In the first three months of 2015, importers have witnessed major Canadian customs valuation law and policy changes. On January 19, 2015, the Canada Border Services Agency (CBSA) issued Customs Notice 15-001, "Treatment of Downward Price Adjustments in Value for Duty Calculations". The Notice embodies the new CBSA policy pursuant to which importers may obtain customs duty refunds in connection with downward transfer pricing adjustments that reduce invoice prices on which customs values of imported goods were based. On March 2, 2015, the Federal Court of Appeal (FCA) upheld the judgment of the Canadian International Trade Tribunal (CITT) disallowing an appeal from a decision of the President of the CBSA in which the President found that certain payments for research, development and design expenses, the subject of a cost-sharing arrangement, were dutiable.
There are no apparent connections between the underpinnings of the new CBSA customs valuation policy and the rationale of the FCA's statement of law. It is more a matter of how these changes to the customs appraisal landscape give to multinational importers with one hand and take away with the other. The new CBSA policy, after a long and heated battle between the CBSA and the importing community, provides an opportunity to importers to obtain customs duty refunds if they can demonstrate they meet certain conditions; the decision of the FCA condones the CBSA practice of adding payments, which are arguably tangential to the imported goods, to the price paid or payable of imported goods and therefore to their dutiable value. The new policy and law are important to multinational enterprises transacting business in Canada that transfer goods, services and/or intellectual properties into Canada; they establish a new paradigm of Canadian customs appraisal.
In "Transfer Pricing Custom Duty Refund Applications “ Let's Do it Right," we outlined the conditions that require fulfillment in order for an importer to successfully obtain refunds relating to downward transfer pricing adjustments. In "Canadian Importers May Now Seek Import Duty Refunds," we warned that the government of Canada should be expected to seek to recapture or balance the loss of revenue resulting from the new CBSA policy by conducting more verifications of customs values declared by related party importers.
In Skechers USA Canada Inc v The President of the Canada Border Services Agency, 2015 FCA 58 (Skechers), the CBSA policy of treating research and development fees as post-importation payments, or subsequent proceeds, was validated by the FCA. In Memorandum D13-4-13, "Post-importation Payments or Fees (Subsequent Proceeds)", dated July 8, 2009, the CBSA identifies payments, other than those that may be characterized as "assists", as being dutiable if paid by the purchaser in a sale for export to Canada for research or development to the vendor, or for the benefit of the vendor, of the imported goods. The CBSA rationalizes its position on the basis that research and development expenditures may be regarded as being for continuing activity required for maintaining an enterprise's business and its competitive position and on the basis that development activities are normally undertaken with a reasonable expectation of commercial success and future benefit realized from increased revenue or from reduced costs. In other words, notwithstanding cost accounting to the contrary, payments to the vendor for research and development are effectively viewed as being in respect of the costs of the goods borne by vendors of goods imported into Canada, not the importer/purchaser, whether or not a direct link exists between research and/or development, which is the subject of the payment, and the actual goods crossing the border.
Skechers Canada challenged this policy before the CITT but did not convince the tribunal that the research and development costs (i) were not in respect of the goods, (ii) were not necessary for the production of the goods in issue or for the basic use of the goods in issue as footwear, (iii) were not related to intangibles, (iv) were general payments unaffected by the imported goods or that, in the alternative, (v) the payments were assists and only a portion of them should have been included in the price paid or payable.
The CBSA had argued, and the CITT concluded, that the research and development payments had been made in respect of the imported goods and should be included in the price paid or payable for the goods (defined as the aggregate of all payments made or to be made, directly or indirectly, in respect of the goods by the purchaser to or for the benefit of the vendor). Rather than arguing that the research and development costs were "subsequent proceeds" to be added to the price paid or payable as contemplated in D 13-4-13, the CBSA and the CITT treated the research and development costs as part of the price of the imported goods. In taking this approach, it was unnecessary that the research and development costs be connected to proceeds of subsequent resale, disposal or use of the goods. (Parenthetically, this distinction may be semantical because neither the CBSA nor the CITT has had any difficulty finding payments by an importer to have been ultimately funded from its revenues, and by implication subsequent proceeds of resale, disposal or use of goods.)
More important than the distinction between the rationales of "price paid or payable" or "subsequent proceeds" for inclusion in the transaction value is the FCA's consideration, as reasonable, of the CITT's conclusion that "the research, design, and development process is an inter-related process, the whole of which is required to produce the goods in issue". The CITT described the design process as interactive or inter-related and not specific to a given line of product. The activities in question that were compensated by the research and development payments were all to be found located "somewhere along the continuum of that lengthy and inter-related process".
In other words, the FCA confirmed the policy position of the CBSA enunciated in Memorandum D13-4-13 governing research and development costs as expenditures of the vendor for a continuing activity required to maintain an enterprise's business, and implicitly as costs to be borne by the vendor and to be passed to the purchaser in the price of the imported goods. Even though the imported goods did not directly benefit from the research and development, they implicitly did so indirectly.
On March 31, 2015, the CBSA re-issued Memorandum D 13-4-13. A close reading of Appendix A draws attention to the exclusion contemplated for payments where the Canadian importer contracts the foreign vendor to conduct the research development, bears all costs and risks of failure, and takes ownership of the research. In these circumstances, the Canadian importer would own all the developed intangibles, and therefore the profits that result. The CBSA distinguishes between a cost that is attributable to the vendor's production of the goods (dutiable) and a cost that is borne by the Canadian importer (non-dutiable). This gives rise to a need to review and reconsider cost sharing agreements.Skechers is not a departure from CBSA policy relating to payments for research and development. But a concern arises from the rationale reflected in the FCA and CITT decisions if it is used to develop additional policies respecting other payments made under cost sharing agreements. How will the CBSA treat cost sharing agreements that are susceptible to interpretation as covering the costs of production, selling, general and administrative expenses associated with the sale of imported goods by a foreign vendor to a Canadian importer?
Memorandum D 13-4-13 examines various services and tries to draw lines between those that arguably relate to Canadian operations and those that do not, with the latter to be treated as dutiable presumably as costs of production or selling, general and administrative expenses of the vendor. Will we see closer scrutiny of cost sharing arrangements relating to services such as marketing? Will the CBSA more closely examine whether cost shared expense is of a nature that is directed to the customer of the importer or might better be categorized as relating to sales to the importer?
Since Mattel, there exist very few instances in which Canadian customs duties are collected on royalties or license fees because of the "condition of sale" requirement and its disposition by the Supreme Court of Canada. But what of cost sharing arrangements dealing with intellectual properties? If the intellectual property continues to be owned by the foreign vendor under the cost sharing arrangement, how will payments, by the importer, that contribute to the value of intellectual properties be viewed? Will they be considered inseparable from the continuum of production of the goods that will be imported into Canada? Will sharing of ownership militate against such a conclusion?
The first three months of 2015 have complicated customs appraisal for multinational enterprise importers in Canada, and made most prudent the review of their customs valuation practices.