JAPAN - TAXES ON ALCOHOLIC BEVERAGES
Document: Report of the Panel
Date: 11 July 1996
Document codes: WT/DS8/R; WT/DS10/R; WT/DS11/R
Complainant: EU
Respondent: Japan
Dispute stage: Appellate Body
Agreements cited: Art. III:2  GATT 1994

JAPAN - TAXES ON ALCOHOLIC BEVERAGES

Report of the Panel

Il.

Il.

IV.

TABLE OF CONTENTS

INTRODUCTION ...... 0... eee eee

FACTUAL ASPECTS .. 0... 2... eee

A.

Japanese Liquor Tax Law... 1.2... ee
1. Terminology and Definitions ...............0.2.00 00 eee
2. Tax Rates... eee ee ne
The 1987 Panel Report on Japan - Customs Duties, Taxes and Labelling

Practices on Imported Wines and Alcoholic Beverages ...............

CLAIMS OF THE PARTIES ....... 0.0... ee ee ee ne

ARGUMENTS OF THE PARTIES .......... 0.2... 00. eee eee ees

UO w>

Preliminary Objection of Japan ....... 0.0.0... eee eee eee eee
The Legal Value of the 1987 Panel Report ..................0000.%
General Presentation of the Arguments of the Parties on Article III:2......
Article III:2, First Sentence... 2... ens
1. The Different Legal Analyses Suggested by the Parties for the
Interpretation of Article III:2, First Sentence ................
a) The Test Suggested by the Community ..............
b) The Test Suggested by Canada.................0..
Cc) The Test Suggested by the United States .............
d) The Test Suggested by Japan................2....
2. Application to the Present Case of the Legal Analysis Suggested by
the Community for Article III:2, First Sentence ..............
a) The First Step of the Test: Like Products .............
b) The Second Step of the Test: Discriminatory Taxes.......
Article III:2, Second Sentence ..........0. 0.0.0. e ee eee eee ne
1. The Different Legal Analyses Suggested by the Parties for the
Interpretation of Article III:2, Second Sentence ..............
a) The Test Suggested by the Community ..............
b) The Test Suggested by Canada...................,
c) The Test Suggested by the United States .............
d) The Test Suggested by Japan... ...............0.0.
2. Application to the Present Case of the Legal Analysis Suggested by
the Community and Canada ....... 0... . eee eee eee
a) The First Step of the Tests Suggested by the Community and
Canada: Directly Competitive and Substitutable Goods ....

i) Physical characteristics, end-uses, tariff line and
availability to the public ...................
ii) Cross-price elasticity .................000.

b) The Second Step of the Test Suggested by the Community for
Article III:2, Second Sentence: “ ... So as to Afford
Protection”... 2.2... ee ee es

Cc) Application of the Second, Third and Fourth Criteria of the
Legal Test Suggested by Canada for Article III:2, Second
Sentence... ee eee

(ii)

F. Application to the Present Case of the Legal Analysis Suggested by the United

States for the Interpretation of Article 11:2 ...................05. 61
1. The Aim of the Legislation .............. 2.0.0. 00000 000 61
2. The Effect of the Legislation ............... 0.0.00 0000. 65
G. Application to the Present Case of the Legal Analysis Suggested by Japan for
the Interpretation of Article II:2 .................. 0.000000. 68
1. Categorization of the Liquor Tax Law ..................4. 68
2. The Aim of the Legislation .............. 0.2... 00200 eee 74
3. The Effect of the Legislation .................0 20.0000 ee 83
a) The Tax/Price Ratio Rates under the Legislation are
Neutral 2.2... ee 83
b) Cross-Price Elasticity ........... 0.022 92
c) Production of Shochu Outside Japan ................ 97
d) Import Statistics... ee ee 100
V. INTERIM REVIEW ................. ee eee eee 101
VI. FINDINGS ........0. 0... cc eee eee ee eee 103
A. Claims of the Parties... 2... ee eee ee 103
B. Preliminary Finding ............. 0. cee ee eee ee 104
C. Main Findings ............. eee eee ee ee eee 104
1. General Principles of Interpretation ..................000. 105
2. Article WI... ee 107
3. Article III:2, First Sentence ....... 0... 0... es 108
a) Overview .. 1... eens 108
b) Like Products ......... 2... eee eee eens 111
C) Taxation in Excess of that Imposed on Like Domestic Products
Le eee 114
4. Article III:2, Second Sentence ..............00200 202 eee 115
a) Directly Competitive or Substitutable Products.......... 115
b) “|... So as to Afford Protection” ...............04. 118
VII. CONCLUSIONS ........ 0.0... ce eee ees 121
Ammex Too. ee eee eee ees 123
Anmex To. ee eee ee 124
Annex TT. 2 ee ee eee 125
Annex IV 2... ee ee eee eee 126
Ammex Vow. ee ee ee ee 127
Ammex VI ow. 1 ee ee ees 128

I. INTRODUCTION

1.1 On 21 June 1995, the European Communities (“the Community”) requested consultations with
Japan under Article XXII of the General Agreement on Tariffs and Trade 1994 (“GATT”) concerning
the internal taxes levied by Japan on certain alcoholic beverages pursuant to the Japan’s Liquor Tax
Law (WT/DS8/1). On 7 July 1995, pursuant to Article 4.11 of the Understanding on Rules and
Procedures Governing the Settlement of Disputes (“DSU”), the United States (WT/DS8/2) and Canada
(WT/DS8/3) requested to be joined in these consultations. Japan accepted these requests on 19 July 1995
(WT/DS8/4).

1.2 On 7 July 1995, Canada requested consultations with Japan under Article XXII of GATT 1994
concerning certain Japanese liquor taxation laws (WT/DS10/1). On 17 July 1995, pursuant to Article 4.11
of the DSU, the United States (WT/DS10/2) and the Community (WT/DS10/3) requested to be joined
in these consultations. Japan accepted these requests on 19 July 1995 (WT/DS10/4).

1.3 On 7 July 1995, the United States requested consultations with Japan under Article XXIII of
GATT 1994 regarding internal taxes imposed by Japan on certain alcoholic beverages pursuant to the
Liquor Tax Law (WT/DS11/1).

1.4 On 20 July 1995, the Community, Canada and the United States jointly held consultations with
Japan with a view to reaching a mutually satisfactory resolution of the matter, but they were unable
to reach such a resolution. On 21 July 1995, the United States and Japan consulted under Article XXTI:1,
but they did not reach a mutually acceptable resolution of the matter.

1.5 On 14 September 1995, pursuant to Article XXIII:2 of GATT 1994 and Article 6 of the DSU,
the Community requested the Dispute Settlement Body (“DSB”) to establish a panel with standard terms
of reference (WT/DS8/5). The Community claimed that:

“a) Japan had acted inconsistently with Article III:2, first sentence, of GATT 1994
by applying a higher tax rate on the category of ‘spirits’ than on each of the two sub-
categories of shochu, thereby nullifying or impairing the benefits accrued to the
European Communities under GATT 1994; and that

b) Japan has acted inconsistently with Article III:2, second sentence, of GATT
1994 by applying a higher tax rate on the category of ‘whisky/brandy’! and on the
category of ‘liqueurs’ than on each of the two sub-categories of shochu, thereby
nullifying or impairing the benefits accrued to the European Communities under GATT
1994,

In the event that the liquors falling within the category of ‘spirits’ were found by the
Panel not to be ‘like products’ to shochu within the meaning of the first sentence of
Article III:2, the [Community] further claimed that:

c) Japan has acted inconsistently with Article III:2, second sentence, of GATT
1994 by applying a higher tax rate on the category of ‘spirits’ than on each of the two
sub-categories of shochu, thereby nullifying or impairing the benefits accrued to the
European Communities under GATT 1994”.

1.6 On 14 September 1995, pursuant to Article XXIII of GATT 1994 and Articles 4 and 6 of the
DSU, Canada requested the DSB to establish a panel with standard terms of reference (WT/DS10/5).
Canada claimed that:

‘In the present Panel report the use of the term “whisky” includes also the term “whiskey” as used in the case of Irish
whiskey and Tennessee whiskey.

“ .., the higher rates of taxation on imported alcoholic beverages including whiskies,
brandies, other distilled alcoholic beverages and liqueurs than on Japanese shochu
imposed pursuant to the Japanese Liquor Tax Law are:

a) inconsistent with Article III:1 and III:2 of GATT 1994;
b) nullifying and impairing the benefits accruing to Canada
pursuant to the WTO”.

1.7 On 14 September 1995, pursuant to Article XXIII:2 of GATT 1994 and Articles 4 and 6 of
the DSU, the United States requested the DSB to establish a panel with standard terms of reference
(WT/DS11/2). The United States claimed that:

“ ... the internal taxes imposed by Japan [pursuant to the Liquor Tax Law] on these
beverages, and in particular the preferential tax treatment accorded to shochu, are
inconsistent with Article III of GATT 1994, and otherwise nullify and impair benefits
accruing to the United States under the GATT 1994”.

1.8 At its meeting of 27 September 1995, pursuant to the first request of the three complaining
parties and with Japan’s acceptance, the DSB established a single panel with the mandate to examine
the requests of the Community, Canada and the United States, all of which related to the same matter,
in accordance with Article 9 of the DSU (WT/DSB/M/7).

1.9 During the 27 September 1995 meeting of the DSB, Norway reserved its right as a third party
to the present dispute. However, on 7 November 1995, Norway informed the Panel of the withdrawal
of its request to participate as a third party in the dispute (WT/DS8/7, DS10/7 and DS11/4).

1.10 Atthe same meeting of the DSB on 27 September 1995, the parties agreed that the Panel should
have standard terms of reference as follows:

“To examine, in the light of the relevant provisions of the covered agreements cited
by the EC, Canada and US in documents WT/DS8/5, WT/DS10/5, WT/DS11/2, the
matters referred to the DSB by the EC, Canada and the United States in those documents
and to make such findings as will assist the DSB in making the recommendations or
in giving the rulings provided for in those agreements”.

1.11 On 30 October 1995, the Panel was constituted with the following composition:

Chairman: Mr. Hardeep Puri

Panelists: Mr. Luzius Wasescha

Mr. Hugh McPhail

Il. FACTUAL ASPECTS

A. The Japanese Liquor Tax Law
2.1 This dispute concerns the Japanese Liquor Tax Law (Shuzeiho), Law No.6 of 1953 as amended
(“Liquor Tax Law”), which lays down a system of internal taxes applicable to all liquors, which are

defined as domestically produced or imported beverages having an alcohol content of not less than
one degree and which are intended for consumption in Japan.

2.2 The Liquor Tax Law currently classifies the various types of alcoholic beverages into ten
categories and additional sub-categories: sake, sake compound, shochu (group A, group B), mirin,
beer, wine (wine, sweet wine), whisky/brandy, spirits, liqueurs, miscellaneous (various sub-categories).

1. Terminology and Definitions

The Liquor Tax Law defines liquors involved in the present disputes - shochu, whisky/brandy,
spirits and liqueurs - as follows:

“Article 3

Paragraph 5 ‘Shochu’ shall mean liquors produced by the distillation of alcohol containing
substances. Included in this definition are those produced by adding water, sugar or
other substances stipulated in government ordinances to the above-mentioned liquors.
They must have an alcoholic strength of 45% vol or less. The liquor must be less
than 36% vol in case distilled by a ‘continuous still’, the definition of which is as
follows: a machine that removes fusel oil, aldehyde and other impurities during the
process of continuous distillation. The definition of the type of sugar which can be
added is given by government ordinances. In case produced by adding substances other
than water, the extract of the product ought to be less than 2g/100 ml.

Note that those enumerated below from (a) through (d) do not fall under the definition
of ‘shochu’.

(a) Liquors produced in whole or in part from malted cereals or fruit (including
dried fruit or boiled-down or concentrated must, but excluding dates or other fruit as
stipulated in government ordinances. The same shall apply hereafter).

(b) Liquors produced by filtering it through white birch charcoal or other substances
specified in government ordinances.

(c) Liquors produced in whole or in part from saccharized substances (e.g. molasses,
sugar, syrup and honey; excluding sugar as defined by government ordinances) and
by the distillation at less than 95% vol.

(d) Liquors produced by flavouring alcohol by way of steeping ingredients of other
substances during distillation.

Paragraph 9 “Whisky/Brandy’ shall mean the following liquors on condition that those listed
in (a), (b) and (d) be excluded in case covered by (b) through (d) of Paragraph 5:

(a) Liquors produced by distillation of alcohol containing substance derived by
first saccharifying malted cereals and water and then fermenting them.The above-
mentioned liquors must be distilled at less than 95% vol.

(b) Liquors produced by the distillation of alcohol containing substance derived

by first saccharifying unmalted cereals with malted cereals and water and then
fermenting them. The above mentioned liquors must be distilled at less than 95% vol.

These definitions (translations from the Liquor Tax Law) were submitted by Japan.

(c) Liquors produced by adding alcohol, spirits, flavouring substance, colorants,
or water to liquors mentioned in above (a) and (b). Excluded from this provision are
those in which the aggregate of the alcoholic contents of the liquors mentioned in above
(a) and (b) is less than ten hundredth (10/100) of those of the liquors resulted from
the addition of the above enumerated substances.

(d) Liquors produced by the distillation of alcohol containing substance obtained
by the fermentation of fruit / fruit and water, or by distillation of wine (including wine
lees). The above mentioned liquors must be distilled at less than 95% vol.

(e) Liquors produced by adding alcohol, spirits, flavouring substance, colorants
or water to liquors mentioned in above (d). Excluded from this provision are those
in which the aggregate of the alcoholic contents of the liquors mentioned in above (d)
is less than ten hundredth 10/100) of those of the liquors resulted from the addition
of above enumerated substances.

Paragraph 10 ‘Spirits’ shall mean liquors other than those as listed from Paragraphs 3 to
9, the extract of which must be less than 2g/100ml. ‘Spirits’ does not include sparkling
liquors made in part from malt other than those produced by the distillation of alcohol-
containing substances made partly from malt. The same exclusion shall apply in the
next paragraph.

Paragraph 11 ‘Liqueurs’ shall mean liquors made from liquors and other substances such
as saccharide (including liquors, but excluding those as stipulated in the government
ordinances), the extract of which is not less than 2g/100ml (excluding liquors as listed
from Paragraphs 3 to 9), and sparkling liquors made in part from malt, as well as the
powdered one which can be dissolved to make a beverage with an alcoholic strength
of not less than 1% vol.

Article 4:
The liquors of the categories as listed in the left column of the following table

shall be split into the sub-categories described in the mid-column thereof, and the
definition of each sub-category shall be shown at the right-column thereof.”

Sub-Category

Shochu A Shochu which are distilled with a continuous
still

Shochu B Shochu other than Shochu A

2. Tax Rates

2.3 Pursuant to the Liquor Tax Law, liquors are taxed at the wholesale level. In the case of liquors
made in Japan, the tax liability accrues at the time of shipment from the factory, and in the case of
imported liquors, at the withdrawal from a customs-bonded area. As explained above, the Liquor Tax
Law divides all liquors into ten categories, some of which are divided into sub-categories. Different
tax rates are applied to each of the various tax categories and sub-categories defined by the Liquor

WT/DS11U/R

Tax Law. The rates are expressed as a specific amount in Japanese Yen (“¥”) per litre of beverage.
For each category or sub-category, the Liquor Tax Law lays down a reference alcohol content per
litre of beverage and the corresponding reference tax rate. For whisky, the reference rate uses an alcohol
strength of 40 per cent; for spirits the alcohol strength is 37 per cent; for liqueurs the alcohol strength
is 12 per cent; for both shochu sub-categories, an alcohol strength of 25 per cent is used. As a result,
the liquors covered by the present dispute are subject to the following tax rates:

Shochu A

(fractions are rounded up to 1 degree)

(5) below 21 degrees ¥108,000

Shochu B

(4) 21 to 25 degrees ¥102,100 minus ¥6,580 for each degree less than 25
(fractions are rounded up to 1 degree)
(5) below 21 degrees ¥69,200

Whisky

Alcoholic Strength

(1) 40 to 41 degrees ¥982,300
(2) 41 degrees and above ¥982,300 plus ¥24,560 for every degree above 40

(3) 38 to 40 degrees ¥982,300 minus ¥24,560 for each degree below 40
(fractions are rounded up to 1 degree)

(4) below 38 degrees ¥908 620

Tax Rate (per 1 kilolitre)

Spirits

Alcoholic Strength Tax Rate (per 1 kilolitre)
(1) below 38 degrees ¥367,300

(2) 38 degrees and above ¥367,300 plus ¥9,930 for each degree above 37

Liqueurs

Alcoholic Strength Tax Rate (per 1 kilolitre)
(1) below 13 degrees ¥98,600
(2) 13 degrees and above ¥98,600 plus ¥8,220 for each degree over 12

2.4 A special formula is applied to determine the rate applicable to beverages having an alcohol
content below 13 per cent or, in the case of “liqueurs”, below 12 per cent (as a general rule, pre-mixes
combining a liquor with water or with other non-alcoholic beverages). This formula yields the result
that the tax rate per litre of pure alcohol levied on these beverages is the same as the tax per litre of
pure alcohol that would be borne by a liquor of the same category at the legal standard strength.

B. The 1987 Panel Report on Japan - Customs Duties, Taxes and Labelling Practices
on Imported Wines and Alcoholic Beverages (“1987 Panel Report”)

2.5 In 1986, the Community requested consultations with Japan in respect of Japan’s Liquor Tax
Law, as it then existed. The consultations failed to resolve the matter and in 1987 a panel was established
to consider, among others, the Community’s claim that the Liquor Tax Law violated Article III:2.

2.6 As of 1987, the Liquor Tax Law divided the whisky/brandy category into whisky and brandy,
and subdivided whisky into three grades, i.e., Special Grade, First Grade and Second Grade. The
category shochu was sub-divided into Groups A and B. Specific tax rates were provided for each
category and sub-category of alcoholic beverages. In addition, an ad valorem tax was applicable to
inter alia, Special, First and Second Grade whiskies where the price exceeded a certain threshold.
This tax was not applicable to either shochu group.

2.7 The 1987 Panel Report concluded that some aspects of the Liquor Tax Law were inconsistent
with Article IH:2, first and second sentences, and suggested that the CONTRACTING PARTIES
recommend that Japan bring its taxes on whiskies, brandies, other distilled spirits (such as gin and
vodka), liqueurs, still wines and sparkling wines into conformity with its obligations under the General
Agreement. In particular, the Panel reached the following conclusions:

“5.5... The Panel concluded that the ordinary meaning of Article IIJ:2 in its context
and in the light of its object and purpose supported the past GATT practice of examining
the conformity of internal taxes with Article III:2 by determining, firstly, whether
the taxed imported and domestic products are ‘like’ or ‘directly competitive or
substitutable’ and, secondly whether the taxation is discriminatory (first sentence) or