The Hindu Business Line : Spirited debate at the WTO

That the European liquor lobby is strong is clear from the EU complaint filed with the WTO that India's multi-layered tax system is a barrier to trade. It is hoped the Commerce Ministry will handle the dispute with the best possible expertise and not be influenced by the EU's recent RTA proposal, says K. SUBRAMANIAN.

The European Union (EU) has fired the salvo signalling its intent to continue the war with India on whisky. After the India-EC Summit at Helsinki in October, there were hopes of a newfound bonhomie in bilateral relations.

During his recent visit to India (November 17-18) post the Helsinki Summit, the EU Commissioner, Mr Peter Mandelson, said that the India-EU cooperation agreement, expected to be signed in the next two years, would be India's largest regional trade agreement (RTA). With this to look forward to, it was hoped that older disputes would be kept aside or resolved over time. That hope has been belied.

On the same day that Mr Mandelson was briefing the press in Delhi, the EC was busy giving final touches to a complaint to be filed with the WTO against India. It is not clear whether the EU Commissioner discussed the issue during his Delhi meetings. Perhaps he was hurt over the Indian response. Certain remarks of the Commerce Minister, Mr Kamal Nath, reported in the press, such as revenue loss to India and lack of reciprocity by the EU, lend credence to this.

The complaint was filed on November 20. If the EU persists with the litigation, it may drag on for years due to WTO procedures and complexity of the legal and financial issues involved.

Indian tax system

The EU's complaint is that India's tax system (Central and State), imposing multi-layered duties, such as Customs duty, additional duty, extra additional duty, etc., is discriminatory and constitutes a barrier to trade. The duties, aggregating to 525 per cent, prevent EU producers from realising the Indian market potential. The European Commission has been suffering for years ever since India replaced quantitative restrictions with the new duty structure.

As diplomatic efforts for over five years failed to get relief, the Commission was forced to defend its rights and ensure compliance by India of its obligations under the WTO. Interestingly, the complaint cites the policy of the Tamil Nadu Government in banning sale of imported drinks in the State.

Likely issues

What are the issues likely to be raised by the EU before the panels? The EU still has faith in the applicability of older GATT principles, viz tariffs and "national treatment" (NT). Further, it may look to the earlier WTO decisions on alcohol.

When the Indian whisky dispute reaches the Dispute Settlement Board (DSB), the Board will deal with issues not raised earlier and go far beyond tariffs and duties. The GATT's original (1947) role in tax matters was limited to Article III, National Treatment on Internal Taxation and Regulation.

As Prof Gary Clyde Hufbauer explains: "Even though the tax world after the Second World War bore no resemblance to the 19th century, these historic assumptions about tax incidence were implicitly adopted in GATT Article XVI... ." (The WTO as Tax Nanny, Centre for Strategic Tax Reform, Institute of International Economics, April 25, 2006.) After a close analysis of WTO rulings on some important issues, especially on the long drawn-out Foreign Sales Corporation (FSC) case, he concludes that "the WTO rules rest on a massive contradiction" and calls for a review.

These issues had not arisen in the early days of the WTO, when three alcohol-related disputes were decided. One related to Chile; the other to Japan; and the last to Korea. The ruling on Japan was handed out in 1995 and the other two in 1999. In all those cases, the native drinks — shochu in Japan, pisco in Chile and soju in Korea — were accorded preferential tax treatment vis-à-vis the imported spirits. When the disputes arose, in Japan and Korea it led to cultural tremors as they were called upon to permit imports prejudicial to their native products.

Common thread

The common thread among the three was the definition of "like products" and "national treatment" under Article III. The appellate bodies took the view that imported and native beverages were `like products' competing with each other and ruled that differential tax treatment was discriminatory and, therefore, violative of the WTO rules.

There have been debates on the soundness of these rulings, especially on the definition of `like products.' In a learned analysis, Prof Konrad von Moltke takes the view that the Appellate Body had erred in its decision. He adds: "This raises thorny issues. Sooner or later, the dispute settlement process will come under close adversarial scrutiny by environmental and other interests." (www.ictsd.org/html/review4.7htm)

Both South Korea and Japan fought the issue for several years and finally agreed to bring taxes in line with the WTO rulings in a phased manner. Ultimately, the foreign liquor lobby did not win the battle. In Japan, consumption of whisky declined while sale of shochu boomed among the health-conscious Japanese. In Korea, the share of tax revenue on soju increased substantially even as that on imported whisky declined.

Whatever the situation in other countries, the issue has to be fought by India for its own special reasons. Given the addiction of Indian drinkers to imported whisky, any lowering of tax will open the `scotch gates.' The adverse revenue implications will be incalculable for the Union Government and work against its fiscal management.

The States may face a more serious predicament. Currently, the States derive, on an average, 15-20 per cent of their revenues from excise, second only to sales tax. The total excise revenue for all the States is around Rs 22,000-25,000 crore. If they are required to forego this revenue, the Centre will have to compensate them. This would be double jeopardy for the Centre. The EU and the Scottish whisky lobby are aware that there are 28 States in the country and they have their own fiscal and developmental constraints.

India is unique

Unlike Japan, Korea or Chile, India is not a unitary state and the tax structure carries historical baggage. There is already an ingrained antipathy to the WTO and the commitments given by the Centre. Thus, any attempt to tinker with the excise duty structure on the plea of WTO compliance would unsettle budgets across the country and lead to a revolt of the States against the Centre.

The stakes involved are high and the issues complex and intractable. Though the EU may be voicing slogans in support of free trade, it is driven more by lobbies than by theories.

The European liquor lobby is quite strong. The manner in which this complaint has been filed is evidence of its clout with the EU.

It is not clear how the Union Commerce Ministry proposes to handle the dispute before the WTO. It is hoped that it will handle it with the best possible expertise on international trade and legal issues and not be distracted by the RTA offered by the EU. Rather, it could insist on the withdrawal of the complaint as a pre-condition to further talks on India-EU cooperation.

(The author, a former Finance Ministry official, has extensive experience in international, financial and trade issues.)

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