13 October 1987


Report of the Panel adopted on 10 November 1987
(L/6216 - 34S/83)


1.1 In a communication dated 22 July 1986, the European Communities requested consultations with Japan under Article XXII:1 on Japanese customs duties, taxes and labelling practices on imported wines and alcoholic beverages (L/6031).

1.2 In a further communication dated 31 October 1986, the European Communities stated that consultations between the EEC and Japan on 4 August and 29 September 1986 had not resulted in a satisfactory settlement and that the Community wished to refer the matter to the CONTRACTING PARTIES in accordance with Article XXIII:2 (L/6078). At the Council meeting on 5-6 November 1986, the Community requested that a panel be established and that, in view of the magnitude of the injury being sustained and the urgency of obtaining a settlement, the CONTRACTING PARTIES apply the "urgency procedure" provided for in paragraph 20 of the Understanding Regarding Notification, Consultation, Dispute Settlement and Surveillance of 1979 (BISD 26S/214) by calling upon the panel to deliver its findings within a three-month period (C/M/204, item 19). Japan replied that an examination under Article XXIII:2 would not help to produce a practical solution to the politically delicate and difficult process of tax reform in Japan and that, for these reasons, Japan could not accept the establishment of a panel. Argentina, Austria, Australia, Canada, Chile, Finland, New Zealand, the United States and Yugoslavia reserved their rights to make a presentation to a panel and to participate in a panel proceeding on this matter (C/M/204, item 19; C/M/205, item 3; C/M/206, item 7). At the Council meeting on 21 November 1986, the Community again requested establishment of a panel with the traditional terms of reference and application of the procedures concerning accelerated work of panels. Japan considered that consultations had not been exhausted and that recourse to Article XXIII:2 and to the "urgency procedure" was inappropriate pending the outcome of the tax reform examination by the Japanese Government in December 1986. At the Council meeting on 4 February 1987, the Council agreed to establish a panel as follows (C/M/206, item 7):

Terms of reference

"To examine, in the light of the relevant GATT provisions, the matter referred to the CONTRACTING PARTIES by the European Communities in document L/6078 and to make such findings as will assist the CONTRACTING PARTIES in making the recommendations or in giving the rulings provided for in Article XXIII:2."


Chairman:Mr. M. Tello
Members:Mr. D. Bondad
Mr. C. Kauter

At the same Council meeting, the representative of Japan outlined measures proposed by his Government in December 1986 as part of the overall reform of Japan's tax system. With regard to the liquor tax, the measures envisaged, inter alia, the abolition of the ad valorem tax, the reduction of the specific tax and the abolition of the grading system for whisky. Regarding the customs tariff on alcoholic beverages, Japan had informed the Community of its intended unilateral tariff rate reduction of 30 per cent in principle. As for labelling, a self-imposed standard covering various items had been established by the Japanese wine industry in response to the Community's requests. He added that despite having been repeatedly asked, the Community had yet to explain the extent to which these new measures were satisfactory and what matters it still considered unsolved. Japan asked the Community to make such an explanation as early as possible, prior to or at the beginning of the panel proceedings (C/M/206, item 7).

1.3 The Panel met with the parties on 18 February, 28 April and 15 June 1987. At the meeting on 28 April, the Panel also heard presentations from Argentina, Canada, Finland, the United States and Yugoslavia. Their views are summarized below in paragraph 4. The Panel decided to send a questionnaire to the parties to the dispute as well as to those third contracting parties which had made use of their right to present their views to the Panel, inviting them to submit additional written information to the Panel. The Panel submitted its report to the parties to the dispute on 22 September 1987.


Liquor Tax System of Japan

2.1 In 1940, the Liquor Tax Law was enacted in Japan. It classified alcoholic beverages into 9 categories and set the tax rates on each category of alcoholic beverages. The "grading system" was introduced to miscellaneous liquors in 1943. Although liquor taxes were basically specific taxes based on quantity, an ad valorem tax was introduced in 1962 to some of the special grade sake, wines and special grade whiskies, of which the price exceeded a certain threshold. This ad valorem tax system was expanded to apply to the lst grade and 2nd grade whiskies in 1971. The revenue from the liquor tax was the third most important revenue source after the income tax and corporation tax in 1985, amounting to 4.9 per cent of total tax revenue.

2.2 The tax system in Japan pursues the objective that taxation should be made according to the ability, on the part of tax bearers, to pay tax ("tax-bearing ability"). In the case of the liquor tax, the tax rates of various liquors are determined not only in accordance with their alcohol contents and other qualities but also by taking into account the tax-bearing ability of prospective consumers. The Japanese Liquor Tax Law classifies liquors into 10 categories. Six categories are further classified into 13 sub-categories and, in the case of sake and whisky/brandy, into three additional grades (see Annex I). The various categories have been defined in Article 3 of the Japanese Liquor Tax Law (see Annex II). Higher tax rates are applied to what are considered to be high-quality high-priced liquors, while lower rates are applied to what are considered low-quality low-priced liquors mainly consumed by those in the lower income brackets (see Annex III reproducing the specific tax rates on the main liquors). The same tax rate is applied to the liquors of the same quality, regardless whether imported or produced in Japan. There is no category where only imported products are subject to taxation. For most of the categories or grades, the standard alcohol content and corresponding standard specific tax rate are set. To the extent that the alcohol content exceeds the standard level, they are subject to increased rates, In certain categories, reduced rates can be applied if alcohol content is below the standard.

2.3 Distilled liquors are comprised of three categories: shochu, whisky/brandy, and spirits (such as vodka, gin and rum). These classifications are based on criteria such as raw materials used and manufacturing method applied. For each category, the current tax rates are determined by taking account, inter alia, of their quality and alcohol content, the pattern and trend of consumption, the tax burden between different categories of liquors, and the objective of imposing higher rates on high-quality high-priced products so that consumers bear a tax burden commensurate with their tax-bearing ability.

2.4 Sake, whisky and brandy are classified into three different grades: special, first and second grade. The grading system for whisky and brandy is based on standards such as the mixture ratio of malt whisky, grain whisky, pure brandy, and the alcohol content of whisky and brandy. The grading system pursues the objective of levying a high tax for high-quality and high-priced whiskies/brandies and an appropriately lower tax in regard to low quality and low priced whiskies/brandies largely drunk by people in the lower income bracket. The grades apply regardless of whether whiskies/brandies are domestic or imported. In fiscal year 1985, 83 per cent of special grade whiskies/brandies, 99.9 per cent of first grade whiskies/brandies and 100 per cent of second grade whiskies/brandies taxed in Japan were Japanese products.

2.5 Ad valorem taxes are applied on special grade sake, special, first and second grade whiskies/brandies, wines, spirits and liqueurs in cases where the price exceeds a certain threshold set for each category of alcoholic beverage (the thresholds and tax rates are reproduced in Annex IV). The ad valorem tax is not levied on liquors in five categories out of ten, such as mirin and beer. The non-taxable threshold of the ad valorem tax is determined based on the manufacturer's selling price for domestic products or the CIF and customs duty amount for imported products. For the main alcoholic beverages, the ad valorem tax is applied to 6.5 per cent of special grade sake, 8.7 per cent of wine and 9.2 per cent of special grade whisky, respectively in volume terms.

2.6 An overall review of the tax system has recently been made in Japan and bills for reforming the tax system have been submitted to the Diet. The proposed reforms of the liquor tax include, inter alia: introduction of a sales tax on alcoholic beverages, which is an excise tax of the same type as the value added tax widely seen in other countries; abolishment of the present ad valorem tax; abolishment of the grading system; abolishment of the present tax rate differentiation within the same categories of wine, liqueurs and spirits; a substantial reduction of specific tax rates for special grade whisky and brandy; the current 2nd grade whisky and brandy will come under the spirits category.


2.7 Japanese bottles of wines, whiskies and brandies currently bear labels using English, French or German terms, such as "Chateau" or "Reserve" or "Village". Japan has enacted various legal regulations in order to prevent the use of trade names in such a manner as to misrepresent the true origin of a product, including the Law for the Prevention of Unfair Competition, the Act against Unjustifiable Premiums and Misleading Representations, a range of "fair competition codes" voluntarily laid down by each industry concerned pursuant to Article 10 of the latter Act and approved by the Fair Trade Commission, and the Law concerning Liquor Business Association and Measures for Securing Revenue of Liquor Tax.


A. Arguments by the European Communities

3.1 The European Communities requested the Panel to find that:

(a) The Japanese system of taxation was discriminatory with regard to imported alcoholic beverages in contravention of the provisions of Article III:1 and 2. The discrimination was due to:

- the absence of uniformity in the Japanese system of taxing alcoholic beverages, which was characterized by a differing tax-assessment basis depending on established product-categories and which amounted to penalizing imported products vis-a-vis domestic producers;

- the application of surprisingly different rates for similar products, based on a classification which resulted in a distinctly heavier levy on imported products than on domestic products;

- practices of the Japanese administration aimed at subjecting imported products to the highest taxation;

- the aggravating impact of extremely high customs duties.

(b) Wines and alcoholic beverages imported into Japan did not enjoy adequate protection as regards origin marking. Bearing in mind the provisions of Article IX:6 and the many representations made to the Japanese authorities on the matter, the Community considered that Japan had not fulfilled its obligations, in terms of those provisions, to co-operate with a view to preventing trade names of wines and alcoholic beverages originating in the Community from being used, under current practices in Japan, in such manner as to misrepresent the true origin of the products.

The Community specified that its claim referred to wines (including champagne and other sparkling wines, bottled wines, sherry and other fortified grape wines, vermouth and other wines of fresh grapes flavoured with aromate extracts), spirits, alcohol and distilled alcoholic beverages (including bottled whisky and brandy, gin, rum, other distilled alcoholic beverages and liqueurs).


3.2 The European Communities claimed that the Japanese system of taxing alcoholic beverages was contrary to Article III: 1, 2 in several respects:

(a) Categorization: Many alcohol taxation systems differentiated between broad categories of liquor such as brewed drinks (e.g. beer), fermented drinks (e.g. wine) and distilled beverages (e.g. whisky). The Japanese classification, however, unlike other systems, made a fundamental distinction between "Western-style" liquors and Japanese "traditional" alcoholic beverages (such as mirin, sake and shochu). These Japanese products had been differentiated for tax purposes as carefully defined separate product categories on the pretext of their traditional character. As a result, "traditional" had become virtually synonymous for "domestic", as confirmed by the extremely low level of imports in the traditional categories, and some domestic products fell into tax categories different from essentially similar competitive and substitutable products imported from the European Communities. Where raw materials and manufacturing processes were not sufficiently distinctive to differentiate "traditional" products, product definitions had been written so as to exclude imported products similar to the traditional products. For example, shochu was similar to vodka; but the shochu category for tax purposes excluded spirits filtered with a birch charcoal filter, which prevented vodka from qualifying for the favourable shochu tax rates. There was no reason in a rational tax system to tax similar products differently merely because they were made by slightly different production methods or from different raw materials (e.g. Whisky diluted with other spirits differently from undiluted whisky). Even though not all of the so-called "traditional" products were made by traditional processes or from traditional ingredients (e.g. Type A shochu) and patterns of consumption now resembled those existing in other developed countries, the artificial differentiation of separate tax categories protected "traditional" domestic products and consumption patterns and was in breach of Article III:1 and 2.

There was also a marked lack of uniformity in the minimum specific tax rates applicable to alcoholic beverages. For instance, the tax per litre on "Western-style" spirits such as gin and vodka was four to seven times higher than the tax on shochu. The tax on a litre of imported special grade whisky was respectively 41 and 26 times higher than the tax on a litre of Type B shochu and Type A shochu. As a result the tax alone on a litre of imported whisky or brandy was twice the retail price of a litre of shochu. The mass volume market for spirits was thus protected for the domestic product shochu by a tax-determined-price mechanism, as had been recognized in the following statement recently made in a Japanese tax review:

"The liquor tax has the effect of creating gaps in price competitiveness among liquor types. The result is an artificial ranking of shochu as a popular liquor and whisky as a high class liquor" (in: Taxation Accounting, 23rd January 1987).

The "traditional" categories (e.g. shochu) benefited from rates which were disproportionately low in comparison with the categories in which there were competitive or substitutable imported products (e.g. gin, vodka, special grade whisky). The extremely detailed and artificial 10 separate tax categories and 13 sub-categories and their very disproportionate tax rates were arbitrary and resulted in different tax treatment of imported and domestic like products or competitive and substitutable products contrary to Article III:1 and 2.

(b) Grading: The classification of whiskies and brandies into three "grades", with significantly different tax rates applied to them, resulted in discriminatory tax treatment of imported and domestic like products contrary to Article III:2. The grading system applicable to whisky and brandy was totally unlike the system applicable to the domestic product sake: Grading of whisky and brandy was mandatory, by raw material and alcohol content, and automatic (i.e. imported products being automatically graded as special grade unless proved otherwise). By contrast, grading of sake was voluntary and by taste, i.e. sake producers could choose whether to submit their products for grading and whether to be subject to the higher rates of tax applicable to graded sake. The system of grading applied to whisky and brandy had the effect of classifying almost all imported whisky and brandy in the special grade, which was by far the most highly taxed grade. This resulted from the fact that special grade included all pure malt and pure grain whiskies and that in all main whisky producing countries a whisky to be certified as such had to be wholly cereal-derived. The same applied to brandy based on similar criteria. The result was that all whisky and brandy imported from the Community was submitted to a tax rate greatly in excess of that applied to like Japanese first and second grade whiskies and brandies, the minimum tax rate on special grade being over seven times higher than the tax rate on second grade whisky. EC imports of lst grade whisky and brandy represented less than 0.1 per cent of total first grade volume and there were no EC imports of 2nd grade products. The grading system thus placed all Community whisky in an artificial luxury category and allowed more than half of the domestic production to benefit from more favourable tax treatment under the second and first grades artificially created for this purpose.

(c) Ad valorem taxes: On some categories, covering basically the traditional products (sake, shochu, mirin), the liquor tax was levied through a specific tax rate only (fixed rates per litre) or almost exclusively (e.g. less than 0.1 per cent of all sake was subject to ad valorem taxation). On the "Western-style" categories, a specific tax rate applied up to a fixed base price of the product (e.g. a specific tax at Yen 60.4 per litre on standard wines up to a "tax barrier" of Yen 1,080 per litre); above this non-taxable threshold of ad valorem tax, a series of very high ad valorem rates, different for various products, replaced the specific tax without any correlation to the specific rates applicable to the same category nor in proportion to alcohol content (e.g. an ad valorem tax of 50 per cent on a bottle of wine with a taxable value of Yen 1,081, more than 8 times higher than the specific tax). Once the threshold had been exceeded, the tax rates became up to 8 times higher than the specific rate on wines, 4 times higher on liqueurs and 2 times higher on spirits. This resulted in tax discrimination among "like products" within categories (e.g. wines, liqueurs and spirits of the same category with prices above or below the "tax barrier") as well as among competitive and substitutable alcoholic beverages of different categories. It first discriminated against like Community products since the application of very high levels of import duties on alcoholic beverages and their inclusion in the taxable value used for applying the threshold ("tax barrier") above which the ad valorem tax was payable, resulted in submitting a much greater proportion of imported products to the disadvantageous ad valorem rate. Secondly, the distinction drawn between traditional products and "Wester-style" products as to the application of an ad valorem rate provided for a more advantageous treatment for a whole sector of the local production where there was no fear of direct foreign competition, due to the careful definition of the "traditional" beverages. The existing gap in specific tax rates between competitive or substitutable products such as whisky, brandy, or spirits on the one hand and shochu on the other hand had therefore been considerably increased. The Community considered that this lack of uniformity in the tax treatment of alcoholic beverages and the selectivity in the application of ad valorem tax was designed solely to afford protection to domestic production and contravened the principles set forth in Article III:1 and, in the light of the interpretative note to paragraph 2, Article III:2 second sentence. Since prices for shochu and ungraded sake could vary considerably and the comparatively lower prices of shochu resulted also from the lower taxation on shochu compared to other distilled beverages, the absence of ad valorem taxation on these products could not be convincingly justified by their price levels.

(d) Calculation of price for tax purposes: There were different methods of calculating ad valorem tax for imported and domestic products. In the case of imports, the tax base was usually the CIF cost plus duty. Importers had no choice as to the method of calculation. For domestic products, there were two methods and producers could choose whichever was the most favourable of them: The manufacturer's selling price to wholesalers, excluding tax, or the retail price less trade margins less tax (the so-called "fixed subtraction ratio system"). Although the latter method was officially described as a "special case", applicable when the retail price was known, in practice it was almost always used. This allowed domestic producers to choose effective tax values for domestic products which could lead to the application of more advantageous rates for domestic products when different ad valorem tax rates were provided as was the case for special grade brandy and whisky. For example, as regards special grade domestic whisky an ad valorem rate such as 164 per cent could apply, whereas for similar imported products only 150 per cent and 220 per cent rates could apply. The difference in the methods of calculation of price for the purpose of assessing ad valorem tax thus led to the possibility of more advantageous treatment for the domestic producers and could result in the imposition of taxes on imported products in excess of like domestic products. This more advantageous treatment in the calculation of price offered to domestic products constituted a breach of Article III:4 and also of the prohibition of "indirect" tax discrimination in Article III:2 when the differing taxation methods resulted in discriminatory tax burdens.

(e) Taxation according to extract content: Another feature of the Japanese system which discriminated between "like" products in violation of Article III:2 was the method of assessment based on extract or non-volatile ingredient content. In the category of "liqueurs" (which were universally recognized as being sweetened and flavoured alcoholic beverages and which therefore had as one would expect a high non-volatile ingredient content) two specific rates of tax were applied according to both alcohol and extract content. This system ensured that almost all Community liqueurs were subject to the higher rate of specific tax whilst some Japanese liqueurs were able to benefit from a lower specific rate (one third of the rate on most Community liqueurs) together with a lower ad valorem rate (50 per cent as opposed to 100 per cent) and a much lower increment per degree of alcohol (9.780 yen per 1 per cent over 13 per cent compared with 24.5 yen per 1 per cent over 15 per cent in the higher rate category). Most Community liqueurs were made to traditional formulae with a fairly high flavouring content. Japanese products had been designed by manufacturers who were aware of the substantial tax advantage for products with an extract content below the 15 per cent extract level. The Community considers that taxation according to extract content was artificial and irrational and discriminated against imports contrary to Article III:2.

(f) Economic and social consequences: According to the European Communities, the high rates of tax on imported alcoholic beverages reduced their availability at points of sale and their choice by the average consumer, and distorted competition amongst alcoholic beverages on the Japanese market. The structure of the tax system influenced the pattern of consumption and clearly did not correspond to the so-called "principle of taxation according to tax-bearing ability". For example, beer which was the beverage consumed in by far the greatest volume by all sections of the population was the second most highly taxed beverage in terms of tax per litre of alcohol. Artificial and arbitrary criteria for assessment of quality were used to justify large tax differentials. In 1985, the spirit shochu, which accounted for approximately 20.4 per cent by volume of consumption of pure alcohol, raised 2.4 per cent of revenue on alcohol whilst special grade whisky accounted for 7.5 per cent of volume of pure alcohol but 15.1 per cent of revenue. Since there was also a substantial divergence in tax per litre of alcohol on different products varying from 2,036 Yen to 53,133 Yen, the Japanese tax system and its wide range of specific tax rates on equivalent products did not appear to be based on social or public health grounds either. The wording of Article III:2 and GATT practice indicated that different tax treatment of imported and domestic products contrary to Article III:2 could not be justified by tax policy considerations. The only questions which needed to be decided under Article III:2 were whether the tax on imported products was in excess of that on like domestic products and whether the internal tax afforded protection to domestic production. The reasons why a national tax system provided protection or discriminated against imported goods were irrelevant.

(g) The proposed tax reform: In the view of the European Communities, the proposed tax reform would not remove the existing tax discrimination and could even aggravate the differential tax treatment of "traditional" and other spirits. It was uncertain whether this or another tax reform proposal would ever be examined or adopted by the Diet. It should, therefore, not be taken into account in the deliberations of the Panel.

3.3 According to the European Communities, the purpose of Article III was to secure for imports the opportunity to compete on equal terms with domestic products. This had been recognized in the finding of the recent panel report on US-taxes on petroleum that "Article III: 2 first sentence, obliges contracting parties to establish certain competitive conditions for imported products in relation to domestic products" (L/6175, paragraph 5.1.9). Article III:2 imposed a two-fold obligation: not to apply directly or indirectly to imported products internal taxes in excess of those applied to like domestic products; and not to apply internal taxes to imported or domestic "directly competitive or substitutable" products in such a way as to afford protection to domestic production. It had been recognized in GATT practice that the term "like product" should be interpreted on a case-by-case basis taking into account the product's end-uses in a given market, consumers' tastes and habits, and the product's properties, nature and quality (BISD 18S/102). It had also been established that minor but clearly perceptible differences in taste, colour and other properties did not prevent products qualifying as "like products" (BISD 28S/112). Tariff classification also provided a useful starting point for determining what might be "like products". The Communities considered the following products to be "like products" within the meaning of Article III:2 (see Annex V):

- All Community whiskies and all Japanese whiskies, whose respective minimum genshu contents and grades had varied over time.

- All Community and all Japanese grape brandies.

- All Community and all Japanese fruit brandies.

- All Community and all Japanese still wines.

- All Community and all Japanese sparkling wines.

In all the above product group)ups there was considerable variation in taste, smell and colour but the similarities between products within each group were such that each was recognized as "a well defined and single product" (BISD 28S/102, paragraph 4.7) whisky, brandy, still wine or sparkling wine. According to the Japanese liquor tax law, second grade whisky, although it contained neutral spirits, must resemble pure malt or grain whisky in flavour, colour and other properties. Differences in prices and "quality" (e.g. alcohol content for whisky, brandy and liqueurs) did not create different types of product.

- Vodka and shochu.

3.4 The interpretative note to Article III:2 made it clear that the second sentence of Article III:2 extended the prohibition to discrimination between directly competitive or substitutable products. It was well established that the concept of "directly competitive or substitutable" products was much wider and could cover also products with different origins, contents and tariff rates but substitutable in terms of their end use, such as apples and oranges, or skimmed milk and vegetable protein products (BISD 25S/49). All distilled liquors in bottled form were competitive in terms of price and substitutable in terms of their end use within the meaning of the interpretative note to Article III:2 and presented a choice to consumers of drinks with a relatively high alcoholic content. For instance, shochu was blended in various proportions with whisky and brandy precisely because the products were compatible and substitutable. All products classified as liqueurs in the Japanese tax classification also presented a choice to the consumer and had to be considered directly competitive and substitutable products.

3.5 According to the European Communities, Article III:2 first sentence had been violated by the following tax practices:

- Whiskies, grape brandy and certain fruit brandies were affected by the grading system applied to the whisky/brandy category which applied a much higher level of taxation to these products not mixed with neutral spirits.

- All Community wines, spirits and liqueurs which were subject to the "mixed" system of specific tax and ad valorem tax applied below and above a tax barrier were prejudiced by the operation of ad valorem taxes (including the different methods of calculating value for tax purposes).

- The alcoholic beverages falling in categories for which tax was determined by extract content (sparkling wine and especially liqueurs) were discriminated against in comparison with like products with a fractionally lower flavouring and sugar content.

The Communities considered that Article III:2 prohibited also indirect or de facto discrimination and that the use of "genshu" content as the basis for the taxation of whisky and brandy was a blatant example of the serious de facto discrimination concealed in the Japanese tax system. Whisky and brandy diluted with neutral spirits or alcohol but flavoured to retain the characteristics of the product were almost exclusively Japanese products. Determining rates of taxation according to the dilution factor was therefore an indirect way of distinguishing between Japanese and imported products. If tax criteria were based on characteristics typical of almost entirely domestically produced products, whether traditional or not, such product differentiation could result in indirect tax discrimination inconsistent with Article III:2. For instance, the almost exclusively domestically produced spirit shochu benefited from favourable tax differentials of between 1/7 (shochu B/other neutral spirits) and 1/41 (shochu B/special grade whisky) in comparison with all other spirits, some of which were "like products" and all of which were competitive and substitutable. The huge tax differential between second-grade Japanese whisky/brandy and even the cheapest Community whisky/brandy inevitably led to a large difference in retail price which put standard imported whisky outside the price range of the majority of private consumers and of lower grade Japanese whisky/brandy. The existence of also some imported goods in the less heavily taxed category (e.g. imported shochu representing 0.4 per cent of domestic production), or of some domestic goods in the more heavily taxed category, could not justify the tax discrimination among like products.

3.6 The Communities considered that a difference in taxation between "like" products based on different categories for tax purposes could certainly not be justified under Article III on the mere fact that there were domestic goods in all tax categories. More specifically, such a situation should be ruled as contrary to Article III:2 when the following conditions were met:

- there was substantial production by the domestic industry of products in the less heavily taxed categories;

- all or a very high proportion of imported products were in the categories subject to the higher rates of tax;

- the criteria used for differentiating between the tax categories of products were artificial, arbitrary and not based on any objective differences which would justify or necessitate a different treatment on social, health or economic grounds (other than protectionist considerations which would be contrary to GATT principles); and

- in every pair of tax categories which result in applying different treatment to "like" products, the effective tax rates in practice applicable to imported products were very much higher, and not merely slightly higher, than the tax rates applicable to the corresponding category composed largely of domestic products.

The same reasoning applied to "competitive or substitutable" products.

3.7 The Community considered that the lack of uniformity in the Japanese tax system applying to the alcoholic beverages market was designed solely to afford protection to domestic production. It contravened the principles set forth in Article III:1 and, in the light of the interpretative note of paragraph 2, the obligation stated in the second sentence of Article III:2. The unequal taxation of directly competitive or substitutable products had a protective effect. Article III:2 second sentence was violated by the fact that:

- All distilled liquors (whisky, brandy, gin, vodka, etc.) which were directly competitive with shochu were affected by the system of categorization which permitted shochu to benefit from extremely favourable taxation in comparison with other spirits.

- All Community products in categories which were subject to ad valorem taxation were at a disadvantage in comparison with Japanese "traditional" products which were only obliged to be subject to specific taxes.

Article IX:6

3.8 In the view of the European Communities, Japanese legislation and practice in the field of wines and spirits labelling had not proved adequate to restrain labelling practices which misled consumers as to the origin of products. Article IX:6 did cover not only the usurpation of a specific regional or geographical name but also the way in which a trade name could mislead as to geographical or regional origin. Japanese rules for the production and commercialization of wines and spirits were in a large part based on codes of conduct established on a voluntary basis by the industry concerned. The "Self-Imposed Rules of the Wine Industry" and the "Standards for the Domestic Wine Labelling" had no legal character whatsoever as they had not been approved by the Fair Trade Commission. The government could not, therefore, ensure the respect of these rules by the imposition of sanctions. Only recently had the industry agreed to indicate "imported wine used" printed on the label in the case where imported wine was blended with domestic wine. Wines bottled in Japan, which might contain as much as 95 per cent imported bulk wine or which could be produced on the basis of imported must, needed bear no indication of the proportions or the source of ingredients. As regards whisky, ingredients were listed but the percentages or the use of neutral spirits were not indicated. Japanese brandy sometimes contained alcohol not made of grapes. Japanese brandy producers used such indications as "V.S.O.P.".

Japanese spirits and wines were labelled in a European style, in a European language with European symbols. Japanese manufacturers used in their labelling French words, French names, German script and other devices with a clear implication that the product was in some sense of European origin. In the case of wines, only recently did the main label indicate the name of the "producer", maintaining however a degree of ambiguity as to his precise activities. A survey made by the EEC in 1986 had indicated that some 45 per cent of Japanese consumers questioned were misled by use of foreign lettering on wine and spirit labels and had mistakenly thought that Japanese wine bottles were of French origin. Given the importance of the label in the case of wines and spirits, the Community had made representations to the Japanese Government in order to obtain the introduction of adequate legislation. It was to be noted that this labelling situation contrasted strikingly with the scope of the Community regulations in the field of labelling of wines and spirits or with the very tight regulations existing in japan for products such as food or pharmaceutical products. It was not customary to write labels on domestically produced bottles designed to be sold on the local market in a foreign language. The only response given up to now by Japan had been the adoption of "self-imposed" rules by the wine industry as regards the country of origin and the content of the product. Nothing had been done as regards spirits. The Community considered that this only partially and inadequately answered its request. In effect it considered that only the adoption of effective legislation could be considered as an adequate Japanese response to its request under the terms of Article IX:6. The Community drew the attention of the Panel to the importance of giving Article IX:6 its full meaning, especially regarding the need for a contracting party to act by means of a state measure to remedy a situation which is detrimental to another contracting party.

B. Arguments by Japan

3.9 Japan requested the Panel to find that Japan's liquor tax did not discriminate between domestic and imported alcoholic beverages and was not applied in such a way as to afford protection to domestic production inconsistent with Article III:1 and 2. Japan had also met its obligations under Article IX:6 by taking necessary measures to prevent misrepresentation of the true origin of alcoholic beverages which might be caused by labelling.


3.10 Japan claimed that its system of taxing alcoholic beverages was fully consistent with Article III:1 and 2.

(a) Categorization: The tax categories had been established in accordance with clear and objective criteria such as raw materials used and manufacturing method applied, and did not make any distinction between domestic and imported products. For each category, the current tax rates had been minutely determined not only by their alcohol contents but also by taking account of various factors such as quality and alcohol content, the pattern and trend of consumption, and the aims of balancing the tax burden between different categories of liquors and of imposing higher tax rates on high-quality, high-priced products so that consumers bear a tax burden commensurate with their purchasing power. For example, a relatively higher tax burden was carried by special grade whisky which had an established image as high-class liquor, and a lower tax burden by shochu which was considered low-class liquor and mainly consumed by persons in low income brackets. The same tax rate was applied to the liquors of the same quality, regardless whether imported or produced in Japan. The existing tax rates were appropriate and consistent in terms of the fundamental Japanese taxation principle of "taxation according to the tax-bearing-ability". The question of how a liquor tax was imposed was a matter to be decided by each individual country. Other countries had also adopted tax systems under which liquors, including distilled liquors, were classified into categories with different tax rates applied. Besides, "Western-style" liquors, generally called "Yoshu" (foreign liquors) in Japan, did not mean that they were foreign products, but simply meant that their historical origin was not in Japan. As a matter of fact, 91 per cent of the whiskies consumed in Japan was domestically produced, and of the special grade whiskies, 83 per cent of that consumed in Japan was produced in Japan. Of the spirits which included vodka, gin, rum, etc. under the japanese Liquor Tax Law, 94 per cent was produced in Japan (in FY 1985). On the other hand, as for shochu which was regarded by the EC as japanese traditional liquor, a certain volume was imported from abroad including the EC countries, and the tax rate was exactly the same as that on shochu produced in Japan. (The quantity of imported shochu had been 1,821 kl in FY 1984 and 2,562 kl in FY 1985).

Article III:1 and 2 did not prohibit the establishment of differences in internal taxes among like products or among directly competitive or substitutable products. Article III:1 and 2 only stipulated that imported products must not be subject to internal taxes in excess of those applied to like domestic products and that internal taxes must not be applied to directly competitive or substitutable imported or domestic products so as to afford protection to domestic production. As long as internal taxes were non-discriminatory between domestic and imported products, and were not applied so as to afford protection to domestic production, establishing differences in tax rates based on the national tax system, even among like products or directly competitive or substitutable products, did not constitute an infringement of obligations under GATT. There was no category where only imported products were subject to taxation. In order to undertake an accurate comparison of taxation levels among different liquors, it was necessary to compare not only tax rates among different kinds of liquors but also to take into account such factors as their prices and alcohol content. For instance, compared on the basis of alcohol content, the tax rate on special grade sake was much higher than spirits and liqueurs, though it was lower than special grade whisky. It was also 7.6 times higher than tax rate on wine. The taxation level on wine was lower than second grade sake, which was a typical popular liquor along with shochu. From this viewpoint, it was incorrect to assume that Japan' s taxation level on "traditional" categories was in general lower than that on "Western-style" liquors. In order to levy taxes according to tax-bearing-ability on each category of liquors, the ratio of liquor tax to retail price of liquors had been traditionally used as an indicator in setting the tax-burden for each category. The reasonableness of this method was confirmed by the fact that ad valorem tax was also computed as a percentage of the price. A simple comparison of amounts of specific tax was misleading. As the table below indicated, the differences in terms of the ratio of liquor tax burden to the retail price were not so great as the tax rate differences among grades might suggest. The ratio on Scotch whisky, which the EC alleged was subject to discriminatory treatment, was actually lower than those on the lst grade and 2nd grade Japanese whiskies.

Table: Ratio of Liquor Tax Burden to Whisky's Retail Price
(Source: Submission by Japan)

Retail Price (A) Liquor Tax Amt. (B) (B)/(A)
(Domestic Product)
Special grade (760ml, 43%) 3,170 yen 1,594.55 yen 50.3%
1st grade (720ml, 40%) 1,620 yen 728.20 yen 45.0%
2nd grade (640ml, 37%) 670 yen 189.56 yen 28.3%
(Imported Product)
Special grade (750ml, 43%) 8,000 yen 1,573.57 yen 19.7%
Special grade (750ml, 43%) 4,000 yen 1,573.57 yen 39.3%

(b) Grading: The grading system was based on the circumstances of production and consumption of whiskies/brandies in Japan. It was applied to sake and whiskies/brandies which run a wide range of quality, and was based upon the principle that liquor tax should be levied according to the tax-bearing ability. It clearly classified the grades according to objective standards such as the mixture ratio of malt whisky or grain whisky (and pure brandy in the case of brandy), and the alcohol content of whiskies. This grading system equally applied to domestic and imported products. The grading system was designed to levy a high tax for high-quality and high-priced whiskies and an appropriately lower tax in regard to the whiskies largely drunk by people in the lower income bracket. Imported whiskies could be sold as first or second grade whiskies, if overseas manufacturers exported products matching the Japanese situation of consumption. This grading system was established in 1943 to seek financial resources in wartime by levying high taxes on high-quality and high-priced liquors and imports of whisky were not considered then in view of the environment at that time. Therefore, it was clear that it had not been in the minds of those who had introduced the system to discriminate against imported products. 83 per cent of special grade whiskies taxed in 1985 had been domestic products. This fact clearly illustrated that the grading system did not either protect domestic products or discriminate against imported products. The establishment of different rates of tax even among like products based on each country's legitimate tax system did not constitute an infringement of GATT obligations. Due to the differences in quality, alcohol content, prices and consumption patterns, special and second grade whiskies could not be considered like products.

(c) Ad valorem tax: The ad valorem tax system supplemented the demerit of the specific tax that the tax amount remained the same regardless of the prices of the products. To offset this, the ad valorem tax had been introduced in those classifications where a great difference existed in market prices, regardless of whether products were "traditional" domestic liquors or "Western-style". For instance, special grade sake which the EC called "traditional" liquor, having a wide range of price, had the ad valorem tax applied. On the other hand, for beer which came under the category which the EC called as "Western-style" alcoholic beverages, having a narrow range of price, the ad valorem tax was not applied. The system was designed to achieve a fair distribution of the tax burden among the beverages of the same category of liquors and was not applied to the disadvantage of imported products. It attempted to alleviate the retrogressive effect inherent in indirect taxes and to ensure equity in tax burden sharing. Each contracting party retained the right to adopt a national tax system which in its judgment was rational, as long as it did not infringe the relevant GATT provisions. A situation that "Western-style" liquors were more frequently subject to ad valorem tax compared with "traditional" liquors was a mere result of the fact that liquor categories running through a wide range of price variations were more frequently found in the "Western-style" liquors than in "traditional" liquors. As for wine and whisky which were main liquors imported from the EC, the imported volumes subject to ad valorem tax were 2,563 kl and 2,126 kl, respectively in Fiscal Year 1985. Both figures were smaller than those of domestic wine and domestic special grade whisky, of which the volumes subject to ad valorem tax were 3,625 kl and 10,570 kl, respectively in the same year. Moreover, in FY 1985, the percentages of volume subject to ad valorem tax in each liquor category were as follows: 7.3 per cent for domestic wine; 11.9 per cent for imported wine; 8.9 per cent for domestic special grade whisky; and 10.7 per cent for imported special grade whisky. These figures clearly indicated that the application of ad valorem tax did not discriminate against imported products, nor did ad valorem tax afford protection to domestic production.

(d) Calculation of price for tax purposes: The ad valorem tax for imported products was easily calculated, for the CIF & customs duty for imported products could be easily grasped and the tax was derived simply by multiplying the tax rate to the price. The calculation of the ad valorem tax for domestic products, however, required considerable work, because the liquor tax had already been included in the price of the transaction (therefore, in calculating the ad valorem tax amount, it would be necessary to deduct the liquor tax amount from the price in order to obtain the correct tax base), and in case of sales to special clients such as a wholesaler with capital affiliation, careful consideration was needed to calculate correctly an ordinary sales price. Therefore, to avoid an increased work load, the tax base could be calculated on the basis of the retail price. If the retail prices were made known to the public by newspapers or other media, the tax base would be derived based on those retail prices, upon confirmation by the tax authorities, after deducting from the retail prices a portion (fixed rate) for the margin of the wholesalers and other distributors, transport charges, etc. This fixed rate was determined based upon the result of market research on the actual transactions. The tax base computed this way was meant to be equivalent to the manufacturer's selling price defined as the tax base. There was no discrimination between domestic and imported products, and no actual difference in tax base between domestic and imported products arose because of this "fixed subtraction system" for the assessment of the tax base for domestic products. It was quite common also in EEC countries that, in the case of indirect taxes, the tax base of imported products included the customs duties. The application of the intermediate tax rate on domestic special grade whisky had no relation to the "fixed subtraction system" and was used as a means of adjustment necessitated by the fact that transactions of liquors in Japan were usually made on the basis of the price including the liquor tax. An intermediate tax rate higher than the specific tax rate was applied in case where the transaction price after deducing ad valorem tax did not reach the non-taxable threshold, although the transaction price after deducing specific tax exceeded the non taxable threshold. This adjustment allowed the gap between the transaction price and the threshold to be collected in full as tax.

(e) Taxation according to extract content: According to Japan, the EEC's claim that "almost all imported liqueurs were subject to the higher rate of (specific) tax because of their higher extract content", was contradicted by facts. Imported liqueurs were divided into, on the one hand, "quality liqueurs", the higher tax group, and, on the other hand, "other liqueurs", the lower tax group on a roughly 50-50 basis. Some 70 per cent of "quality liqueurs" were domestic products. Most "other liqueurs" were fundamentally different from "quality liqueurs" in terms of not only their quality, such as alcohol content, but also use. As such there was no direct competitiveness nor substitutability, let alone likeness, between the two types of liqueur. Consequently, it was rational to classify "quality liqueurs" into different categories in view of the principle of Japan's liquor tax that the different tax rates would apply according to the types of liquors. And in the respective category the same tax rate was applied equally to both the domestic products and the imported ones.

(f) Economic Consequences: Japan pointed out that, even though the share of imported liquors was less than 1 per cent of Japan's liquor market, it should be noted that the share of beer accounted for 65 per cent of the total consumption of liquor and sake for 18 per cent in Japan's liquor market. The total share of these two categories of liquor amounted to 83 per cent. The share of imported products in whiskies and wine, which were of interest to the EEC, had been drastically increased since the liberalization of their imports (February 1970 for wine, and January 1971 for whiskies). As a result, the share of imported whisky accounted for 14.6 per cent in Japan's market of special grade whisky; the shares of imported wine and special grade brandy accounted for 31.5 per cent and 38.2 per cent, respectively, both of which represented a considerable proportion of Japan's market.

Japan did not agree with the EEC's claim that, as a result of prices being raised by the high liquor tax levied on EEC products, the distributors frequently decided against imported products and, thus, the consumer's choice was limited in terms of the point of sale as well as of price. The causes for raising the retail price of EC-produced whiskies were rather due to the fact that imported whiskies had been regarded by consumers as high quality and precious goods and the exporters and distributors of these goods had been following a high price policy, taking advantage of consumers' perceptions. In fact, the margin of imported special grade whiskies during the course of distribution was 60 to 70 per cent of the retail price, which was fairly high in comparison with domestic special grade whiskies of which the margin was usually around 30 per cent.

The ratio of the tax to retail price (tax burden rate to retail price) was nearly 20 per cent for premium imported whisky and nearly 40 per cent for standard imported whisky, of which the tax burden ratio to retail price was fairly low in comparison with domestic special grade whisky of which the ratio was about 50 per cent. As such, the price of imported whiskies was determined largely by the sales policy of agents who often introduced large distribution margins (some of them were requested to do so by the exporters of the products). The setting of retail prices was also closely linked with "commodity images" formed over the years. As for special grade whisky, each company tried to set its prices at a high level in order to maintain and strengthen the "image" of a high quality liquor, thereby securing a large margin. However, in the case of shochu, it was impossible to set the prices high, even if manufacturers desired to have large margin, since shochu was widely perceived as a popular and cheap liquor. Thus, the high production cost and the high quality "image", as well as the large margin, made whisky more expensive than shochu.