Like many areas of law, in customs valuation there are cases that represent so-called high and low water marks – cases that represent the extremes of possible outcomes, given a set of facts. Every once in a while, a case comes along that moves these marks around – often surprising practitioners. The recent case of Skechers USA Canada Inc. v. CBSA is one of those cases, and the decision of the Canadian International Trade Tribunal (the “CITT”) has caught the attention of many practitioners.
In Skechers, the CITT was tasked with considering whether a portion of quarterly payments made under a cost-sharing agreement should form part of the price paid or payable for imported footwear, or whether they were general payments unrelated to the footwear for customs valuation purposes. Under the Customs Act, the “price paid or payable” for goods is defined to broadly include 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.”
Historically, this provision has also not been given a lot of attention by the CITT or the courts, as the focus has usually been on one of a number of different possible additions for payments related to the goods under the transaction value provisions of the Customs Act (e.g., royalties, assists, subsequent proceeds, etc.). Skechers is an important case on “price paid or payable” and re-serves notice to all importers that the base “price paid or payable” threshold can represent a broad inclusion for any payments related to imported goods.
The Skechers case involved the proper customs valuation for Skechers branded footwear imported to Canada between 2005 and 2011, by Skechers USA Canada Inc. (Skechers Canada). The subject goods were purchased by Skechers Canada from Skechers USA Inc. (Skechers USA), and the purchase price consisted of the manufacturer’s invoice price paid by Skechers USA, plus the cost of transportation to the US, warehousing in the US, and an arm’s-length profit component.
Under a separate cost-sharing agreement (the “CSA”) Skechers Canada was required to reimburse Skechers USA for a portion of the costs of “research, development, design, advertising and marketing activities necessary to develop and maintain the Skechers brand and sell footwear” (with the reimbursement amount was calculated based on a ratio of Skechers Canada’s anticipated operating profit, and those of other Skechers entities).
The Canada Border Services Agency (the "CBSA") took the position that the portion of the payments made under the CSA that related to research, design and development (the “R&D Payments”) were required to be included in the price paid or payable for the imported footwear. Before the CITT, the CBSA submitted that the payments in question were “in respect of” the imported footwear, and that it would be impossible to produce the footwear Skechers Canada imported without Skechers USA incurring all the general R&D expenses reimbursed under the CSA. Additionally, CBSA noted the R&D payments were based on anticipated net sales (i.e. sales of the imported footwear).
Skechers Canada took the position that the R&D payments were general payments in respect of intangibles (i.e. developing the Skechers brand) and not payments in respect of the goods. The R&D payments represented Skechers Canada’s contributions to the development of Skechers intangibles rather than the imported footwear. Moreover the payments were unrelated to the imported footwear because payments would be due even if no footwear was purchased from Skechers USA. Lastly Skechers Canada argued that only a portion of the R&D should be added to the “price paid or payable”.
As the burden of proof on customs appeals is on the appellant, it was up to Skechers Canada to convince the CITT that the R&D payments were not "in respect of the goods". Based on the evidence, the CITT actually found to the contrary and rejected Skechers Canada’s submission that the R&D payments were in respect of intangibles. Instead the CITT held that based on Skechers Canada’s own evidence the entire research and development process undertaken by Skechers USA was required and necessary for the development of successful footwear styles, including those purchased by Skechers Canada, and that as such Skechers Canada failed to demonstrate that the R&D payments were not “in respect of the goods at issue”.
The CITT also concluded that the R&D payments were, under normal market conditions and in fact, based on net sales of the imported footwear. The theoretical possibility that Skechers Canada could make no purchasers from Skechers USA and acquire all footwear elsewhere was “insufficient to dissociate the R&D payments from the goods in issue” – thus establishing, in the CITT’s view, a link between the R&D payments and the footwear.
Finally, the CITT rejected Skechers Canada’s request that the R&D payments be further apportioned to represent the R&D costs associated with the footwear actually imported into Canada, concluding that the primary purpose of the CSA was to effect such an apportionment, and that it would be “inappropriate to further apportion the R&D payments”.
By way of commentary, arms-length parties often put significant time and effort into determining an appropriate price that goods may be transferred between them for income tax purposes (e.g., the “transfer pricing analysis”). In that work, payments for goods and often differentiated from payments for “services” and other “intangibles”. Importers must understand that that the OECD model transfer pricing rules that often govern their transfer prices from an income tax perspective are completely different than the GATT based rules underpinning Canada’s customs valuation rules. As the decision in Skechers demonstrates, the heart of the inclusion for “price paid or payable” – means that what may be considered payments for “services” for income tax purposes, could well be considered “dutiable” payments for the goods for Customs purposes. That is the so-called customs valuation “whipsaw” – where CRA demands a low price for purposes of income taxation (to prevent a company from "artificially" increasing their cost of goods sold), but CBSA demands a higher price for purposes of applying duties and value-added tax.
The bottom line is that each time a taxpayer undertakes a “transfer pricing analysis”, they need to be seeking – at the same time – a specialized opinion on customs valuation implications.
With a limited right of appeal to the Federal Court of Appeal on questions of law (and very significant deference given to decisions of the CITT), it is quite possible that the CITT’s decision in Skechers will remain a Canadian standard for the application of the “price paid or payable” requirement.