More On Customs and Trade
Goods imported to Canada must be reported at the border, be properly classified under Canada's Customs Tariff, be identified in terms of their proper origin, be properly valued, and clearly and legibly marked in accordance with Canada's marking rules. Each of these steps is must be carried out, or penalties and other equally nasty things will ensue. Other ramifications will also arise if the steps are not taken properly as, for example, the possible denial of NAFTA preferential status if each of the first 2 steps (e.g., classification and origin) are not taken properly.
After being reported, an imported good must be classified under the provisions of the Customs Tariff. [i] To determine the proper tariff classification, reference must be made to Schedule I of Canadas Customs Tariff, which is a list of possible tariff classifications based on the internationally accepted Harmonized Commodity Description and Coding System (the "Harmonized System").
As its name indicates, the Harmonized System is a coding system used by virtually all of the world's major trading nations, and it is broken into Sections, Chapters, Headings and Subheadings. Chapters contain two-digits, Headings contain four-digits, and Subheadings contain six-digits.
The Harmonized System is said to be harmonized to the six-digit (or Subheading) level, meaning that goods imported to the various countries using the Harmonized System should be all identically coded to the Subheading level, and 6 digits are all that are generally required on NAFTA Certificates of Origin. (See infra).
The most important concept to be borne in mind when classifying goods under the Harmonized System, is that the System is hierarchical in nature, with classification required to be performed using a step-by-step methodology.
While the wording of each Heading and Subheading is relevant, so are specific Section and Chapter notes located at the beginning of the Chapter or Section. To complement this legal core of materials, there are also Explanatory Notes which, while not forming part of the legal Harmonized System, must also be reviewed in interpreting the Headings and Subheadings.
Note: In many instances, there will be only one possible tariff classification for an imported good.
Once the basic tariff classification for an imported good is determined, the next required step is determining whether that good qualifies for NAFTA treatment. That generally requires determining if the good originated in a NAFTA country under specific rules of origin found in the NAFTA, and reproduced in Canadian (U.S. and Mexican) domestic law.
As can plainly be seen, determining origin can be one of the most difficult processes in customs or tax law. Complicating matters, since the Certificate of Origin must be signed by the exporter or producer, based on its knowledge or pre-existing documentation, much work must technically be done by the exporter prior to any export / import of the goods taking place.
Tip: Importers may be unpleasantly surprised by the lack of understanding on the part of exporters and producers as to their obligations under NAFTA in issuing proper NAFTA Certificates. Unfortunately, in too many cases, the exporter or producers processes are lacking, making it difficult for the exporter or producer to substantiate the NAFTA Certificates issued when audited by the importing countrys customs administration (called a NAFTA Verification Audit). Where errors are found, NAFTA preferential status can be denied, on a go-backward basis, with the obligation on the exporter to simply notify its importers of that fact.
Perhaps more significantly, the ultimate problem really ends up in the importers lap, with the importer effectively left holding the bag. The reason is that while the exporters obligation stops with simply notifying the importer that NAFTA preferential rates never really applied, the voluntary compliance models in place in Canada and the U.S., require the importer to take subsequent positive steps to correct for the importations. Corrections usually mean claiming MFN rates instead of NAFTA rates, which sometimes means applying positive rates of duty to historic importations, and paying those duties to Canada Customs, plus interest.
Once the tariff classification and origin of imported goods can be determined, and the duty rate identified, it is then necessary to consider the proper value for duty (or VFD) of the imported goods. [ii] A casual reference to the Customs Tariff indicates that duties are generally applied on an ad valorem basis, expressed as a percentage and applied to the value of the imported goods. The product of these two factors determines the duties actually payable.[iii] Accordingly, a sound basis for valuing imported goods is at the heart of Canadas customs regime.
Canada's rules for valuing imported goods are found in sections 44 through 53 of the Customs Act, which parallel the rules in place in most other member-nations of the WTO (e.g., they are virtually identical to rules in both the U.S. and E.U.).
Transaction Value Primary Method
The primary method of customs valuation is the so-called Transaction Value method, which applies where goods have been sold for export to Canada to a purchaser in Canada, and a number of other conditions are met. If applicable, the focus of the Transaction Value method is the price paid or payable for the imported goods, with certain statutory additions, and certain statutory deductions.
Where Transaction Value is not available, a series of other methods must be considered, one after the other, with (generally) the first available method that works being the required method, as follows:
Transaction Value of Identical Goods ( 49)
Transaction Value of Similar Goods ( 50)
Deductive Value ( 51)
Computed Value ( 52)
Residual Value ( 53)
Transaction Value Conditions
While meant to be the primary method of valuation, most importers and exporters will already realize that there are some strict conditions regarding the application of Transaction Value.
The legislative wording, for example, requires at a minimum that the goods be sold for export to Canada to a purchaser in Canada. Additional restrictions are imposed if the price paid or payable cannot be determined, or where, for example, there are (1) restrictions respecting the disposition or use of the goods; [iv] (2) the sale of the goods or the price paid or payable for the goods is subject to some condition or consideration of which a value cannot be determined; or (3) the purchaser and the vendor of the goods are related, and their relationship can be seen to have influenced the price paid or payable for the goods unless certain other conditions can be met.
The Sold for Export Requirement
Just what transactions constitute valid sales for export has been a bone of contention with Canada Customs for some time. Generally speaking, a "sale" contemplates the transfer of title in goods, from a vendor to purchaser, for a price or other consideration, [v] and the CBSAs own policy generally reflects that: see D-Memorandum 13-4-1. The requirement that a sale occurs has some obvious ramifications. For example, Transaction Value would not be available where leased goods are imported, nor would it be available for transfers of goods between a foreign company and an international branch. [vi] In parent-subsidiary relationships, an issue will also arise as to whether the parent and subsidiary are in true vendor-purchaser relationships, or whether the parent controls the subsidiary to such an extent that the latter can be viewed as the mere agent of the former, negating a buy-sell.
The Sold for Export to a Purchaser in Canada Requirement
Canada Customs recently had the to a purchaser in Canada language added to the section 48 sold for export requirement. The amendment was in response to the much written about Harbour Sales case, and has attempted to maintain Canada Customs view that Transaction Value is only available in two general cases:
1. The Importer is a Resident, and both (a) carries on business in Canada (i.e., with a general authority to contract, plus other factors), and (b) is managed and controlled by persons in Canada; or
u2. The Importer is a Non-Resident, but with a Permanent Establishment in Canada (as above), and both (a) carries on business in Canada, and maintains a (b) physical permanent establishment in Canada.
The change obviously makes the application of Transaction Value a bit more complicated, and requires some additional consideration of whether the sale for export to Canada has been made to what Canada Customs considers a proper Canadian purchaser. The meaning of purchaser in Canada and the general rules described above can be found in the Purchaser in Canada Regulations, and Canada Customs D-Memo 13-1-3, Customs Valuation Purchaser in Canada Regulations (December 11, 1998). Understanding Canada Customs view on purchasers in Canada could also be the subject of a whole separate presentation, [vii] and will not be dealt with here in any further detail. Suffice it to say that while the Purchaser in Canada Regulations do create a fair degree of certainty where the purchaser is a Canadian incorporated entity, with mind and management in Canada, there are a number of difficult issues currently emerging with respect to their application, especially in the context of non-resident importers. [viii]
Statutory Additions and Deductions. Assuming Transaction Value is available, and once the price paid or payable for the goods can be determined, [ix] the final transaction value (i.e., the amount which will represent the VFD of the imported goods) is determined by adding certain amounts to the price paid or payable, and by deducting certain other amounts, in accordance with the rules in section 48(5) of the Customs Act.
Amounts which must be added to the price under section 48(5)(a) of the Customs Act include, for example, commissions and brokerage fees in respect of the goods incurred by the purchaser, packing costs, the value of any assists in respect of the goods, certain royalties and licence fees, and certain freight costs incurred in moving the goods to (and at) the point of direct shipment to Canada.
Amounts which must be deducted from the price under section 48(5)(b) include amounts for in-bound transportation costs from the place of direct shipment, certain expenses incurred in respect of the imported goods after importation, and amounts for Canadian duties and taxes payable on importation.
Again, a full discussion of the ramifications of the statutory additions and deductions required under section 48(5) of the Customs Act is beyond the scope of this presentation, and readers are directed to secondary sources. [x]
The Customs Whipsaw: Transfer Pricing (Dis)Connect
Perhaps a necessary implication of the statutory addition and deduction process described above is a necessary disconnect between the transfer price of a good for income tax purposes described above as generally equal to the price paid or payable for the good for Customs purposes and the VFD of the goods for customs purposes, and on which duties and GST are payable.
Importers must therefore be cognizant of the fact that while international transfer pricing rules required related parties to establish supportable transfer pricing procedures for Taxation purposes, the valuation amount that is used for Customs purposes may be a markedly different number.
As the very last paragraph of the Canada Revenue Agencys (CRA - formerly the Canada Customs and Revenue Agency, or CCRA) Information Circular 87-2R (September 27, 1999) makes clear:
Part 12 Customs Valuations
225. The methods for determining value for duty under the current provisions of the Customs Act resemble those outlined in this circular. However, differences do remain. The Department is not obliged to accept the value reported for duty when considering the income tax implications of a non-arm's length importation.
Thus, even though the CRA was, at the time this circular was written, then integrated as between its Customs, Excise and Taxation functions, it took the position that two potentially different valuation bases can occur for Taxation and Customs purposes, and that there is no necessary symmetry between the transfer pricing rules used by Taxation, and the valuation methods used by Customs. Now that the CBSA has formally split from the CCRA (now CRA), there is every reason to believe that the potential dichotomy will continue to exist.
While somewhat anomalous, this approach is generally consistent with CBSAs historical position, and is indicative of the problems facing taxpayers involved in Customs valuation reviews: they are faced with a whipsaw, with high customs values being assessed by Canada Customs, but no ability to translate those assessments into positive income tax implications.
Tip: Importers carrying out transfer pricing analyses must understand that the transfer price they determine for Canadian income tax purposes which the CRA will have a vested interest in ensuring is low enough to accommodate reasonable Canadian corporate income tax revenues will usually be a different amount than the VFD figures used to import the goods. That is largely due to the requisite statutory additions and deductions described above.
The situation in the U.S. may differ somewhat, as the Internal Revenue Code has rules (e.g., section 1059A) aimed directly at ensuring that a valuation for U.S. Customs purposes be the same, subject to certain limitations, as an acceptable transfer price for U.S. Taxation purposes.[xi]Unfortunately, these rules do not function to absolutely preclude asymmetry, and the U.S. is still far away from a perfectly symmetrical environment.
On-Going Significance of Valuation
Since tariff classification and origin determination may well lead to the conclusion that a particular good is duty-free under NAFTA, or perhaps an MFN duty concession negotiated under the WTO, many importers assume that valuation is not that important to the importing process.
Unfortunately, Canada Customs has not adopted that view. In fact, and despite the rather pre-mature reports of its death, Customs Valuation continues to remain a significant part of Canada Customs' post-entry assessment process, and an active player in special investigations as well.
There are a number of reasons why Customs wishes to ensure that Canadas valuation rules continue to be complied with. First, despite the bold steps Canada has taken under NAFTA, and at the WTO, a significant portion of Canadian trade still remains subject to duty and excise, demanding a proper valuation of goods imported to Canada, and exported abroad.
Second, and irrespective of whether particular goods are subject to customs duties when imported, the GST usually always applies at the border, and the GST rules run off the value for duty of the imported goods, as determined for Customs purposes.
While the GST paid at the border is generally recoverable by commercial importers, the GST rules still require a proper accounting of the GST payable in the first instance, and where mistakes are made (usually non-deductible) interest and penalties will apply. In the worst-case scenario, ascertained forfeitures can be levied, imposing non-deductible, and non-creditable penalties as high as 3 times the GST short-paid. The 15% Harmonized Sales Tax in place in Canadas Atlantic provinces only serves to magnify this result.
Finally, Customs is interested in ensuring that Canadas trade statistics are properly recorded, and in ensuring that the value of the goods entering Canada is consistently and properly declared.
All of this has thus led Canada Customs to ensure that Canadas new Administrative Monetary Penalty system continues to apply to valuation declarations, specifically requiring that incorrect valuation declarations be corrected under section 32.2 of the Customs Act under the pain of potential AMPs if the corrections are not made.
[i] It is important to note that the VDP does not apply to penalties imposed under legislation that is administered by the CBSA on behalf of other government departments and agencies nor does it apply to penalties that are imposed for contraventions that are not related to accounting and payment provisions of custom legislation (e.g., broken seals).
[ii] Note that the concession under the VDP that only interest at the prescribed rate apply is, in itself, relief from penalties. That is because the ordinary interest that would apply to most customs non-compliance would be interest as the specified rate pursuant to subsection 33.4, which applies interest at the specified rate to any duties which are owing. Specified interest is statutorily defined to be interest, expressed as a percentage per year, equal to 6% per year plus the prescribed rate effectively adding a 6% penalty on top of prescribed rate interest.
[iii]In Canada the legislative authority to waive or cancel penalties and interest otherwise payable is provided for in subsection 3.3(1) of the Customs Act and the authority to waive or cancel specified interest is found in subsection 126 of the Customs Tariff.
[iv] For further information see Customs Notice N-332, Voluntary Disclosures Program.
[v] There is some uncertainty as to just what the nature of this requirement is. According to paragraph 151 of Customs D-Memo 17-1-5, [a]ccounting information must be presented or transmitted and accepted by the customs automated system within five business days of the date customs releases the goods, and at paragraph 106, [t]he accounting period includes the business day during which the goods were released (day 0) and the following five full business days (days 1 to 5). That seems to suggest that the VDP requirement is simply this: if the information can be correctly presently during normal guidelines, it should not be presented through the VDP.
[vi] Subsection 59 of the Customs Act provides as follows:
59(1) Re-determination of further re-determination - An officer, or any officer within a class of officers, designated by the Minister for the purposes of this section may
(a) in the case of a determination under section 57.01 or 58, re-determine the origin, tariff classification, value for duty or marking determination of any imported goods
(i) four years after the date of the determination, on the basis of an audit or examination under section 42, a verification under section 42.01 or a verification of origin under section 42.1, or
(ii) four years after the date of the determination, if the Minister considers it advisable to make the re-determination; and
(b) further re-determine the origin, tariff classification or value for duty of imported goods, within four years after the date of the determination or, if the Minister deems it advisable, within such further time as may be prescribed, on the basis of an audit or examination under section 42, a verification under section 42.01 or a verification of origin under section 42.1 that is conducted after the granting of a refund under paragraphs 74(1)(c.1), (c.11), (e), (f) or (g) that is treated by subsection 74(1.1) as a re-determination under paragraph (a) or the making of a correction under section 32.2 that is treated by subsection 32.2(3) as a re-determination under paragraph (a).
[vii] Judicial review is be available pursuant to section 18.1 of the Federal Courts Act which provides as follows:
18.1(1) An application for judicial review may be made by the Attorney General of Canada or by anyone directly affected by the matter in respect of which relief is sought.
(2) An application for judicial review in respect of a decision or an order of a federal board, commission or other tribunal shall be made within 30 days after the time the decision or order was first communicated by the federal board, commission or other tribunal to the office of the Deputy Attorney General of Canada or to the party directly affected by it, or within any further time that a judge of the Federal Court may fix or allow before or after the end of those 30 days.
(3) On an application for judicial review, the Federal Court may
(a) order a federal board, commission or other tribunal to do any act or thing it has unlawfully failed or refused to do or has unreasonably delayed in doing; or
(b) declare invalid or unlawful, or quash, set aside or set aside and refer back for determination in accordance with such directions as it considers to be appropriate, prohibit or restrain, a decision, order, act or proceeding of a federal board, commission or other tribunal.
(4) The Federal Court may grant relief under subsection (3) if it is satisfied that the federal board, commission or other tribunal
(a) acted without jurisdiction, acted beyond its jurisdiction or refused to exercise its jurisdiction;
(b) failed to observe a principle of natural justice, procedural fairness or other procedure that it was required by law to observe;
(c) erred in law in making a decision or an order, whether or not the error appears on the face of the record;
(d) based its decision or order on an erroneous finding of fact that it made in a perverse or capricious manner or without regard for the material before it;
(e) acted, or failed to act, by reason of fraud or perjured evidence; or
(f) acted in any other way that was contrary to law.
[viii] See subsection 32.2(2) of the Customs Act.
[ix On this point, see subsection 32.2(6) of the Customs Act.
[x] See for example, Aumann v. McKenzie  3 W.W.R. 233.
[xi] Paragraph 26 of D11-6-6 provides states as follows:
26. "Reason to believe" does not occur if, all things being equal, there is conflicting information, such as rulings, issued by the CCRA. If there is conflicting or unclear information, importers are encouraged to contact their regional client services office. If an officer determines that the information is conflicting or provides some uncertainty to the importer, the officer will provide corrective action, in the form of a new ruling, for example. The date of the new ruling will then constitute the date of "reason to believe" for purposes of self-adjustment.