In one of the most important customs cases in years (Skechers USA Canada Inc. v The President of the Canada Border Services Agency (2013), AP-2012-073 (CITT), referred to in this article as Skechers Canada), the Canadian International Trade Tribunal (CITT) confirmed an aggressive interpretation by the Canada Border Services Agency (CBSA).
The case concerned additions to the transaction value for intercompany payments made outside of the invoice amount or transfer price that relate to design and development costs allocated to the importer.
As part of a recent enforcement trend of the CBSA toward assessing customs duty on intercompany management or other fees not included in the transfer price, the CBSA determined that the total research and development (R&D) intercompany fees paid by the Canadian company were part of the value for duty allocated over the goods actually imported.
In a potentially far-reaching decision, the CITT endorsed this decision for cases where the importer cannot demonstrate that the payments are unrelated to the goods.
The Skechers Canada case
The taxpayer in Canada purchased footwear from its US affiliate and established a transfer price for goods based on the US affiliate’s factory cost from the offshore manufacturer plus transportation, warehousing and an amount for profit.
This price included the cost of “assists” relating to the molds and samples that the US affiliates provided to the manufacturers for the successful models subsequently imported. It did not include, however, the value of the design work performed in respect of the development of unsuccessful prototypes or models (approximately 45,000 of the 50,000 models under development never made it to the final stage), nor the costs for the general R&D expenses of the US affiliate (salaries and overhead). Therefore, the taxpayer also made payments for these costs to the US affiliate under a cost-sharing agreement (CSA).
The fees paid by the taxpayer under this agreement were a function of the volume of import purchases. They were calculated based on operating profit of the taxpayer pursuant to the terms of the CSA and thus varied with volumes of imports and sales.
As noted, of the approximately 50,000 models under development, only 5,000 made it to the final cut, and of this only approximately 1,700 were imported to Canada. Accordingly, most of the payments for research and design and development under the CSA were not included in the transfer price.
Both parties to the dispute agreed that the Tribunal should use the “transaction value” customs valuation methodology (the adjusted transfer price). The issue concerned whether the payments for R&D under the CSA were “in respect of” the goods and therefore part of the “price paid or payable” pursuant to Subsections 45(1) and 48(4) of the act.
A basic provision of customs valuation is that the transaction value must include all payments made “in respect of” the goods. The taxpayer contended that the payments were for intangibles and not in respect of the goods as they were for developing the brand.
In a precedent-setting decision, the Tribunal held that all payments under the CSA relating to research, development and design were dutiable because they were, in the Tribunal’s words, “clearly in respect of the goods” given that the evidence disclosed that “the R&D payments most directly concern the footwear products themselves.”
There was one continuous process by which the research, design and development process flowed through the season to develop the footwear. Therefore, the activities and associated costs covered by the R&D payments can all be located somewhere along the continuum of that lengthy and interrelated process and the research and design efforts and associated fees were “directly aimed” at developing the models available for purchase each season by the taxpayer.
Thus, the Tribunal found that the costs were directly related to developing and designing the particular footwear that was imported. The payments and the imported goods were directly linked as the fees were calculated based on the taxpayer’s Canadian operating profit and, hence, if imports increased, so would the payments.
What does the Skechers Canada decision mean?
As a result of the decision, in Canada, at least for now, payments made by the Canadian purchaser to the overseas vendor for “research, design and development” costs, whether they result in actual production of the purchased models or are allocable to other non-imported models or aborted designs, are part of the value of the goods for customs purposes where the Canadian importer pays amounts that vary with sales and imports, to an affiliate under a CSA.
Impact on supply chain planning
The case is a wake-up call for many multinationals to consider customs planning rather than just income tax or logistics planning. Further, it highlights the need to be aware of, or to seek advice from advisors experienced with, the latest case law or CBSA policy. Customs compliance and leading practices for planning need to be considered along with any other savings to achieve the best overall efficiency for the supply chain.
First and foremost, a supply chain structure must be considered very carefully when importing goods into Canada, particularly through a supply chain involving affiliated parties. Often a direct sale from the manufacturer to the importer may have customs planning advantages.
Where there are purchases from a related party who sources the goods abroad, it is important to ensure that the transfer price is acceptable for customs valuation purposes and to confirm whether any adjustments are required for other payments, such as R&D costs and royalties. In a direct sale, “assists” must also be considered.
The onus is on the importer to prove that any payments made are not in respect of the goods under the act. This point is often overlooked. In this case, it was crucial as the Tribunal made its finding on the basis that the taxpayer did not discharge this onus. It is important to keep the importer’s onus of proof in mind when undertaking any customs duty planning and also when deciding to make any appeal against a determination.
This article was first published in EY´s Indirect Tax Briefing: July 2014