragraph 7.149.
6.35 With respect to paragraph 7.150, Chile notes that there is more local production of some high
alcohol spirits than imports. This is already noted and considered in our Findings. We decline to
change this paragraph.
6.36 In paragraph 7.152, we stated that there "a ppears to be no correlation between value and
alcohol consumption." That is our conclusion. We then continue by noting that there would be an
inverse relationship, if any . Chile disagrees with the reference to a possible inverse relationship,
stating that this further statement would only be true if the products were perfect substitutes. Chile's
comment is not on our conclusion, as much as it is on the further statement about a possible inverse
relationship. We do not see the basis for Chile's stat ement that this further statement is only true if
products are "perfect substitutes". We acknowledge that Chile would not agree with the point given
its disagreement with our conclusions on the issu e of "directly competitive or substitutable".
Nonetheless, given our conclusions on that issue, we think the paragraph is accurate and decline to
change it.
6.37 Chile disagrees with our assessment in paragra ph 7.154 that the stated policy objectives are
not achieved and that, even if they were, it would no t be evidence of discrimination but could be due
to some other factor. We found no evidence of these other factors here. Therefore, we found this to
be supporting evidence of our Finding. As with ma ny other points discussed in the Findings and in
this Interim Review, it must be remembered that we did not view any single factor in isolation. In
weighing all the evidence, such things as a lack of rational connections between stated objectives and
resulting measures constitutes a factor among others. Chile also argued here that competing
objectives results in achievement of second best soluti ons to all the problems. However, we found a
lack of rational connections, including second best ones. We decline to change paragraph 7.154.
6.38 With respect to paragraph 7.155, Chile argues th at there is an important distinction between
laws and regulations specifically with respect to the regulation concerning minimal alcohol content of
beverages. In Chile's view, regulations are more fl exible. We think the term "laws" is broad enough
to cover both legislation and regulations. Noneth eless, we will change paragraphs 7.145, 7.155 and
7.159 and footnote 437 to reflect Chile's distincti on. As we explicitly noted, we make no findings
concerning this regulation, but it does constitute a rele vant fact of our inquiry. Also, we stated that
the Chilean argument concerning dilution of produc ts was not persuasive because such products
would need to change both their generic names and certain physical characteristics.
6.39 In regard to paragraph 7.156, Chile states that it does not attempt to justify its tax regime by
referring to the fact that it applies duties lower than the bound rates. Rather, Chile states that it
provided this as an example of how Chile does not u se such instruments despite their legality. Chile
says it offers the example as an indication of the intent and nature of its policy instruments. The very
point we made in paragraph 7.156 is that such goo d intentions in one area are not relevant to an

examination of a completely different measure. We do, however, agree that Chile did not attempt to
"justify" the tax measure in question, because Chile in fact still maintains that the measure is GATT-
consistent and therefore not needing justification. We amended the paragraph accordingly.
6.40 Chile disagrees with the summary paragraph 7.159. On one particular point, Chile notes that
its prior tax systems have not been found inconsis tent with GATT or WTO obligations. We note that
the structure of the Old Chilean System is precisely the same as the Transitional System. Only the
rates of taxation differ. Other than changing the reference to the product labelling measure (which is
not at issue) to reflect Chile's prior comment that it is a regulation not legislation, we decline to
further amend this paragraph.
VII. FINDINGS
A. C
LAIMS OF THE PARTIES
7.1 The claim of the European Communities is th at both the Transitional System and the New
Chilean System are inconsistent with Chile's obligations under GATT Article III:2, second sentence.
7.2 The European Communities claims that347:
(i) the Transitional System, which is applicab le through 30 November 2000, is contrary
to GATT Article III:2, second sentence, because it provides for the imposition of
lower internal taxes on pisco than on ot her directly competitive or substitutable
imported spirits, which fall within the tax cat egories of "whisky" and "other spirits",
so as to afford protection to Chile's domestic production;
(ii) the New Chilean System, which will become applicable as of 1 December 2000, is
also contrary to Article III:2, second senten ce, because it results in the imposition of
lower taxes on pisco with an alcohol content of 35  or less than on other directly
competitive or substitutable imported spirits which have a higher alcohol content, so
as to afford protection to Chile's domestic production.
348
7.3 In response, Chile claims that this Panel should reject the unwarranted and intrusive
interpretation of the reach of Article III that th e European Communities has put forward in this
dispute, and that in keeping with the plain langua ge and the history of Article III, the Panel should
find that the New Chilean System is fully consistent with Article III:2, second sentence.
7.4 Chile also argues that to the extent that the Pa nel considers the Transitional System to be at
issue notwithstanding the short time in which it will remain in effect, it would be appropriate for the
Panel to find that pisco is not directly competitive or substitutable with other distilled spirits in Chile,
and hence that the Transitional System also conforms with Article III:2, second sentence.

347 The European Communities notes that in its pane l request, it also invoked a violation of GATT
Article III:2, first sentence. Even though certain spirits exported from the Eu ropean Communities to Chile
(including in particular certain types of brandy) may be considered as being "like" to pisco, the European
Communities has decided not to pursue that claim, given that those spirits are in any event "directly competitive
or substitutable" with pisco.
348 The European Communities argues that the New Chilean System already constitutes mandatory
legislation, and as such, it may be the subject of dispute settlement under the WTO Agreement, citing Panel
Report on United States – Taxes on Petroleu m and Certain Imported Substances, BISD 34S/136, paras 5.2.1-
5.2.2.

B. I
NTERPRETATION OF ARTICLE III:2
7.5 Article III:2 provides two standards for examin ing complaints about a Member's internal
taxation laws. The first sentence of Article III:2 provides:
The products of the territory of any Member imported into the territory of any other
Member shall not be subject, directly or indi rectly, to internal taxes or other internal
charges of any kind in excess of those applied, directly or indirectly, to like domestic
products.
The second sentence provides:
Moreover, no Member 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 1.
Paragraph 1 of Article III in turn provides:
Members recognize that internal taxes a nd other internal charges, and laws,
regulations and requirements affecting the internal sale, offering for sale, purchase,
transportation, distribution or use of pr oducts, and internal quantitative regulations
requiring the mixture, processing or use of products in specified amounts or
proportions, should not be applied to importe d or domestic products so as to afford
protection to domestic production.
7.6 The meaning of the second sentence in light of its reference to the firs t sentence is further
clarified in Ad Article III as follows:
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.
349
7.7 Thus, the first sentence of Article III:2 examines whether products of an exporting country are
taxed in excess of the taxes on the "like" domestic product. The second sentence examines whether
products of an exporting country are taxed simi larly to domestic products which are "directly
competitive or substitutable." Both sentences first examine the relationship between the domestic and
imported products; however, the second sentence i nvolves additional and different inquiries with
respect to two other elements; namely, an examination of the extent of the difference in taxation350 and
whether the taxation differences are applied so as to afford protection to the domestic industry.
7.8 In Japan – Taxes on Alcoholic Beverages II, the Appellate Body considered the overall
interpretation of Article, and stated that:

349 Ad Article III has equal stature under internationa l law as the GATT language to which it refers,
pursuant to Article XXXIV. See also Appellate Body Report on Japan – Taxes on Alcoholic Beverages
(hereafter, " Japan – Taxes on Alcoholic Beverages II "), adopted on 1 November 1996, WT/DS8/AB/R ,
WT/DS10/AB/R, WT/DS11/AB/R, p. 24.
350 If the products are determined to be "like" then any taxation of the imported product in excess of the
domestic product is prohibited. There is no de minimis possibility as there is unde r the second sentence where
Ad Article III provides only that they must be "similarly taxed."

The broad and fundamental purpose of Article III is to avoid protectionism in the
application of internal tax and regulatory measures. More specifically, the purpose of
Article III is to ensure that internal meas ures are "not applied to imported or domestic
products so as to afford protection to domestic production."
351
7.9 According to the Appellate Body, the terms of Article III:1 must be given their ordinary
meaning, in light of the overall object and purpose of the WTO Agreement. Taking this approach, the
Appellate Body affirmed that Article III:1 contains a general principle, while Article III:2 provides for
specific obligations regarding internal taxes and internal charges. The Appellate Body stated that:
Article III:1 articulates a general principle that internal measures should not be
applied so as to afford protection to dom estic production. This general principle
informs the rest of Article III. The purpose of Article III:1 is to establish this general
principle as a guide to understanding and interpreting the specific obligations
contained in Article III:2 and in other paragraphs of Article III.
352
7.10 The Appellate Body noted that Article III:2, second sentence, unlike the first sentence,
specifically invokes Article III:1. In this regard, th e Appellate Body noted that three issues must be
addressed to determine whether an internal tax me asure is inconsistent with Article III:2, second
sentence:
(i) the imported products and the domestic products are "directly competitive or
substitutable products";
(ii) the directly competitive or substitutable imported and domestic products are "not
similarly taxed"; and
(iii) the dissimilar taxation of the directly co mpetitive or substitutable imported domestic
products is "applied so as to afford protection to domestic production".353
7.11 We also note that the burden of proof in cases su ch as this has been discussed at length by the
Appellate Body in United States -- Shirts and Blouses .354 It is up to the European Communities as
complainant to present evidence su fficient to establish the case that the Chilean measures in question
are inconsistent with Chile's obligations under Article III. If they do so, it is then necessary for Chile
to bring forward evidence and arguments to disprove th e claim. At that point, it is up to a panel to
carefully weigh all the evidence and reach its conclusions based upon the results of that weighing.
C. "DIRECTLY COMPETITIVE OR SUBSTITUTABLE"
1. General
7.12 The complainant in this case has not argued that any of the imported or domestic products
are "like". We shall, therefore, proceed exclus ively under Article III:2, second sentence, which is
concerned with the question of direct competitiveness or substitutability.

 351Appellate Body Report on Japan - Taxes on Alcoholic Beverages II, supra., p.16.
 352 Ibid., p 18.
353 Ibid., p. 24. See also Appellate Body Report on Canada – Certain Measures Concerning
Periodicals (hereafter, " Canada – Periodicals "), adopted on 30 July 1997, WT/DS31/AB/R, pp 24-25 and
Appellate Body Report on Korea – Taxes on Alcoholic Beverage , adopted on 17 February 1999,
WT/DS75/AB/R, WT/DS84/AB/R, para. 107.
354 Appellate Body Report on United States – Measures Affecting the Imports of Woven Shirts and
Blouses from India (WT/DS33/AB/R), pp. 12-17. See also Appellate Body Report on Korea – Taxes on
Alcoholic Beverages, supra., paras. 155-158.

7.13 As a prerequisite to the analysis of the ev idence presented, it is important to establish the
correct interpretation of the term "directly competitive or substitutable". In this regard, the Panel is
guided by Article 31 of the Vienna Convention on th e Law of Treaties ("Vienna Convention"), that
summarizes the international law rul es for the interpretation of treati es. Article 31.1 of the Vienna
Convention provides that terms shall be interprete d in good faith, in accordance with the ordinary
meaning of the terms in their context, and in light of the object and purpose of the treaty. Article 31.2
provides further, that the context includes the full text, the preamble, the annexes and any mutually
agreed interpretive language. Article 31.3 provides th at account shall also be taken of any subsequent
practice or interpretations as well as relevant rules of international law.
7.14 The category of "directly competitive or substitu table" products is broader than the "like
product" category covered under the firs t sentence. The Appellate Body in Japan – Taxes on
Alcoholic Beverages II stated that how much broader this category should be "is a matter for the panel
to determine based on all the relevant facts in that case".
355 It will be important to look at not only
such matters as physical characteristics, common e nd-uses, and tariff-classifications, but also at the
market. The Appellate Body also stated that it is appropriate to examine elasticity of substitution as a
means of examining the relevant markets.
7.15 The Appellate Body in Japan – Taxes on Alcoholic Beverages II agreed with the reasoning of
the panel with regard to the analysis of direc tly competitive or substituta ble products. That panel
made two important observations. First, the pane l noted that the responsiveness of consumers to
various products offered in the market may vary from country to country. 356 Second, the panel
cautioned that differences in responsiveness of consumers to various products should not be
influenced or determined by internal taxation because "a tax system that discriminates against imports
has the consequence of creating or ev en freezing preferences for domestic goods." 357 The Appellate
Body stated that no single criterion is decisive in determining whether any two products are "directly
competitive or substitutable".
7.16 The question for us to decide is whether, in Chile, the domestic a nd imported products at
issue in this case are directly competitive or substitu table. This requires evidence of the relationship
between the products, including, in this case, comparis ons of their end-uses, physical characteristics,
channels of distribution and prices.
7.17 There have been two relatively recent disput es dealing with taxes on alcoholic beverages,
Japan – Taxes on Alcoholic Beverages II and Korea – Taxes on Alcoholic Beverages. The findings in
these two cases can offer, in our view, instructiv e guidance on the determination of the various
questions at issue in this dispute. However, we ar e mindful of the statement of the Appellate Body in
Japan – Taxes on Alcoholic Beverages II , that these disputes must be determined on a case-by-case
basis taking into account the conditions prevailing in the particular market at issue.
7.18 Consequently, we will draw guidance from th e general analyses used in these two earlier
cases, among others, but the determination of the central question whether the two categories of
products are directly competitive or substitutabl e will be based on the facts and circumstances
prevailing in this case.
7.19 The definition of "like" products is narrow for purposes of Article III:2. The definition of
"directly competitive or substitutable" products is br oader. The question is how much broader. In

355 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 25.
356 Panel Report on Japan - Taxes on Alcoholic Beverages , adopted on 1 November 1996, WT/DS8/R,
WT/DS10/R, WT/DS11/R, para. 6.28, citing Working Party on Border Tax Adjustments, para. 18.
357 Ibid., citing the Panel Report on Japan – Customs Duties, Taxes and Labelling Practices on
Imported Wines and Alcoholic Beverages, BISD 34S/83 (hereafter, "Japan – Taxes on Alcoholic Beverages I").

this regard, we note the analysis of the panel in Korea – Taxes on Alcoholic Beverages concerning the
negotiating history of Article III:2, second sentence. That panel stated:
Article 32 of the Vienna Convention provides that it is appropriate to refer to the
negotiating history of a treaty provision in order to confirm the meaning of the terms
as interpreted pursuant to the application of Article 31. A review of the negotiating
history of Article III:2, second sentence and the Ad Article III language confirms that
the product categories should not be so narrowly construed as to defeat the purpose of
the anti-discrimination language informing the interpretation of Article III. The
Geneva session of the Preparatory Committee provided an explanation of the
language of the second sentence by noting that apples and oranges could be directly
competitive or substitutable. Other exampl es provided were domestic linseed oil and
imported tung oil and domestic synthetic rubber and imported natural rubber. There
was discussion of whether such products as tramways and busses or coal and fuel oil
could be considered as categories of direc tly competitive or substitutable products.
There was some disagreement with respect to these products.
358
2. Evidentiary matters
(a) Potential competition
7.20 The European Communities submitted that Article III:2, second sentence, is concerned not
only with tax differentials between products that are actually comp etitive or substitutable in a given
market, but also with tax differentials between products that are potentially competitive or
substitutable. The European Communities furthe r argued that the notion of potential competition
must be deemed to include not only competition that would exist "but for" the tax measures at issue,
but also competition that could reasonably be expected to develop in the near future.359
7.21 It is well established in GATT jurisprudence, that Article III does not protect export volumes
but, instead, protects competitive opportunities. In this regard the Appellate Body stated in Japan –
Taxes on Alcoholic Beverages II that:
[I]t is irrelevant that the "trade effects" of the tax differentia l between imported and
domestic products, as reflected in the volum es of imports, are insignificant or even
non-existent. Article III protects expectations not of any particular trade volume but
rather of the equal competitive rela tionship between imported and domestic
products.360
7.22 We agree with the panel in Korea –Taxes on Alcoholic Beverages (which reasoning was
upheld by the Appellate Body)361 when it stated that:
We will not attempt to speculate on what c ould happen in the distant future, but we
will consider evidence pertaining to what c ould reasonably be expected to occur in
the near future based on the evidence presented. How much weight we will give to
such evidence must be decided on a case-by-case basis in light of the market structure
and other factors, including the quality of the evidence and the scope of the inferences
to be drawn. If one is dealing with pr oducts that are experience based consumer

358 Panel Report on Korea – Taxes on Alcoholic Beverages , supra., para. 10.38, citing EPCT/A/PV/9,
p.7; E/Conf.2/C.3/SR.11,p.1 and Corr.2; and E/Conf.2/C.3/SR.40, p.2.
359 See EC First Submission at para. 102. We note that Chile did not address this issue.
360 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p.16.
361 Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., paras. 112- 124.

items, then trends are particularly important and it would be unrealistic and, indeed,
analytically unhelpful to attempt to sep arate every piece of evidence and disregard
that which discusses implications for market structure in the near future.
362
7.23 The Appellate Body further explained in its Findings in that case that:
In view of the objectives of avoiding prot ectionism, requiring equality of competitive
conditions and protecting exp ectations of equal competitiv e relationships, we decline
to take a static view of the term "direc tly competitive or substitutable." The object
and purpose of Article III confirms that the sc ope of the term "directly competitive or
substitutable" cannot be limited to situations where consumers already regard
products as alternatives. If reliance could be placed only on current instances of
substitution, the object and purpose of Article III:2 could be defeated by the
protective taxation that the provision aims to prohibit.363
7.24 We agree that panels should look at evidence of trends and changes in consumption patterns
and make an assessment as to whether such trends and patterns lead to the conclusion that the
products in question are either directly compe titive or substitutable now or can reasonably be
expected to become directly competitive or substitutable in the near future.
7.25 In the case before us, as in the Korea case, potential competition is relevant for several
reasons. Until 30 November 1997, whisky faced very high rates of taxation (45 percentage points
higher than pisco). We must take into consider ation the possibility that the current level of actual
competition between pisco and other spirits is less than the level that c ould have developed under
equal tax conditions. It is possible that the tax sy stem in question (in conjunction with other measures
not at issue, such as previously higher duties) may have inhibited consumers from choosing imports.
(b) Product categories
7.26 The European Communities submitted that all pi sco must be considered as a single product
for the purposes of the determination whether it is directly competitive or substitutable with imported
distilled spirits. The European Communities argued that the four varieties of pisco are distinguished
solely in terms of alcoholic strength, and as such the difference does not warrant treating each of them
as a distinct product for the purposes of Article III:2, second sentence since there is no correlation
between the alcoholic strength of pisco and its quality/price.
7.27 The Appellate Body is of the view that the grouping of products is "a practical device to
minimise repetition when examining the competitive relationship between a large number of differing
products."364 The Appellate Body has gone further to stat e that whether, and to what extent, products
can be grouped is a question to be determined on a case-by-case basis. 365 In determining this question,
a panel has to take into account the components of the products that are being grouped to determine
whether there is enough similarity to warrant th eir being grouped together, notwithstanding some
variation in composition, quality, function or price.366
7.28 In the case before us Chile did not argue that th e various types of pisco constituted different
products for either analytical purposes or for determ ining whether the imports and pisco were directly
competitive or substitutable. The European Commun ities also argued that the appropriate category of

362 Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.50.
363 Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., para. 120.
364 Ibid., para. 142.
365 Ibid., para. 143.
366 Ibid., para. 142.

imported products for cons ideration is all distilled alcoholic beverages identified in HS 2208 as
described in the request for establishment of a pa nel. Chile has not made any arguments to the
contrary. This is the category of imported products identified as appropriate by the Appellate Body in
Japan – Taxes on Alcoholic Beverages II. To take as the appropriate grouping of imports all products
contained in HS 2208 does not, in this case, prejudge the matter as the panel and Appellate Body were
concerned might happen in Korea – Taxes on Alcoholic Beverages . This is because, in effect, Chile
argued that the whole category of pisco is suffici ently distinct from all other distilled alcoholic
beverages that this is the proper basis for comparis on with respect to the analysis of the issue of
directly competitive or substitutable. Under Chilean law pisco is an appellation of origin referring to
spirits made from grapes grown in a particular region of Chile. Thus pisco is exclusively a domestic
product and reference to imports identified by HS 2208 does not include pisco. "Pre-judgment" is not
an issue in this case.
7.29 We take the parties' positions in this case as strong evidence that the appropriate category of
imports with respect to the Chilean market is all distilled alcoholic be verages identified in HS 2208
and the relevant domestic products for purposes of the issue of directly competitive or substitutable is
all pisco. The Panel shall proceed accordingly.
3. Product comparisons
(a) General
7.30 The next step is to consider the various attr ibutes of the products at issue to determine
whether these attributes support a conclusion that th ere is a directly competitive or substitutable
relationship between the imported and domestic products. In this regard, we will examine the end-
uses of the products, their physical characteristics, the channels of distribution, price relationships
(including cross-price elasticities), and other relevant characteristics.
367
(b) End-uses
7.31 Overlap in end-use determines to a great extent direct competitiveness or substitutability. The
Appellate Body in Japan – Taxes on Alcoholic Beverages II specifically agreed with the panel finding
to the effect that:
[T]he decisive criterion in order to determine whether two products are directly
competitive or substitutable is whether they have common end-uses, inter-alia, as
shown by elasticity of substitution.368
7.32 In other words, the overall inquiry focu ses on whether there are common end-uses by
examining a number of factors which can include elas ticity of substitution. It is worth examining the
extent of the current overlap of the end-uses as well as the appropriate definition of what a common
end-use is for purposes of this inquiry. The cu rrent overlap of end-uses can be limited due to, inter
alia, the very measures at issue, protective tariffs, resulting low volumes and high sales costs or other
factors. It is also possible that the inquiry in so me cases can include an examination of other relevant
markets than the one in question to see if there is evidence of common end-uses of the products and
take that into consideration.

367 These are the criteria we have ex amined in this case. There may be other criteria more or less
relevant in other situations depending on the facts available.
368 Appellate Body Report on Japan –Taxes on Alcoholic Beverages II, supra., p. 25, quoting the Panel
Report, para. 6.22.

7.33 In this regard, it is worth noting that the panel in Korea – Taxes on Alcoholic Beverages
observed that:
End-uses constitute one factor which is pa rticularly relevant to the issue of potential
competition or substitutability. If there are common end-uses, then two products may
very well be competitive, either immediately or in the near and reasonably predictable
future.
369
7.34 The European Communities asserts that pisco and the imported distilled spirits are already
used by Chilean consumers for similar end-uses. The European Communities refer to a market
research done on the drinking habits of a representative sample of consumers. 370 The European
Communities argues that on the basis of the 1997 SM Survey, pisco and the imported distilled spirits
are consumed in the same way (straight, diluted with water, ice, soft drinks or fruit juice, and in
cocktails). The European Communities thus argues that there is a substantial overlap of end-use
between whisky and pisco, the two spirits which Chile emphasises as being the most different.
7.35 Chile raises questions on the probative value of the consumer surveys being relied on by the
European Communities. With resp ect to the discussion of end-uses, Chile disagrees with the results
of the 1997 SM survey. In Chile's view, questions that ask consumers what they would choose if their
preferred spirit were unavailable can only lead to abnormal and unpredictable answers. Chile also
points out that the data in the 1998 SM Survey 371 is a purported quantitative analysis, in which
consumers were faced with a hypothetical change in the prices of whisky, pisco and other spirits, the
results of which can only be misleading.
7.36 Chile argues that it is oversimplistic to concl ude that all spirits whose basic constitution is
water and alcohol, and which are drunk mixed in no t too different a manner, have necessarily the
same end-uses. In Chile's view, this argument is tantamount to saying that consumers' only
consideration is simply to have alcohol, irrespective of the form in which it is contained. Chile argues
that even wine and beer share these characteris tics and end-uses despite being different forms of
alcoholic beverages.
7.37 Chile further argues that assertions by the Eur opean Communities that the 1997 SM Survey
shows that both pisco and imported distilled spir its are consumed by Chileans in roughly similar
percentages at various occasions and in various places, e.g., discos, bars, at home after work, at
friends' homes etc., has no probative value. Accordi ng to Chile, the categories of end-uses offered by
the European Communities are simply too broad. Chile argues that pisco is more of a popular spirit in
Chile than the imported spirits, such as whisky, whic h tend to be more expens ive and, consequently,
are consumed by the wealthier segment of the population.
7.38 The parties disagreed over the appropriate breadth of categories of end-uses. The European
Communities' position is that if two spirits have sim ilar end-uses, it is a factor tending to show that
the two products are directly competitive or subs titutable. On the other hand, Chile asserts that
similar end-uses are common features applicable to every alcoholic beverage without being in any
way determinative of the question of direct competitiveness or substitutability.
7.39 In our view, the 1997 SM Survey provides some useful evidence about overlapping end-uses.
It tends to confirm the observation that distilled alcoholic beverages are used for relaxation and
socialisation in appropriate social settings. Chile's rebuttal largely turns on the observation that the

369 Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.78.
370 Comprehensive survey done by Search Marketing S.A., Santiago, December 1997 ("the 1997 SM
Survey"), EC Exhibit 21. See also the 1998 SM Survey (EC Exhibit 22) discussed more fully below.
371 See Table 23 in Descriptive Part of this Report.

evidence submitted by the European Communities prov es too much due to the broad nature of the
proposed categories of end-uses. Indeed, it may very well be that beer and wine can be used for some
of the same purposes and may very well share some of the same end-uses as distilled alcoholic
beverages. Beer and wine might be directly comp etitive or substitutable with some or all distilled
alcoholic beverages in the Chilean market, but that is not the subject of our inquiry. Moreover, that
does not detract from the probativen ess of the evidence in regard to the substitutability of distilled
alcoholic beverages.
7.40 We note that, while we find the 1997 SM Survey useful, we do not rely on this single piece of
evidence for our analysis. Rather, in the process of weighing all the evidence presented, we take the
1997 SM Survey into consideration in determin ing whether the imported and domestic distilled
alcoholic beverages are directly competitive or subst itutable. That some portions of the survey are
broad and if applied to other non-distil led alcoholic beverages might also show overlap of end-uses,
does not mean that the survey is irrelevant to our inquiry. To put it another way, it may be that
distilled alcoholic beverages are a subset of a broa der category of directly competitive or substitutable
products (and we make no findings in that regard), but that does not lead to the conclusion that the
subset at issue here is not made up of directly competitive or substitutable products.
7.41 We also note that there was a survey produ ced by the Adimark company (the "Adimark
Survey") for the Chilean industry and provided to the Chilean legislature during its deliberations on
changing the tax system for distilled alcoholic bevera ges. This survey was based on a very limited
number of persons, but persons who were chosen presumably quite carefully to be representative of
specific categories of Chilean cust omers. According to the survey, certain categories of consumers
found whisky and pisco quite subs titutable and would shift consumpti on to whisky in favorable price
conditions which could result from tax equalisation. This was particularly pronounced for young
consumers. Another category showed a willingness to increase whisky consumption initially in
response to these price changes, but could return more to pisco over the long run because of its
identification as a traditional Chilean drink.
7.42 While we note the limited nature of the sample s in this study, it confirms and highlights the
data and conclusions of other evidence such as th e 1997 and 1998 SM Surveys. There appears to be
no question that pisco is identified as the traditional drink of Chile. It is probable that pisco will retain
such identity regardless of the tax structure. Howe ver, the argument becomes tautological if it should
be claimed that pisco is the traditional drink and is, therefore, perceived somewhat differently so that
it may receive favorable tax treatment based on its character as a traditional drink. This would
amount to a difference in perception that is reinforced by the tax system and then used as justification
to maintain the favourable tax treatment itself.
7.43 Products do not have to be substitutable for a ll purpose at all times to be considered
competitive. It is sufficient that there is a pattern that they may be substituted for some purposes at
some times by some consumers. The Adimark Survey shows this. It is not extensive enough to show
the extent of such willingness, but we note that it was based on representative groups. The Adimark
Survey shows the price sensitivity of the demand for the product. There is an increased willingness to
try imports as the price changes in a manner reflectiv e of tax equalization. The Adimark Survey also
shows the nature of alcoholic beverages as an expe rience good. The sections of Chilean society most
reluctant to switch from pisco to imports is the gr oup with least exposure to such products. They
show a willingness to try imports if available at lowe r prices, but think they would go back to pisco in
the long run. Those with the greatest experien ce already with imports showed the willingness to
switch more readily. Furthermore, the Adimark survey shows the nature of the consumption
decisions at issue here. Distilled alcoholic bevera ges are products with low prices relative to income,
and therefore it is relatively easy to switch consump tion to another product fo r a portion of needs and
still maintain loyalty to familiar br ands on a broader basis. There can be some level of substitution

without fundamental changes in consumption pattern s such as might be required with respect to high
priced consumer durables.
7.44 We do not wish to over-emphasise the Adimark Surv ey. It is useful evidence, particularly
given that it was produced for use by the legislatur e and not commissioned strictly for the purposes of
this dispute, and that it was based on representative samp les of Chilean society. It is consistent with
other evidence.
7.45 As the Appellate Body has noted, Article III cases deal with markets.
372 The panel in Korea –
Taxes on Alcoholic Beverages noted the usefulness of examining marketing strategies in determining
whether products are substitutable. 373 Marketing strategies that highlight fundamental product
distinctions or, alternatively, underlying similarities may be useful tools for analysis.
7.46 The evidence of trends towards increasing overl ap in end-uses is supported by the marketing
strategies of the domestic Chilean companies. Thes e companies met the threat of imports of distilled
alcoholic beverages by, among other things, crea ting and selling premium pisco, which is more
expensive than ordinary pisco and is usually co lourfully presented as an up-market distilled spirit
generally having an alcohol content comparable to whisky, cognac or up-market brandy. The
complainants also produced eviden ce that these products were being advertised as competitive with
up-market imported distilled spirits.374
7.47 There is evidence that imported spirits and pisco are used similarly in various social settings –
homes, bars, discos etc. The advertising of pisco indicates to consumers that it is suitable as an up-
market distilled spirit which shows that the inte ntion by the producers is to put it in the same
competitive category with such up-market imports as whisky, cognac, brandy, etc. The various
surveys reviewed also show that consumers have an increased willingness to shift between domestic
and imported spirits for at least some purchases and some occasions. The current actual overlap in
end-uses plus the evidence of potential overlap, is supportive of a conclusion that pisco and the
imported distilled spirits are directly competitive or substitutable.375
(c) Physical characteristics
7.48 It is necessary to examine the ph ysical characteristics of the products at issue. In our view,
the closer the physical similarity the greater the likelihood of a directly competitive or substitutable
relationship.
7.49 The European Communities argues that pisco and the imported distilled spirits share the same
basic physical characteristics in that all have th e essential feature of being beverages containing
alcohol obtained using naturally fermented ingr edients by similar distillation processes. The
differences between pisco and whisky, according to the European Communities, are no greater than,
for example, differences between brandy and whisky. This implies that the different substances from
which brandy and whisky are distilled, that is grape wine and malted barley, are not fundamental
physical characteristics in determining substitutab ility. Other differences arise from post-distillation
processes such as ageing, colouring or flavouring that confer on each type of distilled spirit its own
identity. In the EC's view, however, the differences are not so important as to render the various types
of distilled spirits incapable of being directly substituted with each other by consumers.

372 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 25.
373 Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.95.
374 See EC Exhibit 51, Control's Recipe Brochure, EC Exhibit 52, Capel's Internet home page & Exhibit
54, Capel's advertising brochure.
375 We note that these conclusions with respect to end-uses support our conclusion that the identified
imported products should be considered as a single category.

7.50 Chile's response is that pisco and the importe d distilled spirits share virtually no common
physical characteristic other than containing alcohol and water. According to Chile, the ingredients of
pisco and say, whisky, are markedly different. Chile points out these two spirits are made from
different ingredients, pisco from grapes and whisky from grain. Chile further argues that the basic
similarities the European Communities refers to are me re characteristics of all distilled spirits and that
the ultimate physical characteristics, which consumer s use to distinguish between different types of
spirits, are determined by the other processes involved in the production of spirits.
7.51 We are of the view that an examination of th e physical characteristics of products is more
critical in determining whether two products are " like" than in the determination of whether two
products are directly competitive or substitutable. This does not mean, however, that products'
physical similarities should not be examined wh en determining whether products are directly
competitive or substitutable. The Appellate Body has noted that:
"Like" products are a subset of directly competitive or substitutable products: all like
products are, by definition, directly competitive or substitutable products, whereas not
all directly competitive or substitutable" products are "like".
376
7.52 Consequently, if two products are near ly physically identical, they are "like". 377 Because it
necessarily follows that they are also then directly competitive or substitutable, physical similarity is a
useful category of examination for our analysis in th is case. This is relevant where such activities as
marketing campaigns or government tax regimes, have created a distinction in consumer perceptions
between very similar products. Su ch distinctions that result from consumer perception are relevant
but not determinative of the nature of an actual or potential competitive relationship.
7.53 These physical similarities are relevant to the inquiry, particularly with respect to potential
competition. We regard the aspect of a product bei ng a potable distilled spirit with a high alcohol
content as an important defining characteristic.378 We note that all the products presented to the Panel
have this significant common feature.
7.54 In our view, the post-distillation differences due to the filtration, colouring or aging processes
of the beverages are not so important as to render the products non-substitutable. 379 We find these
differences relatively minor. There are some diffe rences imparted from such things as aging in
wooden barrels. Some spirits have added flavourings such as juniper berries in gin. But we also note
that pisco shares many identical physical characteris tics with other spirits made from grapes such as
grappa, cognac, brandy or "Peruvian pisco".380 Overall, weighing the evidence presented, we find that
the common physical features of the imported and domestic products are supportive of a finding that
the imported and domestic products in question are directly competitive or substitutable.381

376 Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., para. 118.
377 Panel Report on Japan – Taxes on Alcoholic Beverages II, supra., para. 6.22.
378 We note that alcoholic beverages containing only fermented ingredients cannot achieve as high a
concentration of alcohol as is possible through the distillation process.
379 See Tables 7 and 8 of the Descriptive Part of this Report. Indeed the panel in Korea – Taxes on
Alcoholic Beverages found that post-distillation differences between soju and imported spirits at issue in that
case were relatively minor compared to the common featur e of being potable distilled spirits. Panel Report on
Korea – Taxes on Alcoholic Beverages, supra., para. 10.67.
380 We note that the product labelled pisco by Peru is not allowed to use that appellation in Chile. Peru
claims that it has a disagreement with Chile over who has rights to the appellation. That question is outside our
terms of reference and we take no position on it and no implication should be drawn from our use of the term
"Peruvian pisco."
381 We note that these conclusions with respect to physical characteristics support our conclusion that
the identified imported products should be considered as a single category.

(d) Channels of distribution and points of sale
7.55 The European Communities argues that the 1997 SM Survey shows that all types of premises
market both pisco and the imported distilled spirits together. For both categories, the preferred outlets
are the same, supermarkets and liquor stores. The European Communities also argue that their
presentation in the retail outlets in the same shelf space is evidence of their substitutability.
7.56 Chile does not dispute the factual assertion that pisco and imported distilled spirits are sold in
the same sales channels and can even share shelf space, but does not agree th at this is evidence of
substitutability. According to Chile, such an argument is as unreasonable as an assertion that
toothpaste and soap are substitutable because they are sold in the same channels and share shelf space.
Chile also presented evidence showing that imports, a nd not pisco, are more likely to be distributed in
supermarkets than pisco, while pisco is more commonly available in traditional stores.
7.57 The Panel in Korea – Taxes on Alcoholic Beverages noted that:
[C]onsiderable evidence of overlap in channels of distribution and points of sale…..is
supportive of a finding that the identified imported and domestic products are directly
competitive or substitutable.
382
We agree with that panel's finding on this point. In the case before us, there is no dispute that the two
categories of distilled spirits are sold in similar sa les channels, albeit arguably in somewhat different
proportions, and indeed actually share shelf space. Chile has pointed out that many products share
shelf space, but cannot be considered substitutable becau se of that. That is of course true. However,
the consistent practice of putting these products on adjoining shelf space in similar outlets is one piece
of evidence supporting a finding of substitutability. If it is a coincidence that products happen to be
next to each other on shelves, one would not expect it to be repeated consistently.
7.58 It is also the case that complementary products are often grouped together to help in their
marketing. However, as revealed in our discussion of overlapping end-uses above, we find no
evidence that pisco and the imports are consider ed as complements by consumers in the way, in
Chile's example, soap and toothpaste might be.
7.59 In our view, if products have quite distinct ch annels of distribution that could be a negative
indicator with respect to substitutability. For example, if the products were regularly presented
separately, it would be one piece of evidence that perhaps consumers did not group them together in
their perceptions. In our view, the facts before us indicate an overall pattern of use of channels of
distribution, including the presentation of the products within those channels, that is supportive of a
finding that the domestic and imported products are directly competitive or substitutable.383
(e) Prices
7.60 The European Communities submitted that th e consumer survey in the 1998 SM Survey 384
shows that factors that have a direct impact on the prices of other spirits but not on the price of pisco
itself, affect the demand for pisco, which shows a directly competitive or substitutable relationship
between pisco and those other spirits. According to the European Communities, the survey measured
respondent's reaction to changes in the relative pric e of pisco and the other distilled spirits, and their
response indicates a significant degree of cross-price elasticity between pisco and other spirits. In

382 Panel Report on Korea – Taxes on Alcoholic Beverages, para. 10.86.
383 These conclusions with respect to channels of distribution and points of sale support our conclusions
that the identified imported products should be considered as a single category.
384 EC Exhibit 22.

such a scenario, the share of respondents choosing whisky and other spirits instead of pisco would
increase from 17.7% to 30.5%.
385
7.61 The European Communities further argues that th e survey showed that pisco consumers, by
an overwhelming majority (70%), would opt for othe r spirits if pisco was unavailable, and only 17%
would opt for wine or beer.386
7.62 The European Communities asserts that the 1998 SM Survey shows the immediate reaction of
consumers to price changes. Bearing in mind that the consumption of dis tilled spirits is based on
habit, which changes very gradually, short-term elasticities are bound to be much lower than long-
term elasticities. What this means, according to the European Communities, is that over a period of
time, the price changes resulting from the elimination of tax differentials are likely to lead to a shift in
consumption from pisco to other spirits by a larger degree.
7.63 To back up their claims on cross-price el asticity, the European Communities submitted a
study conducted on the Chilean distilled spirits ma rket in 1995 by the Gemines consulting group. 387
Chile also submitted a separate study with respect to the cross-price elasticity of pisco and imported
distilled spirits. 388 We note at the outset, that both this study and the Chilean data lack a model
incorporating the supply side, and as such all the variation in the data is interpreted as movements
along, or shifts of, the demand curve.
7.64 We also note that the studies relied on by both pa rties rely on small samples. In the case of
the Chilean data, the number of observations is pa rticularly low. In the case of the 1995 Gemines
study, it lacks data for the key independent variable , the price of whisky, for almost half the sample
period. For these reasons we treat these studies with caution.
7.65 The European Communities argues that the 1995 Gemines study, which was actually done for
the Chilean pisco industry, provides further evid ence of significant cross-price elasticity between
pisco and whisky. The European Communities not es that the Gemines study, which estimated the
cross-price elasticity between pisco and whisky on the basis of historical sales and price data in the
period 1985-92, found a cross-elasticity rate between pisco and whisky of 0.26%, indicating that if the
price of whisky went up by 10%, the sales volum e of pisco would increase by 2.6%. The European
Communities point out that the Gemines study found that on this basis, pisco and whisky are
"substitutes albeit to a limited extent".389
7.66 The European Communities states that another Gemines study done in 1996, whose findings
were widely published, concluded that a reduction in the tax on whisky by 50% would lead to a 47%
drop in the price of whisky, which would in turn lead to a 17% drop in the demand for pisco.390

385 See EC First Submission, Table 19.
386 Ibid., Table 17.
387 The Possible Effects on the Pisco Industry of a Reduction in the Tax on Whisky , Gemines,
August 1995 (the 1995 "Gemines Study"). This study apparently was commissioned by the Chilean pisco
industry.
388 See Annex II, Chile First Submission.
389 1995 Gemines study, p.61, EC Exhibit 20.
390 1996 Gemines study, as reported in El Diario, 2 July 1996, EC Exhibit 30. This evidence submitted
by the European Communities indicating a significant cross-price elasticity is all the information we have about
this report. We note that Chile wa s requested to submit a copy of this report. Chile was unable to do so.
According to Chile, the study is the property of the pisco industry which refused to make it available due to
alleged flaws in the results as well as confidential business information cont ained therein. Chile argues that
neither it nor its industry is compe lled to submit such information. We find the decision of Chile and its
industry regrettable. Confidential bu siness information can be protected. If there are alleged flaws in an

7.67 Chile points out that the EC's main evidence, 1998 SM survey, shows a remarkable lack of
reliability. For instance, in the case of whisky, Chile argues that a more detailed analysis shows that
whisky has a price elasticity of negative 5, meaning that a 10% reduction in price will lead to a 50%
increase in volume, a result which is, accord ing to Chile, completely out of range.
391 Chile further
argues that the elasticities on the other spirits do no t deserve any comment because of their unrealistic
results. We note, however, that the surveyors compared the envisaged reaction of the survey
respondents to preferences expressed after the pric es of pisco, whisky, and "other spirits", have
changed in response to a hypothetical situation of a tax of 27% ad valorem being applied uniformly to
all distilled spirits. Elasticity of substitution is a "p artial concept" in that it is a measure of the
relationship between one quantity and one price and assu mes that all other factors are held constant.
For example, a cross-price elasticity measurement could hold the price of pisco constant, decrease the
price of whisky and determine the changes in quantity of pisco. In this study, because prices change
simultaneously, the outcome of changes in th e quantity demanded do not allow the accurate
computation of either own-price or cross-price elasticities since the other explanatory variables did
not remain unchanged (i.e., the ceteris paribus requirement in this type of analysis has not been
provided for, and partial derivatives have not been determined).
7.68 The question arises, as to how a panel should deal with concepts such as cross-price elasticity
in determining whether two classes of products ar e directly competitive or substitutable. In Japan –
Taxes on Alcoholic Beverages II , the Appellate Body affirmed the decision of the panel to look at the
economic concept of "substitution" as one means of examining relevant markets. However, the
Appellate Body emphasised that this should be c onsidered together with all other legitimate
considerations, in the aggregate, in determining direct competitiveness and substitutability, i.e., the
use of cross-price elasticity of demand is not th e decisive criterion, but merely one among other
criteria, such as physical characteristics, common end-uses, etc.392
7.69 The Panel wishes to emphasise that the concep t of substitution in markets should not be
confused or equated with a numerical measurement of the extent of substitution as found in the co-
efficient of cross-elasticity. The existence of substitution between pisco and imported distilled
beverages lies at the heart of this dispute and is th e fundamental issue in light of both the treaty text
and in terms of analytical approach. Howeve r, the econometric measurement of the degree of
substitution may not, partly for the reasons discussed below, always adequately reflect the extent of
substitution.
7.70 A high coefficient of cross-price elasticity would of course lend more credence to a claim of
direct competitiveness or substitutability, although a low coefficient of cross-price elasticity is not
necessarily fatal to a claim of direct competitiveness or substitutability. Indeed, a low coefficient of

otherwise relevant study, the party can submit comments in that regard. Chile has done so with respect to the
1995 Gemines study which was also a study commissioned by the Chilean industry. It is true that there is no
compulsory discovery process in WTO dispute settlement proceedings. However, the overall dispute settlement
process cannot work fairly and efficiently either at the consultation or panel stage if relevant evidence is
withheld. In this case, the Chilean pisco industry deci ded to withhold this evidence . While it is the Chilean
government which is party to this case, it would be unr ealistic and artificial to argue that the panel should not
address the issue based on this distinction given the direct underlying economic interest of the Chilean industry.
Thus, Chile did not avail itself of the opportunity to re but the evidence presented by the European Community.
(See also the Panel Report on Indonesia – Certain Measures Affecting the Automobile Industry , adopted on 23
July 1998, WT/DS54, WT/DS55, WT/DS59, WT/DS64, paras. 14.230-14.235. We note that this case involved
the failure of a complainant's industry to submit evidence supporting complainant's case, but we agree generally
with the point that parties and their industries should not be able to withhold relevant evidence and expect
panels to view it favourably.).
391 See Chilean Statement at Second Meeting at pp. 12-14.
392 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p.25.

cross-price elasticity may be due to the very measures in question in the dispute. In this regard, the
Appellate Body stated that:
[A] tax system that discriminates against im ports has the consequence of creating and
even freezing preferences for domestic goods. In the Panel's view, this meant that the
consumer surveys in a country with such a tax system would likely understate the
degree of potential competitiveness between substitutable products.
393
7.71 It is our view that in general economic terms, a high estimated coefficient of elasticity would
be important evidence to demonstrate that products are directly competitive or substitutable provided
that the quality of the statistical analysis is high. In this case, in the 1995 Gemines study, for example,
a cross-price elasticity of demand for pisco with resp ect to whisky of 0.26 was obtained, which is low
(a 10% rise in the price of whisky will lead to an increase of only 2.6% in the demand for pisco).
Nonetheless, we accept this as eviden ce of substitutability, recognising that some of the other factors
discussed below are also indirectly influenced by the price of whisky and may have an impact on the
market. We continue to recognise the above-menti oned need for caution in light of concerns about
the quality of a particular statistical study.
7.72 Customs, traditions and consumer preferen ces embodied in brand loyalties could render
demand less sensitive in the short run to changes in price and in come than would otherwise be
expected. It has been noted that alcoholic beverages are "experience goods" for which demand
changes only slowly as consumers become gra dually more familiar with new products. 394 We also
think that the estimated elasticity would have been higher, had whisky been less expensive and we
note that the whisky imported into Chile tends to be at the higher end of the price range for distilled
spirits generally. Whisky is taxed at a much higher rate than pisco and we also note that tariffs on
imported spirits were high for a long period of time. These factors, which include the very measures
at issue here, can have a noticeable impact on the pr ice of the imports, both directly and indirectly.
For instance, the tax and tariff st ructure can change product offerings towards more expensive items
and partly as a result, increase other costs such as distribution. If the retail price of whisky were lower
than what it is now, or other normally lower priced products were readily available in a neutral tax
setting, it is not unreasonable to expect based on the information before the panel that new customer
groups could be attracted and the actual cross-pr ice elasticity would be higher than the current
estimates.395
7.73 All these factors point to the logic in the Appellate Body's reasoning in the Japan – Taxes on
Alcoholic Beverages II case, that undue weight should not be placed on estimated price-elasticity,
demand-elasticity or cross-price elasticity. Studies that attempt to measure the relationship between
dependent and independent variables and are only part of the totality of factors a panel should take
into account in determining the question of direct competitiveness or substitutability.396
7.74 As we have already noted, Chileans consider pisco as a traditional or national drink. We
further noted that this does not mean that pisco cannot be substituted for at any time and at any

393 Panel Report on Japan – Taxes on Alcoholic Beverages II, supra, para. 6.28, citing Panel Report on
Japan – Taxes on Alcoholic Beverages I, supra., para. 5.9.
394 Appellate Body Report on Korea – Taxes on Alcoholic Beverages , supra., para. 123 citing the
Panel Report on Korea on Alcoholic Beverages, paras. 10.44, 10.50 and 10.73.
395 The Panel in Japan – Taxes on Alcoholic Beverages II specifically noted that calculated cross-price
elasticities in cases such as these will generally underestimate the actual degree of substitutability. Panel Report
on Japan – Taxes on Alcoholic Beverages II , paras. 6.28 and 6.31. This was expressly approved by the
Appellate Body in that case and reitera ted in the Appellate Body decision in Korea – Taxes on Alcoholic
Beverages. Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., para. 120.
396 See Appellate Body Report in Japan – Taxes on Alcoholic Beverages II, supra., p. 25 and Appellate
Body Report on Korea – Taxes on Alcoholic Beverages, supra., paras. 120-123 and 134.

occasion. In this regard, we note that Chile submitted that pisco, in any of its categories, has a pre-tax
price that is substantially lower than whisky, and that consequently taxation has no real effect on retail
prices.
397 We also note the EC response that Chile is comparing the price of a relatively expensive
brand of whisky such as Johnnie Walker, with an inexpensive brand of pisco. The European
Communities also points out that the differences in prices between different varieties of pisco can be
as large as differences between prices of a particular variety of pisco and say, whisky.
7.75 We agree with the European Communities on the question of price differences between pisco
and imported distilled spirits. From the evidence before us, it is clear that one cannot speak of a price
difference between pisco and all imported distilled spirits. The price differences are only relative,
depending on which variety of pisco is being compared with which imported distilled spirit. To assert
that all pisco is within a certain price range and a ll imported spirits in another price range is to go
against the weight of evidence.398 What is important is the effect of relative price movements, since it
is relative prices and their changes that influen ce consumer behaviour in the dynamic situation of
changes in the demand for directly competitive or substitutable products.399
7.76 It is, therefore, arguable that the retail price levels of imported distilled spirits, such as whisky,
could have been influenced by the taxes at issue in this dispute. Despite this, as we have noted, there
is some degree of cross-price elasticity between pisco and the imported distilled spirits including
whisky (which as we have earlier noted, Chile finds most difficult to envisage being substitutable with
pisco).
7.77 As we noted, earlier cases have stated that the concept of cross-price elasticity is a strong
indicator of substitutability. As we also observed above, a low estimated coefficient, as determined in
the study submitted by the European Communities and the data from Chile, is not in itself conclusive
that substitutability does not exist. We further not e that studies that measure elasticity applied to
historical data may reveal little about the potential for substitution and competition.
7.78 In the case before us, we find it significant that the studies indicate some degree of cross-price
elasticity, indicating a potential for substitutability. The level of the elasticity may be a function of
actual retail price levels, which c ould be influenced by taxation and other factors such as past
measures, including tariffs, as well as higher distri bution costs and other factors resulting from lower
volumes.400 In our view, therefore, the evidence presen ted by the data in the various studies and
surveys is supportive of the other factors in arrivi ng at a determination that pisco and the imported
distilled spirits are directly competitive or substitutabl e. In this regard, we agree with the panel in
Korea – Taxes on Alcoholic Beverages when it stated that:
[T]he question is not of the degree of competitive overlap, but its nature. Is there a
competitive relationship and is it direct? It is for this reason, among others, that
quantitative studies of cross-price elasticity are relevant, but not exclusive or even
decisive in nature.401

397 Table I, Annex I, Chile First Submission.
398 We also note that there are other distilled spirits imported into Chile in relatively smaller quantities
that are often sold at lower prices than many brands of whisky. We also note the EC's argument that small
import volumes, due in part to the ta x differentials, can lead to a concen tration of imports in higher price
categories.
399 See Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.94.
400 See Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., paras. 122-123.
401 Panel Report on Korea – Taxes on Alcoholic Beverages , supra., para. 10.44. See also Appellate
Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p. 25, and Appellate Body Report on Korea –
Taxes on Alcoholic Beverages, supra., paras. 120-123 and 134.

7.79 We find, therefore, that the existence of cro ss-price elasticity between pisco and the imported
distilled spirits, although at a low level in the studi es, is further indication of a directly competitive
and substitutable relationship between the two.
4. Conclusions with respect to "directly competitive or substitutable"
7.80 Substitutability and competitiveness refer to the ability of products that may be dissimilar in
some respects to satisfy a particular consumer want . This definition would suggest that "end-use" is a
very important indicator of substitution.
7.81 In our view, studies or surveys that rev eal the following all serve as evidence of
substitutability in end-uses:
(i) a tendency among consumers to regard products as substitutes in satisfying a
particular need;
(ii) that the nature and content of marketing st rategies of producers indicate that they are
competing for the expenditure of potential consumers in a particular market segment;
and
(iii) that distribution channels are shared with other goods;
7.82 In evaluating substitutability in end-use, it may be useful in this regard, to refer to an
approach in consumer theory which has been gaining ground.
402 According to the theory, goods are,
in the eyes of consumers, never really perceived as commodities that are in themselves direct objects
of utility; rather, it is the properties or character istics of the goods from which utility is derived that
are the relevant considerations. It is these charac teristics or attributes that yield satisfaction and not
the goods as such. Goods may share a common character istic but may have other characteristics that
are qualitatively different, or they may have the sa me characteristics but in quantitatively different
combinations. Substitution possibilities arise because of these shared characteristics. The oft-cited
hypothetical textbook example of butter and margarine may be instructive. Butter and milk are both
dairy products that share important characteristics that margarine does not have. However, butter and
margarine each have combinations of characteris tics that make them good substitutes as compliments
for bread, which is not the case with milk. The characteristics of butter and margarine can be
expressed as physical properties such as spreadability , taste, colour and consistency. These physical
characteristics combine to render both products good substitutes as bread complements. The latter
represents the end-use of the commodities as determ ined by their combination of characteristics
derived from certain physical characteristics.
7.83 In our view, the same type of reasoning can be applied to the substitutability of pisco and
other spirits such as whisky, brandy, cognac, etc. With respect to whisky and pisco, although the two
spirits are distilled from different substances, namely barley and grapes respectively, they share the
characteristics of being potable liquids with high al cohol content, which is the product of distillation,
as well as being receptive to mixing with non-alcoholic be verages. In any event, even the differences
in ingredients between whisky and pisco is not sufficient to render these two distilled alcoholic spirits,
both of which have a high alcohol content and more or less satisfy a similar need, incapable of being
substituted with each other. As for brandy, cognac a nd some other spirits, we have already noted that
the differences in physical characteristics are onl y post-distillation differences such as colour and
smell which are not sufficiently significant to chan ge the basic character of spirits essentially made
from grapes or other fruits.

402 See Kelvin J. Lancaster, "A New Approach to Consumer Theory", in Journal of Political Economy,
Vol. LXXIV (April 1966), pp. 132-157.

7.84 We should stress that the complainants did not ha ve to prove that there is a complete overlap
in their analysis of substitutability. We take note in this regard, as discussed above, that the
negotiators of what became Article III:2, second sentence, considered, inter alia , that apples and
oranges were directly competitive or substitutabl e products. Moreover, we take guidance from the
earlier panel findings which found that current market conditions may be distorted by government tax
and regulatory policies which tend to freeze consumer preferences in favour of the domestic products.
We do not agree that there are pre-tax price di fferences in the present case of such a level as to
establish that the products in question are not even potentially competitive. In addition, after-tax price
differences are partly a function of the tax system bot h in direct impact and indirectly through other
factors such as product availability and distribution costs.
7.85 The complainants have established that, as be tween pisco and the imported distilled spirits,
there is certainly a degree of current competition an d the likelihood of greater competition in future.
We also note that the production and marketing deci sions of the pisco producers also reflect such a
realisation. The evidence submitted
403 clearly shows their desire to convey an image of pisco as a
drink that competes with the best imported distilled spirits. We believe that when a product is being
marketed in ways that suggest that it is in co mpetition with the most up-market imported distilled
spirits, this is evidence of at least potential compe tition with those imports. In addition, evidence of
actual or potential competition must be viewed in the context of the fact that consumer habits on
consumption of distilled spirits only change gradually over time. 404 We are of the view that the
totality of the evidence presented supports a finding that the imported distilled spirits, and pisco are
directly competitive or substitutable.
7.86 We also note that our findings are consistent with a recent opinion of the Chilean Central
Preventive Commission 405 ("the Commission") which, in deciding on a merger between two major
pisco producers, stated that:
[T]here are two conditions that must be met for a monopoly to exist:
(i) Non-availability of substitute products for pisco; and
(ii) Existence of barriers to entry preventing new pisco growers from entering the market.
With respect to the first condition, the Commission w as satisfied that this was not the position in the
Chilean market because:

403 See EC Exhibits 50-54.
404 Some of the imported products have an extensive history in the marketplace. Whisky, for example,
has long been present in the Chilean market and subject to high duties and/or taxes. However, we note that the
taxes and duties on whisky were increased substantially in the 19 80's, which appeared to result in a substantial
and sustained loss of market share.
405 In its submission dated 23 November 1998, the European Communities provided some commentary
on the Commission paper. Subsequently, Chile argued that the EC had not requested nor been granted
permission to file such comments. Chile requested permission to file further comments itself or, in the
alternative requested the Panel disregard the EC's comments. The Panel decided not to grant Chile's request for
further time for commentary, given that the Commission paper was a document of the Chilean government that
was issued 11 days prior to the seco nd substantive meeting of the Panel w ith the parties. Chile, in fact, did
make some comments on the Commission paper at that meeti ng. We agreed to take into further consideration
Chile's alternative request and have decided to grant it. The European Communities did not ask for time to
make further comments on the Commission paper and chos e to submit its comments in a submission that was
explicitly limited by the Panel to commentary on other do cuments. Accordingly, we will disregard the EC's
comments on the Commission paper.

The broad range of substitute products for pisco available in the liquor segment of the
alcoholic beverages market should allow a full substitution in view of the "premium"
that consumers are willing to pay for the specific features offered by pisco.
406
The Commission also observed that:
[T]he market for alcoholic be verages is the pertinent mark et for pisco. This market
includes beer, wine and liquor. Specifically, pisco participates in the segment formed
by liquor, brandies and distilled liquor, in a particular niche covered by appellation
regulations.407
Ultimately, the Commission concluded that:
[P]isco faces major competition from other al coholic beverages, such as wine, beer
and whisky, due to the usual practice of drinking pisco diluted with non-alcoholic
beverages. Therefore, in the market for alcoholic beverages,…….there are
alternative products which consumers of alcoholic beverages can choose to drink
(emphasis supplied).408
7.87 We note that the Commission was dealing with the question of competition from an anti-trust
perspective, which generally utilises narrower market definitions than used when analyzing markets
pursuant to Article III:2, second sentence. 409 Consequently, it seems logical that competitive
conditions sufficient for defining an appropriate ma rket with respect to anti-trust analysis would a
fortiori suffice for an Article III analysis. We woul d, therefore, regard the findings of the
Commission as tending to confirm the finding that in the Chilean market, pisco and imported distilled
spirits are directly competitive or substitutable products.
7.88 In summary, we are of the view that there is sufficient unrebutted evidence in this case to
show both present and potential direct competition between the two categories of products.
Accordingly, we find that the evidence concerning physical characteristics, end-uses, channels of
distribution and pricing (including cross-price elasticity), 410 leads us to conclude that the imported
and domestic products at issue in this case are directly competitive or substitutable.

406 Legal Opinion adopted by the Central Preventive Commission, Merger of Pisco-Manufacturing
Cooperative Societies CAPEL and Control, Case Record No. 107-97, pp. 4-5.
407 Ibid., p. 2.
408 Ibid., p. 8.
409 The panel in Korea – Taxes on Alcoholic Beverages was of the view that the definition of a market
in anti-trust is not the same as under Article III. Th e panel felt that because the two concepts (anti-trust and
competitive opportunities under Article III) are designed to address different concerns their definitions of the
market need not be the same. According to the panel, since Article III is primarily concerned with competitive
opportunities it defines markets more broadly than anti-trust which is designed to protect the actual mechanisms
of competition. See Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.81. We agree with
that panel's conclusions on the general relationship of the definition of markets in anti-trust cases and under
Article III.
410 The European Communities argued that tariff cl assification can be important in determining
whether products are directly competitiv e or substitutable. In this case, the European Communities referred to
the 4-digit Harmonized System category 2208 as such evidence. Chile responded that 4-digit classifications are
too general to be of much analytical use and in some cases contained products which Chile maintained clearly
were not substitutable. We note th at the Appellate Body and previous panels have referred to the tariff
classifications of products in making determinations. However, two issues must be taken into account. First, is
the classification sufficiently narrow to be of much probative value? Chile has a valid point in urging caution in
this regard. Second, is relying on tariff classifications merely duplicative of examinations made in greater detail
for the specific market in question in regard to such fact ors as physical characteristics and similar end-uses? In

D. "
NOT SIMILARLY TAXED"
1. General
7.89 The Appellate Body in Japan – Taxes on Alcoholic Beverages II stated that "to be 'not
similarly taxed', the tax burden on imported products must be heavier than on 'directly competitive or
substitutable' domestic products and that burden must be more than de minimis in any given case". 411
The Appellate Body noted that this determination must be made on a case-by-case basis.
7.90 In our view this means that panels should look at the particular market in question and the
products themselves. That is, there is no set le vel of tax differential wh ich can be considered de
minimis in all cases. This follows fro m the Appellate Body's observation that with respect to "like
products" the similarities between the products are so strong that it can be presumed that any
differential in taxation will have an impact on th e market. However, when products are somewhat
different, but are still directly competitive or substitutable, then de minimis differences in taxation are
permissible because it is not necessarily true that sma ll differences in tax levels will have an effect in
the market.
7.91 For some products a very small di fference in tax levels could be de minimis, a difference that
would be too large to be considered de minimis for other products. As always in cases such as these,
the determination must be based on examination of the market in question, the market of the
respondent Member. However, caution must be used because the very taxes in question, as well as
other governmental policies, may have had an impact on the market resulting in difficulty determining
whether a relatively small level of differentiation is de minimis or does indeed have a discernable
effect on the market.
7.92 We must also note that this examination of whether products are similarly taxed or not
involves no evaluation of the purpose or effect of the differences. Dissimilar taxation is not in itself
inconsistent with Article III:2, second sentence. It is only inconsistent if such tax differentials are
applied in a manner so as to afford protection.
2. Transitional System
7.93 The Transitional System took effect on 1 Dece mber 1997 and lasts until 1 December 2000.
The Transitional System continues the pre-existing system of differentiation based on three categories
of distilled beverages: pisco, whisky and "other sp irits." Prior to the beginning of the implementation
of the Transitional System, whisky was taxed at 70% ad valorem, while other spirits were taxed at
30% and pisco at 25%. The rates for pisco and other spirits remain the same throughout the period of
the Transitional System. For the 12 months be ginning on 1 December 1997 the rate on whisky
dropped to 65%, falling to 59% for the 12 months beginning on 1 December 1998, to be reduced
further to 53% for the final twelve month period the Transitional System is in effect.
7.94 The European Communities argues th at these tax differentials are qu ite large and, even at the
lowest differential in the final period of the Trans itional System, the rate for whisky (53%) is more
than double the rate for pisco (25%). The EC argues that this is more than de minimis. The European
Communities also argues that pisco will be taxed at a lower rate than the category of "other spirits".
The European Communities states that, while the differential is lower th an with respect to whisky, it

our view, with respect to the Chilean market, there is no t a great amount of probative value in referring to HS
2208 in light of other evidence available, but we note that the classification is consistent with our conclusions.
411 Appellate Body Report on Japan – Taxes on Al coholic Beverages II , supra., p. 27. See also
Appellate Body Report on Canada – Periodicals, supra., at 29.

is still large enough to be capable of affecti ng the competitive relationship between the products,
citing the 1998 SM survey.
7.95 Chile does not contest the EC's arguments with respect to the Transitional System, relying
instead on its arguments that the domestic and imported products are not directly competitive or
substitutable.
7.96 It is obvious that the level of difference in taxation between the imported and domestic
products is greater than de minimis . We note that there is Chilean production of both whisky and
other spirits, but by definition there are no impor ts of pisco. Whisky (imported and domestic)
currently is taxed at more than twice the rate of pisco. While this difference will narrow somewhat
next year, it clearly will remain more than de minimis. With respect to other spirits (again, including
both domestic and imported) the diffe rence is five percentage points ad valorem . The 1998 SM
Survey indicates that such a difference has an impact and is greater than de minimis. Chile does not
contest the EC's arguments and evidence to the effect that this is greater than de minimis in the context
of distilled alcoholic beverages in Chile.
7.97 We are of the view that under the Trans itional System imported and domestic distilled
alcoholic beverages are not similarly taxed. Th e fact that some of the domestic production (e.g.,
products such as Chilean whisky) is similarly taxed is i rrelevant to this step of the analysis. That is, it
is sufficient to find that certain of the imports are taxed dissimilarly compared to certain of the
domestic substitutable products. It is not necessary to show that all of the imports are taxed
dissimilarly to all of the domestic products.
412
3. New Chilean System
7.98 The New Chilean system becomes effective on 1 December 2000. 413 The distinction between
types of distilled alcoholic beverages utilised in th e Transitional System is eliminated. Instead, the
New Chilean System assesses taxes on an ad valorem basis that varies according to alcohol content.
All distilled alcoholic beverages of 35° of al cohol or less are taxed at the rate of 27% ad valorem.
The rate increases by four percentage points ad valorem per degree of alcohol content through 39°,
topping out at a rate of 47% ad valorem for alcoholic beverages of higher than 39°.
7.99 The European Communities argues that this system still taxes the domestic and imported
products dissimilarly. They claim that 90% of pi sco sales will be taxed at the lowest rate of 27%
while imports such as whisky, vodka, rum, gin and tequila will be taxed at 47% while brandy will be
taxed at no less than 39 %. The European Comm unities notes that under Chilean law, whisky, vodka,
rum, gin and tequila must contain at least 40° of alcohol.
7.100 According to the European Comm unities, the New Chilean System cannot be considered as a
tax on alcohol content, because it is applied on th e value of the beverage as a whole and not on the
value of the alcohol content. Moreover, the Eur opean Communities argues that the value of distilled
spirits is not directly related to alcohol cont ent. For those reasons the European Communities
considers that, in order to determine whether pisco and the other spirtis are "similarly taxed", we
should compare the rates per bottle of each spirit. Such ad valorem rates are manifestly different
varying between 27% and 47% in steps of four per centage points and such differences are clearly not
de minimis. In the alternative, the Eu ropean Communities argues that, at any rate, pisco and the other

412 See Appellate Body Report on Canada – Periodicals, supra., p. 29; Panel Report on Korea – Taxes
on Alcoholic Beverages, supra., para. 10.100 (fn. 412).
413 The new Chilean System has been enacted but not implemented. There appears to be no discretion
allowed in its enforcement. The law is certain and definitive. We consider it appropriate to examine the law to
determine its consistency with Article III:2, second sentence. Neither party has argued to the contrary.

spirits are also "not similarly" taxed when one compares the rates per degree of alcohol. The rates
vary from 0.771% per degree of alcohol at the level of 35° of alcohol to 1.175% per degree of alcohol
for beverages at 40°, which is a rate of taxa tion more than 50% higher per degree of alcohol.
414
According to the European Communities, this difference also is more than de minimis.
7.101 Chile responds that the New Chilean System is based on objective and neutral factors. In
Chile's view, the criterion of alcohol content was recognized by the panel in Japan – Taxes on
Alcoholic Beverages I as a permissible objective means of taxation. Chile notes that that case
involved non-taxable thresholds and taxes applied in a manner not directly proportional to alcohol
content and that the panel did not object to eith er characteristic. In Chile's view, there is no
requirement in GATT/WTO jurisprudence for the pr oposition that tax systems must be directly
proportional.
7.102 Chile argued that it has many products in the higher tax ranges of the New Chilean System,
including gran pisco and pisco reserve, as well as locally produced brandy, rum, gin, vodka and
whisky. Chile also notes that the European Communiti es produces many spirits that contain 35°
alcohol or less. Chile states that according to th e EC's arguments, the EC tax structures would also
produce dissimilar taxation. According to Chile, it all depends on how one looks at the issue.
Specific tax systems are preferential to high priced products, while ad valorem tax systems are
preferential to low priced products. Chile made extensive arguments with respect to the taxation
system of EC member states to show that such systems were not proportional or could be considered
discriminatory depending on how they were viewed.
7.103 In our view the question of dissimilar taxation is relatively straightforward. It does not
involve judgements about the objectivity of the laws or regulations involved. It does not involve an
assessment of who benefits from the tax system. It does not involve an examination of the design,
structure or architecture of the law in question. Such inquiries are relevant only to the next step of our
analysis; namely, whether any system of dissim ilar taxation has been applied so as to afford
protection to domestic production. All we are doing at this point is determining whether there is
dissimilar taxation of directly competitive or subs titutable imported and domestic products. Even if it
were to turn out that the large majority of impor ted products benefited from a particular tax, that
would be irrelevant to this stage of the analysis. Our only issue here is to identify whether there is
dissimilar taxation.
7.104 We note Chile's references to the panel report in Japan –Taxes on Alcoholic Beverages I , but
we also note that the method of analysis in that case, as well as in the panel finding in Japan – Taxes
on Alcoholic Beverages II, was somewhat different from the test utilised now. In those panel reports
there was not clear demarcation between the analysis of "dissimilar taxation" and "so as to afford
protection". The Appellate Body in Japan – Taxes on Alcoholic Beverages II made it clear that panels
should review the matter in two distinct steps. 415 Some of the Chilean argumentation with respect to
the question of dissimilar taxation is more appropriately considered in the next step of our analysis.
7.105 We do agree with the Chilean observation that tax systems can appear dissimilar depending
on how one looks at them. However, we do not think that observation is relevant to our
consideration.
416 A tax system based on taxing value is generally considered not to be applying

414 The European Communities suggests that there is a third typical method of taxation which is based
on volume without reference to value or alcohol content. However, this type of taxation is not used in whole or
part in the New Chilean System.
415 See also Appellate Body Report on Korea – Taxes on Alcoholic Beverages, supra., para. 107.
416 If taken further, one could argue that an overa ll system of indirect taxation provides dissimilar
taxation if viewed from the perspective of direct income taxation. Such an observation may not be inaccurate,
but it also is largely devoid of meaning.

dissimilar taxation if done on a purely ad valorem basis (i.e., a single ad valorem rate applied
uniformly to all products). The difficulty in evaluating the New Chilean System is that it is not
strictly an ad valorem system. It applies ad valorem rates that vary not just by the value but qualifies
the rate by alcohol content.
7.106 With respect to Chile's argument that it is permitted to choose any objective criteria it wishes
in formulating its tax system, we make the following observations. First, we note that the justification
of "objective criteria" is troublesome in this regard . Some of the arguments on objectivity are, as we
stated, relevant to the third step of the analysis, if at all. Second, it is unclear whether any "objective
criteria" would suffice even in Chile's proposal. Wo uld it be permissible, for instance, to tax white
spirits differently from brown spirits? The color of spirits is a major dividing line in consumer
perception of distilled alcoholic beve rages and is certainly "objective" in that it is fairly clear into
which category a particular beverage would fall. However, use of such "objective criteria" could
result in different taxation of, for example, white rum and dark rum, which would be completely
arbitrary. Thus it is clear that Chile's reliance on the argument that its system is based on "objective
criteria" is not sufficient.
7.107 To argue as Chile does that there is no rule requiring proportionality is rather beside the point.
Even utilising the EC's system of expressing the difference of percentage points per degree of alcohol,
an evaluation of the nature of the system still involv es mixing together two types of criteria. It is not
clear that, even if proportional with respect to some particular products, assessing an ad valorem tax
qualified by the additional criterion of alcohol content would result in a system of taxation that would
survive examination under this step of the analysis . In this case, a statement that the New Chilean
System does not assess taxes in a proportional manner is merely another way of stating that it is not
really an ad valorem system strictly speaking (and certainly is not a specific system).
417
7.108 We reiterate our observation in the section above that a system of taxation which results in
non-de minimis dissimilar taxation of directly competitive or substitutable products is not in itself
inconsistent with Article III:2, second sentence. It is only inconsistent if such a dissimilar system of
taxation is applied so as to afford protection to dom estic production. We, in fact, agree that a system
which mixes criteria, and possibly even one that explicitly treats imported and domestic directly
competitive or substitutable (but not "like") products differently, is not necessarily GATT-inconsistent.
However, such a system could be found to involve dissimilar taxation and, therefore, require further
analysis under the third step.
7.109 Chile has suggested that saying that the Ne w Chilean System involves dissimilar taxation
would be condemning luxury tax systems. However, in the context of the products involved in this
case, a luxury tax system would be an ad valorem tax system that increased rates as the value of the

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

products increased, not as some specific characteristic changed. Thus, for example, a system that
assessed taxes at a rate of 20% for products va lued between 1000 and 5000 pesos, 30% for products
valued between 5,000 and 10,000 pesos, and 40% for products valued above 10,000 pesos and so on
might arguably constitute a luxury tax. However, varying the ad valorem rate based on alcohol
content does not necessarily tax high priced goods at a higher rate because the additional criterion of
alcohol content is not necessarily related to value. Therefore, we need not reach the issue of whether
luxury tax systems are consistent with the requirements of Article III:2, second sentence.
418
7.110 The difference in taxation between the top (47%) and bottom (27%) levels of ad valorem
rates of taxation of distilled alcoholic beverages is clearly more than de minimis and is so by a very
large margin. Indeed, it is obvious that the differe nce of four percentage points between the various
levels of alcohol content also constitutes a greater than de minimis level of dissimilar taxation. 419
7.111 Furthermore, if viewed from the perspective of specific taxation the difference of over 50%
per degree of alcohol between pisco of 35° (0.7 71 percentage points per degree of alcohol) and
whisky and other imports of 40° (1 .175 percentage points per degree of alcohol) is much greater than
de minimis. We also are of the view that the differential between the individual degrees of alcohol are
more than de minimis. For instance, spirits of 35° are assessed taxes at 0.771 percentage points per
degree of alcohol; spirits of 36° are assessed at 0.861 percentage points per degree of alcohol; and
spirits of 37° are assessed at 0.946 percentage points per degree of alcohol. These are significant
percentage differences.420
7.112 We also wish to be clear that we are not conc luding that any "hybrid" system must result in
dissimilar taxation. For one thing, such a broad conclusion would require further examination of the
definition of the term "hybrid." For another, it w ould be beyond our terms of reference. Rather, our
finding is that this particular system utilised by Chile results in dissimilar taxation that is not de
minimis.
7.113 As with our finding above with respect to th e Transitional System, the fact that some
imported and domestic distilled alcoholic beverages could in particular factual circumstances be
assessed identical taxes, or di fferent taxes at less than de minimis levels, does not change our
conclusion.421 It is sufficient for this step of the analys is to find that some of the imports are being
taxed dissimilarly from some of the domestic production and the difference is more than de minimis.
E. "SO AS TO AFFORD PROTECTION TO DOMESTIC PRODUCTION"
1. General
7.114 In its report on Japan – Taxes on Alcoholic Beverages II, the Appellate Body stated that:
[The] third inquiry under Article III:2, second sentence, must determine whether
"directly competitive or substitutable products" are "not similarly taxed" in a way that
affords protection. This is not an issue of intent. It is not necessary for a panel to sort

418 We also note, that a luxury tax system could be found to result in dissimilar taxation, but still not
result in a violation of Article III:2, second sentence, as long as such a system was not applied so as to afford
protection to domestic production.
419 See discussion with respect to Transitional System , above, and results of the 1998 SM Marketing
Survey.
420 We also note because of the particular structure of the New Chilean System, the rates decrease from
15° to 35°, increase substantially from 35° to 39° and then begin to decrease above 40°.
421 See Appellate Body Report on Canada – Periodicals , supra., p. 29. See also Panel Report on
Korea – Taxes on Alcoholic Beverages , supra., para. 10.100, fn. 412; and Panel Report on United States –
Section 337 of the Tariff Act of 1930, BISD 36S/345, para. 5.14.

through the many reasons legislators and re gulators often have for what they do and
weigh the relative significance of those reasons to establish regulatory intent.
422
7.115 The Appellate Body further noted that rather th an review the intent of legislators to see
whether there was protectionist intent, the real i ssue was one of "how the measure in question is
applied".423 The Appellate Body went on to explain that the question of application of a measure can
be discerned from an examination of the "design, architecture and revealing structure of a
measure".424 The Appellate Body further observed that the very magnitude of dissimilar taxation
could be evidence of protective application, but there often will be other factors and that panels should
give full consideration to all the relevant facts on a case-by-case basis.
7.116 In its report on Canada – Periodicals, the Appellate Body provided extensive quotations from
a Canadian Minister Designate concerning a Task Force Report which preceded the legislation under
examination. There was also a quotation from the Minister of Canadian Heritage during the debate on
the legislation to the effect that:
[T]he reality of the situation is that we must protect ourselves against split-runs
coming from foreign countries and, in particular, from the United States.425
7.117 The Appellate Body also noted the effect in the market-place that one split-run magazine had
pulled out of the Canadian market and that a Canadian-owned split-run magazine had ceased
production of its US edition. In lig ht of these various facts, as well as the magnitude of the dissimilar
taxation, the Appellate Body concluded that the sy stem of dissimilar taxation was applied in a way
that afforded protection to domestic production.
7.118 To a certain extent, this may appear as a change by the Appellate Body in their approach to
this part of the analysis of Article III:2, second sentence. However, in its report in Japan – Taxes on
Alcoholic Beverages II , the Appellate Body stated that the cen tral issue was the design, architecture
and revealing structure of the measure. It goes without saying that the stated objectives by the
government of the Member concerned may be relevant in evaluating the design of a measure.
However, caution must be exercised in doing th is for many views can be expressed in open
parliamentary debates and this was why the Appella te Body stated that delving into individual
legislators' intent is not a useful exercise. T hus, presumably, the Appellate Body was distinguishing
between statements by a government and statements by individual legislators.
7.119 Also, it is worth noting the nature of the quotations used in Canada – Periodicals . The
statements were supportive of a finding of a protec tive objective and structure of the provision.
Statements by a government against WTO interest s (e.g., indicating a protective purpose or design)
are most probative. Correspondingly, it is less likely that self-serving comments by a government
attempting to justify its measure would be particul arly probative. To put it another way, dissimilar
taxation applied so as to afford protection to domestic production cannot be justified as WTO-
consistent because of good intentions. There is no b asis for such a justification in the text of GATT
1994.
7.120 Finally in this regard, such statements as referred to by the Appellate Body in Canada –
Periodicals are really only useful as a factor confirming other evidence. The Appellate Body did not
rely just on the statements; rather, account also was taken of the results in the marketplace and the fact
of the high level of differential in tax rates between the domestic and imported products.

422 Appellate Body Report on Japan – Taxes on Alcoholic Beverages II, supra., p.27.
423 Ibid., p. 28 (emphasis in the original).
424 Ibid., p. 29.
425 Appellate Body Reports on Canada – Periodicals, supra., p. 31.

7.121 The European Communities subm itted evidence concerning the Chilean legislative process
that led to the adoption of the Transitional System and the New Chilean System. Among other things,
the European Communities has alle ged that the taxation systems were arrived at as part of an
agreement between the Chilean domestic industry and the government. As part of this, the European
Communities argues that the pisco industry agreed to sacrifice the high alcohol content versions of
pisco in order to preserve the preferential tax treatment of the large majority of pisco production under
35° alcohol content. According to the European Communities, there is no other logical reason why
the pisco industry would agree to this increase in taxation of some of its products.
7.122 We do not think it fruitful or appr opriate to try to evaluate the Chilean legislative process.
As noted above, all sorts of agreements can be made in order to obtain support from a domestic
constituent for changes in tax rates. Some may not even have anything to do with the legislation at
hand. Furthermore, it is normal for one constituent to wish to push a tax burden onto another even if
the products made by both constituents are not directly competitive. The competition in spreading tax
burdens may be very different from the competition in the marketplace. We do not find the evidence
of legislative purpose offered by the European Co mmunities to be particularly probative in this
instance.
7.123 In our view, an important question is who receiv es the benefit of the dissimilar taxation. This
is implicit in the reference of the Appellate Body and previous panels to the magnitude of the tax
differentials. For example, the magnitude of the diff erentials would not be particularly relevant if the
products realizing the resulting bene fits were imports. Furthermore, the Appellate Body's review of
the results of the application of dissimilar taxation in the marketplace in Canada – Periodicals shows
that the Appellate Body was reviewing who had benefitted from the tax rate differentials. This is only
logical given the language of Article III itself.
7.124 We must consider in this regard that Article III is to protect competitive opportunities. If
there have been significant governmental restrict ions in the market-place (which can include
completely WTO consistent measures such as tariffs) it may be that there are relatively few, if any,
imports and the distribution of the current benefits of the dissimilar taxation may be reflective of this
fact. In such a situation, it would be necessary to consider if the large differentials could be having
the effect of inhibiting potential imports.
2. Transitional System
7.125 The European Communities has ar gued that there are a number of factors that support a
conclusion that the dissimilar taxation under the Tran sitional System is applied in a way so as to
afford protection to domestic production. The European Communities refers to the following factors:
 the magnitude of the tax differentials;

 the absence of legitimate policy purposes for applying a lower rate to pisco;

 the fact that the beneficiary of the differentials (pisco) is by Chilean law a domestic
product;

 the fact that the vast majority of Chilean production of distilled spirits is pisco;

 the fact that the majority of whisky (the highest taxed product) is imported; and,

 the alleged admission by the Chilean govern ment that the reason for enacting the
New Chilean System is that the prior and existing systems were discriminatory.

7.126 Chile responds that the purpose of the Transiti onal System is to allow time for the domestic
and foreign producers and distributors to prepare for the changes under the New Chilean System and
also to begin phasing in immediate benefits for whis ky producers. In effect, Chile argues that the
Transitional System should not be condemned as bei ng a measure applied so as to afford protection
when the primary result is the lessening of taxes on importers.
7.127 We take note of this point made by Chile that the primary beneficiary of the changes under
the Transitional System are some of the imported products, specifically whisky. However, it is not for
the Panel to inquire into such issues as whethe r political deference should be accorded for these
efforts. The fact that the Transitional System lessens the protective effect does not vitiate the
conclusion that, even at its least discriminatory, it is a system that does and will afford protection to
domestic production.
7.128 The Transitional System assesses tax rates by type of spirits. The lowest tax rate is on pisco
which under Chilean law is exclusively a domestic pr oduct. There could be an import physically
identical to pisco and it would be assessed a tax rate five percentage points higher. This illustrates the
protective nature of the structure of the tax system.
7.129 The largest category of imports by far at the pr esent time is whisky and that is presently taxed
at a rate of 53% (at its least discriminatory leve l beginning 1 December 1999) compared to pisco's
25% and pisco accounts for almost 75% of domestic produc tion of distilled spirits. It is clear that the
beneficiary of this structure is the domestic industry.
7.130 In our view, the design, architecture and struct ure of the Transitional System is to apply
dissimilar taxation in a manner so as to afford protection to domestic production. The fact that the
level of protection is lessened dur ing the period of applicability of the law does not obviate the fact
that its objective is to maintain such protection during the period.
3. New Chilean System
(a) Arguments
7.131 The European Communities argues that under the New Chilean System taxes are assessed in a
dissimilar manner so as to afford protection to domestic production based on the following arguments:
(i) the European Communities argues that the magnitude of the tax differentials is large
with a range from 27% for most pisco to 47% for most imports.
(ii) the European Communities notes that these large differentials in the rates do not serve
any legitimate policy purpose. It cannot be for health reasons, because there is no
correlation between alcohol content and heath factors related to distilled beverages. It
cannot be for income redistribution, becau se the taxes are not just ad valorem and
there is no necessary correlation between alcohol strength and value.
(iii) the European Communities claims that the large majority of Chile's distilled beverage
production (between 70 and 80 percent, according to the European Communities) will
enjoy the lowest rate of taxation, while over 95% of imports will be taxed at the
highest rate.
(iv) according to the European Communities, the New Chilean System was the product of
negotiations between the pisco industry and the Chilean government and reflects the
desire of the pisco producers for protection from imports. The European
Communities also points to statements made by various sectors of Chilean industry

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

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

an exception to that principle, it would be difficu lt for them to resist similar requests from other
industries.
(b) Discussion
7.138 In light of all the evidence and arguments offe red by the parties, we now proceed to examine
whether the New Chilean System applies dissimilar taxes in a manner so as to afford protection to
domestic production.
427
7.139 First, we address a question of interpretati on important to our examination of the New
Chilean System. Chile cites some of the drafting history of the provision which eventually became
Article III:2 of the GATT. Chile notes that the Sub-Committee responsible for the Article reported
that:
The Sub-Committee was in agreement that unde r the provisions of Article 18 [Article
III of the GATT], regulations and taxes w ould be permitted which, while perhaps
having the effect of assisting the production of a particular domestic product (say,
butter) are directed as much against the domestic production of another product (say,
oleomargerine) of which there was s ubstantial domestic production as they are
against imports (say, imported oleomargerine).
428
7.140 Chile draws from this the conclusion that it is permissible to have taxation systems that may
have differential impact on some products incl uding imports and domestic products as long as the
distinctions are "objective and neutral". 429 We agree that there may be differences between taxation
of directly competitive products, but we see no basis for extending the statement of the sub-committee
to mean that something described as "objective and neut ral" can be used to justify dissimilar taxation.
We recall the precepts of Articles 31 and 32 of the Vienna Convention, that our decisions should be
guided by the treaty language itself and that resort to the negotiating history is useful either to confirm
an understanding of the language of the treaty or to clarify the meaning in the case of ambiguity. In
this case, the treaty language appears to be clear. Dissimilar taxation, as we ha ve noted before, is not
in and of itself, inconsistent with the requirements of Article III:2, second sentence. It is only if such
system of dissimilar taxation is applied in a way so as to afford protection to domestic production that
there is a violation of the GATT. In our view, this language of the Sub-Committee merely confirms
that. There is no violation per se due to dissimilar taxation. It depends, in that example, on who
benefits from such a taxation system and, as a coroll ary, who has a disadvantage. Is it the imports or
some portion of the domestic industry? We see no basis for reading into this Sub-Committee report
an interpretation that a system of dissimilar taxation is permissible if the criteria used to distinguish
products are "objective and neutral." It says no such thing and such an interpretation would be
inconsistent with the treaty lang uage that any system which imposes dissimilar taxation in a manner
so as to afford protection to domestic production is inconsistent with a Me mber's obligations under
the GATT 1994 regardless of the alleged objectivity of the criteria chosen.
7.141 Chile says it agrees that Article III:2 applies beyond mere de jure discrimination to also cover
de facto discrimination. However, when examined furt her, it seems that Chile actually is willing to
extend Article III:2 beyond de jure discrimination in only the most minimal manner. According to
Chile, the findings in Japan – Taxes on Alcoholic Beverages I and II and Korea – Taxes on Alcoholic
Beverages are that tax systems based on "subjectiv e" criteria such as product type names are

427 Chile has repeatedly urged us to take into co nsideration the tax systems of other Members when
evaluating the New Chilean System. It is a well settle d point of GATT/WTO jurisprudence that such other
systems are irrelevant to an evaluation of the Member's measure which is the subject of the specific dispute.
428 Reports of the Committees and Principal Sub-Committees, ICITO 1/8, 64 (Geneva, Sept. 1948).
429 See First Submission of Chile, paras. 34-35.

impermissible. Chile then takes a further analytical step by asserting, therefore, that systems based on
"objective" criteria are permissible.
 430 This step is a non-sequitur. It is the case that Japan and Korea
made distinctions based on types of beverages. However, the findings with respect to the second and
third analytical steps under Article III:2, second sentence, were not dependent on that fact alone. As
the panel stated in Korea – Taxes on Alcoholic Beverages:
The structure of the Liquor Tax Law itself is discriminatory. It is based on a very
broad generic definition which is define d as soju and then there are specific
exceptions corresponding very closely to one or more characteristics of imported
beverages that are used to identify products which receive higher tax rates. There is
virtually no imported soju so the beneficiaries of this st ructure are almost exclusively
domestic producers.
431
7.142 Thus, the panel rested its conclusion in part on the factual finding that the primary
beneficiaries of the particular structure in that case were the domestic producers. At no point did the
panel in that case or the panels and Appellate Body in the cases of Japan – Taxes on Alcoholic
Beverages I and II state or imply that any system based on so-called "objective" factors would
necessarily survive scrutiny under Article III:2.
7.143 Chile also contends that there is not even de facto discrimination here because the imported
product could easily be diluted to take advantage of the lower available tax rates. We do not find this
persuasive. Exporters should not be required to alte r important characteristics of their products and,
indeed, change their generic name in order to compete equally with the domestic product.
432 To state
it that way clearly demonstrates the flaw in the Chil ean argument. It is evident that there will not be
equal competitive conditions unless the foreign produ cers make certain important changes in their
products, changes that Chile has not attempted to justify by any exception or rule of the WTO
Agreements.433 The only reason Chile offers for the forei gn producers to change their products is to
take advantage of preferential tax rates. A me asure which imposes such requirements obviously does
not provide the equal competitive conditions required by Article III.
7.144 Chile argues that this is a matter of intellectua l property protection irrelevant to this case.
According to Chile, the EC's arguments that it should not have to change it's products names in order
to sell in Chile is akin to arguing that the Ag reement on Trade-Related Aspects of Intellectual
Property Rights (TRIPS) is being extended to put an affirmative obligation on Chile to support the use
of names such as whisky, vodka, gin and rum. We do not share Chile's view that there is such a
necessary legal connection here between the concep t of protected names, such as trademarks, and
generic product names. The two types of names simply are not the same. The European Communities
is not here asserting a trademark in the word "whisky. " There is, in fact, Chilean whisky, as there is
whisky produced in many countries. The issue here is whether a producer can be forced to give up its
generic name and be compelled to sell its product as something different in order to enjoy equal tax
treatment.

430 See Report, para. 4.399, Chile Second Submission, para. 28 and Chile's Statement at the Second
Meeting, paras. 26-31.
431 Panel Report on Korea – Taxes on Alcoholic Beverages, supra., para. 10.102 (emphasis added).
432 Chile argues that there is an inconsistency betwee n arguing that products are directly competitive
and substitutable and arguing that they should not be forced to change di stinctive physical characteristics and
names. We do not agree. Products which are direc tly competitive or substitutable have differences between
them or they would be "like." Indeed, even like products do not need to be identical. It is perfectly logical for
marketers to emphasize one pr oduct's distinctive qualities in order to compete effectively with other directly
competitive products. We are not dealing with commodities here.
433 For instance, as justified by legitimate techni cal requirements or for health and safety reasons
excepted under Article XX.

7.145 Furthermore, Chile is correct that it is under no obligation to assist the European
Communities or any other Member in marketing its pr oducts under particular names. However, Chile
is under an obligation not to apply a discriminatory tax regime to directly competitive or substitutable
imports simply because they carry particular names. Indeed, Chile's earlier arguments concerning the
decisions in Japan –Taxes on Alcoholic Beverages I and II and Korea – Taxes on Alcoholic
Beverages makes Chile's position on this issue untenable . According to Chil e, in those cases there
was protective application of tax systems based on definitions of a favoured type of spirit that was
overwhelmingly produced domestically. Surely it must follow that there is impermissible
discrimination if a type of spirit which is ma inly imported is, by definition of generic name or type,
taxed at a higher rate.
434 The difference is very small between a law offering favorable treatment as
long as a product is called "X" and a regulation discriminating against a product if it is called "Y".435
7.146 Related to the question of "objective" criteria is the argument concerning the policy objectives
of the taxation system. Chile states that the Eur opean Communities has no right to question its policy
objectives in structuring the New Chilean System as l ong as its system is based on objective criteria.
The European Communities replies that it is evidence of the protective application of a measure if the
measure is inconsistent with the stated policy objectiv es. To a certain extent, both parties are correct
in their arguments.
7.147 We agree with Chile that it is not for the Pane l to question their policy objectives. Chile lists
these objectives as: (1) maintaining revenue collection; (2) eliminating type distinctions as were found
in Japan and Korea; (3) discouraging alcohol c onsumption; and, (4) minimizing the potentially
regressive aspects of the reform of the tax sy stem. We offer no comment on whether these are
appropriate goals and objectives of tax policy. It is not for us to evaluate the measure in these terms,
either to condemn it or condone it.
7.148 In our view, the failure of a measure to confor m to its stated objectives may be indicative of
certain aspects of its design structure and architectur e. That is, while we will not examine the stated
objective itself to determine its legitimacy, it is a relevant inquiry to examine the relationship between
the stated objective and the measure in question. If a rational relationship between the stated
objective and the measure is lacking, this may prov ide evidence of protective application, which we
will take into consideration along with other factors.
7.149 With respect to the question of maintaining revenue neutrality, we note that there is no
rational reason why such a structure as devised by Chile is necessary for this purpose. Chile has
acknowledged that the same revenue result could be achieved with a single ad valorem rate at some
point between 27% and 47%.
7.150 With respect to eliminating type distinctions, the New Chilean System does not achieve this.
As discussed above, the favorable tax treatment accor ded to products called "pisco" was removed.
However, the system was replaced with one prov iding unfavourable tax treatment for any products
called "whisky", "gin," "vodka" or "rum," which happen to be primarily imports.
7.151 With respect to discouraging alcohol consumpti on, the gradations based on degree of alcohol
content arguably may achieve such a result, although the evidence seems to be more persuasive to the

434 We note that the Chilean regulation regarding alcohol content (Decree 78/1986 implementing Law
No. 18,455) is not at issue in this dispute. We make no findings with respect to the consistency of this
measure.with Chile's WTO obligations. Rather, what we are reviewing, in part, are the results of the interaction
of that Decree with the Chilean spirits taxes which are the measures at issue. Decree 78/1986 constitutes one of
the relevant facts of this case.
435 We note that in making its projections of the fis cal impact of the New Chilean System, the Chilean
Finance Ministry assumed that whisky, vodka, gin, ru m and tequila would continue to be sold using their
generic names.

contrary.
436 Moreover, if there were a direct co rrelation such as Chile proposes then the tax
differential between products with 35° of alcohol and 39° degrees of alcohol should be the same as
the differential between products with, for instance, 40° and 44° of alcohol unless there is an adequate
rational explanation for the difference. However, the tax rate almost doubles between 35° and 39° but
is the same between 40° and 44° and such an explanation is lacking.
7.152 Even then, the Chilean response is somewhat beside the point, for this is a system based not
just on alcohol content, but on ad valorem rates qualified by the additional criterion of alcohol content,
and there appears to be no correlation between valu e and alcohol consumption. Or, if there is a
correlation, it is more likely to be an inverse rela tionship. If money a consumer might set aside to
purchase distilled alcoholic beverages is spent on high value products, it follows that it will result in
lower absolute levels of alcohol consumption than if spent on low value products.
7.153 With respect to minimizing the regressive aspects of the tax reform, this is only true if the
factual situation were to remain static. As it curre ntly stands in the Chilean market, the lower priced
spirits generally are also the lower alcohol cont ent products, thereby reinforcing the progressive
nature of the tax system if the market shares do not change prior to implementation. However, this is
a coincidence of factors, not anything inherent in alcoholic beverages. For instance, in many markets
there are quite low priced whiskies sold at the same alcohol content as high priced whisky. Expensive
cognac sold in Chile will have a lower alcohol content than a relatively inexpensive vodka or rum, etc.
As Article III is meant to protect competitive oppor tunities, not market shares, Chile cannot base its
justification of the system on currently existing facts, (e.g., distribution of market shares across the tax
rates) which may exist partially, or even primarily, due to the tax system itself.
7.154 Chile argued that the New Chilean System was a result of a series of compromises between
these competing objectives so it is not totally linke d to any one objective. We recognize that
legislation is generally the result of compromises. However, the mere fact that compromises are
necessary cannot justify the resulting legislation if it is otherwise inconsistent with WTO obligations.
Furthermore, it is difficult for Chile to, on the one hand, justify its tax system based on the stated
objectives, but then, on the other hand, argue that the objectives are not reached due to legislative
compromises. As we noted above, if the stated objectives and the measure are inconsistent, it may
provide evidence confirming the discriminatory design, structure and architecture of a measure. We
find that to be the case here.
7.155 To assist in evaluating the overall design, stru cture and architecture, we review the New
Chilean System in the context of its predecessor syst ems. The prior systems through the Transitional
System have imposed dissimilar taxation to all products not called "pisco." Pisco is a term limited to
certain Chilean production according to Chilean law. As we have concluded above, this dissimilar
taxation is greater than de minimis and was, and will continue to be , applied so as to afford protection
to domestic production. The New Chilean System eliminated the de jure discrimination in these
systems and moved to taxation on the basis of a co mbination of alcohol content and value. These
levels were not arbitrarily chosen and applied. Between 70 and 80 percent of Chilean production
consists of products with less than 35° alcohol content and, therefore, enjoy the lowest tax rate of 27%.
Over 90% of pisco is in this category, pisco being the spirit enjoying de jure discrimination in its
favor until 1 December 2000. However, under Chil ean regulations, most of the imported beverages
have generic names that require them to contain at least 40° of alcohol. Thus, almost 95% of current
imports will be taxed at the highest rate of 47% or lose their ability to retain their name (their generic
name, not their brand names) The beverages would also require a change of an important physical

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

characteristic, namely their water/alcohol ratio. This is a clear case of a de jure discriminatory system
being replaced by an at least equally de facto discriminatory system.
437
7.156 As a last matter relating to the objective of the New Chilean System, Chile argues that it
cannot have intended the system to be protective, for if protection was the goal Chile could have
raised tariffs which are currently at 11%, but bou nd at 25%. Once again, we note that a lack of
protective actions with respect to tariff rates is irrelevant to an examination to the completely different
issue of whether a system of taxation is applied in a manner so as to afford protection to domestic
production. Therefore, the fact that Chile could take protective actions that would be permissible
under Article II, but chooses not to, is simply irrelevant to a finding that the New Chilean System is
inconsistent with Chile's obligations under Article III.
7.157 Chile has also argued that the New Chilean Syst em cannot be found to be applied in a manner
so as to afford protection to domestic production because there actually are more domestic products at
the highest level of taxation than imports. Most of this domestic production consists of high alcohol
content versions of pisco.
7.158 It is important at this juncture to recall that Article III is meant to protect competitive
opportunities. There is no question that the structure of the New Chilean System will distort
competition between directly competitive domestic products and products which are now imported
and ones that might reasonably be considered pot ential imports. First of all, it does not save a
measure from running afoul of Article III:2, second sentence, merely because there are domestic
products taxed at the same level as the imported products, as we noted in the previous section.
438
Second, as Chile itself has noted, there is consid erable world-wide supply capacity of potential
imports, the majority of which would be taxed at the highest level. The potential imports have the
right to equal competitive opportunities to the Chile an market which they cannot receive under the
New Chilean System. Were all distilled alcoholic be verages taxed at the same level, or at a level
reflecting no more than de minimis differences, then it is entirely possible that the percentages of
domestic versus imports at 40° alcohol content or above would ch ange dramatically. That is, lower
value, high alcohol content imports could become more viable in the marketplace, particularly as
consumers become more familiar with the products. In effect, Chile offers the result of its
discrimination over a long period of time as a justification for perpetuating it. On balance, we find the
most persuasive evidence to be that roughly 75% of domestic production will enjoy the lowest tax rate
and that over 95% of current (and potential) imports will be taxe d at the highest rate unless the
imported products change their alcohol content and abandon their generic, familiar product names.
7.159 In sum, considering: (1) the structure of the Ne w Chilean System (with its lowest rate at the
level of alcohol content of the large majority of domestic production and its highest rate at the level of
the overwhelming majority of imports); (2) the larg e magnitude of the differentials over a short range
of physical difference (35° versus 39° of alcohol content); (3) the interaction of the New Chilean
System with the Chilean regulation which requires mo st of the imports to remain at the highest tax
level without losing their generic name and changing th eir physical characteristics; (4) the lack of any
connection between the stated objectives and the r esults of such measures (recognizing that "good"
objectives cannot rescue an otherwise inconsistent measure); and, (5) the way this new measure fits in
a logical connection with existing and previous systems of de jure discrimination against imports, we
find that the dissimilar taxation assessed on directly competitive or substitutable imports and domestic
products is applied in a way that affords protection to domestic production.

437 We note that, for most types of spirits, th e New Chilean System will actually increase the
discrimination against them compared to pisco.
438 See Appellate Body Report on Canada – Periodicals, supra., p. 29. See also Panel Report on Korea
– Taxes on Alcoholic Beverages, supra., para. 10.100, fn. 412; and Panel Report on United States – Section 337,
supra., para. 5.14.

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