Case study 7-2 to answer discussion question 1.
CASE 7-2 Japan—Taxes on Alcoholic Beverages
World Trade Organization, Dispute Settlement Panel, 1998 Panel Reports WT/DS8/R, WT/DS10/R, WT/DS11/R82
MAP 7.2 Japan (1998)
Canada, the EU, and the United States complained that Japan imposed lower taxes on shochu, a locally produced alcoholic beverage, than it did on imported alcoholic beverages, including vodka, in violation of Article III, paragraph 2, of GATT 1994.
Report of the Panel
The Panel noted that the complainants are essentially claiming that the Japanese Liquor Tax Law is inconsistent with GATT Article III:2 (hereinafter “Article III:2”). Article III:2 reads:
The products of the territory of any contracting party imported into the territory of any other contracting party shall not be subject, directly or indirectly, to internal taxes or other internal charges of any kind in excess of those applied, directly or indirectly, to like domestic products. Moreover, no contracting party shall otherwise apply internal taxes or other internal charges to imported or domestic products in a manner contrary to the principles set forth in paragraph 1.
GATT Article III:1 (hereinafter “Article III:1”), which is referred to in Article III:2, reads:
The contracting parties recognize that internal taxes and other internal charges, and laws, regulations, and requirements affecting the internal sale, offering for sale, purchase, transportation, distribution, or use of products, and internal quantitative regulations requiring the mixture, processing, or use of products in specified amounts or proportions, should not be applied to imported or domestic products so as to afford protection to domestic production.
82This Dispute Settlement Panel Report is posted on the WTO’s Web site at www.wto.org/english/tratop_e/dispu_e/cases_e/ds8_e.htm.
Article III:2, First Sentence
a) Definition of “Like Products”
The Panel noted that the term “like product” appears in various GATT provisions. The Panel further noted that it did not necessarily follow that the term had to be interpreted in a uniform way. In this respect, the Panel noted the discrepancy between Article III:2, on the one hand, and Article III:4 on the other: while the former referred to Article III:1 and to like, as well as to directly competitive or substitutable products (see also Article XIX of GATT), the latter referred only to like products. This is precisely why, in the Panel’s view, its conclusions reached in this dispute are relevant only for the interpretation of the term “like product” as it appears in Article III:2.
The Panel noted that previous panels had agreed that the term “like product” should be interpreted on a case-by-case basis, but had not established any particular test to be followed in defining likeness. Previous panels had used different criteria in order to establish likeness, such as the product’s properties, nature and quality, and its end-uses; consumers’ tastes and habits, which change from country to country; and the product’s classification in tariff nomenclatures.
In the Panel’s view, “like products” need not be identical in all respects. However, in the Panel’s view, the term “like product” should be construed narrowly in the case of Article III:2, first sentence. This approach is dictated, in the Panel’s view, by two independent reasons: (i) because Article III:2 distinguishes between like and directly competitive or substitutable products, the latter obviously being a much larger category of products than the former; and (ii) because of the Panel’s conclusions reached with respect to the relationship between Articles III and II.
As to the first point, the distinction between “like” and “directly competitive or substitutable products” has already been discussed. As to the second point, as previous panels had noted, one of the main objectives of Article III:2 is to ensure that WTO Members do not frustrate the effect of tariff concessions granted under Article II through internal taxes and other internal charges, it follows that there should be a similar interpretation of the definition of products for purposes of Article II tariff concessions and the term “like product” as it appears in Article III:2. This is so in the Panel’s view, because with respect to two products subject to the same tariff binding and therefore to the same maximum border tax, there is no justification, outside of those mentioned in GATT rules, to tax them in a differentiated way through internal taxation….
…In the view of the Panel, the term “like products” suggests that for two products to fall under this category they must share essentially the same physical characteristics. Flexibility is required in order to conclude whether two products are directly competitive or substitutable. In the Panel’s view, the suggested approach can guarantee the flexibility required, since it permits one to take into account specific characteristics in any single market; consequently, two products could be considered to be directly competitive or substitutable in market A, but the same two products would not necessarily be considered to be directly competitive or substitutable in market B. The Panel next turned to an examination of whether the products at issue in this case were “like products,” starting first with vodka and shochu. The Panel noted that vodka and shochu shared most physical characteristics. In the Panel’s view, except for filtration, there is virtual identity in the definition of the two products. The Panel noted that a difference in the physical characteristic of alcoholic strength of two products did not preclude a finding of likeness especially since alcoholic beverages are often drunk in diluted form. The Panel then noted that essentially the same conclusion had been reached in the 1987 Panel Report, which …agreed with the arguments submitted to it by the European Communities, Finland, and the United States that Japanese shochu (Group A) and vodka could be considered as “like” products in terms of Article III:2 because they were both white/clean spirits, made of similar raw materials, and the end-uses were virtually identical.
Following its independent consideration of the factors mentioned in the 1987 Panel Report, the Panel agreed with this statement. The Panel then recalled its conclusions concerning the relationship between Articles II and III. In this context, it noted that (i) vodka and shochu were currently classified in the same heading in the Japanese tariffs … and (ii) vodka and shochu were covered by the same Japanese tariff binding at the time of its negotiation. Of the products at issue in this case, only shochu and vodka have the same tariff applied to them in the Japanese tariff schedule.
Consequently, in light of the conclusion of the 1987 Panel Report and of its independent consideration of the issue, the Panel concluded that vodka and shochu are like products. In the Panel’s view, only vodka could be considered as [a] like product to shochu since, apart from commonality of end-uses, it shared with shochu most physical characteristics. Definitionally, the only difference is in the media used for filtration. Substantial noticeable differences in physical characteristics exist between the rest of the alcoholic beverages at dispute and shochu that would disqualify them from being regarded as like products. More specifically, the use of additives would disqualify liqueurs, gin and genever; the use of ingredients would disqualify rum; lastly, appearance (arising from manufacturing processes) would disqualify whisky and brandy….
b) Taxation in Excess of That Imposed on Like Domestic Products
The Panel then proceeded to examine whether vodka is taxed in excess of the tax imposed on shochu under the Japanese Liquor Tax Law. The Panel noted that what was contested in the Japanese legislation was a system of specific taxes imposed on various alcoholic drinks. In this respect, it noted that vodka was taxed at 377230 Yen per kiloliter—for an alcoholic strength below 38°—that is 9927 Yen per degree of alcohol, whereas shochu A was taxed at 155700 Yen per kiloliter—for an alcoholic strength between 25° and 26°—that is 6228 Yen per degree of alcohol (see Figure 7.8). The Japanese taxes on vodka and shochu are calculated on the basis of and vary according to the alcoholic content of the products and, on this basis, it is obvious that the taxes imposed on vodka are higher than those imposed on shochu. Accordingly, the Panel concluded that the tax imposed on vodka is in excess of the tax imposed on shochu.
The Panel then addressed the argument put forward by Japan that its legislation, by keeping the tax/price ratio “roughly constant,” is trade neutral and consequently no protective aim and effect of the legislation can be detected. In this connection, the Panel recalled Japan’s argument that its aim was to achieve neutrality and horizontal tax equity. To the extent that Japan’s argument is that its Liquor Tax Law does not impose on foreign products (i.e., vodka) a tax in excess of the tax imposed on domestic like products (i.e., shochu), the Panel rejected the argument for the following reasons: The Variation in Taxes Between Shochu and Vodka
i. The benchmark in Article III:2, first sentence, is that internal taxes on foreign products shall not be imposed in excess of those imposed on like domestic products. Consequently, in the context of Article III:2, first sentence, it is irrelevant whether “roughly” the same treatment 363364through, for example, a “roughly constant” tax/price ratio is afforded to domestic and foreign like products or whether neutrality and horizontal tax equity is achieved.
ii. Japan had argued that the comparison of tax/price ratios should be done on a category-by-category basis, but its statistics on which the tax/price ratios were based excluded domestically produced spirits from the calculation of tax/price ratios for spirits and whisky/brandy. Since the prices of the domestic spirits and whisky/brandy are much lower than the prices of the imported goods, this exclusion has the impact of reducing considerably the tax/price ratios cited by Japan for those products. In this connection, the Panel noted that one consequence of the Japanese tax system was to make it more difficult for cheaper imported brands of spirits and whisky/brandy to enter the Japanese market. Moreover, the Panel further noted that the Japanese statistics were based on suggested retail prices and there was evidence in the record that these products were often sold at a discount, at least in Tokyo. To the extent that the prices were unreliable, the resultant tax/price ratios would be unreliable as well.
iii. Nowhere in the contested legislation was it mentioned that its purpose was to maintain a “roughly constant” tax/price ratio. This was rather an ex post facto83 rationalization by Japan and at any rate, there are no guarantees in the legislation that the tax/price ratio will always be maintained “roughly constant.” Prices change over time and unless an adjustment process is incorporated in the legislation, the tax/price ratio will be affected. Japan admitted that no adjustment process exists in the legislation and that only ex post facto adjustments can occur. The Panel lastly noted that since the modification in 1989 of Japan’s Liquor Tax Law there has been only one instance of adjustment.
Consequently, the Panel concluded that, by taxing vodka in excess of shochu, Japan is in violation of its obligation under Article III:2, first sentence.
[The Panel also found that “shochu, whisky, brandy, rum, gin, genever, and liqueurs are ‘directly competitive or substitutable products’ and Japan, by not taxing them similarly, is in violation of its obligation under Article III:2, second sentence, of the General Agreement on Tariffs and Trade 1994.”]
The Panel recommends that the Dispute Settlement Body request Japan to bring the Liquor Tax Law into conformity with its obligations under the General Agreement on Tariffs and Trade 1994.
The WTO panel considered whether Japan’s policy of taxing imported vodka (and whiskey, brandy, and other imported alcoholic beverages) at a higher rate than Japanese shochu was a violation of GATT Article III. This section of GATT requires that imported goods be accorded “national treatment”—that is, not subjected to higher internal taxes than similar domestic products. After comparing vodka and shochu, the panel decided that they were indeed “like” products. Since imported vodka was taxed at a higher rate, this practice constituted a violation of Japan’s obligations under GATT-WTO rules.
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