On March 2, 2015, the Federal Court of Appeal (the "FCA"), in the decision Skechers USA Canada Inc. v. President of the Canada Border Services Agency1, upheld the judgment2 of the Canadian International Trade Tribunal (the "CITT") to the effect that payments made by Skechers USA Canada Inc. (the "Appellant") to its parent company, Skechers USA Inc. (the "Parent"), for research, development and design expenses as part of an internal cost-sharing agreement (the "CSA") must be included in the price paid or payable for the footwear imported in Canada by the Appellant for customs valuation purposes.
Facts and Background
The Appellant and its Parent were in the business of selling Skechers-brand footwear. The footwear, which was designed by the Parent and manufactured in China, was sold by the Parent to the Appellant for resale in Canada. The Parent's research and development team designed, prepared and developed approximately 40,000 to 50,000 prototype samples every year. Of the prototypes developed, only 5,000 were typically retained for mass production after a five-month selection process (the "Process"), and only 1,700 were eventually marketed by the Appellant in Canada.
The transfer price invoiced to and paid by the Appellant in consideration for the footwear was the sum of the price paid by the Parent to the Chinese manufacturer, the cost of shipping the goods to the United States, the Parent's warehousing costs in the United States, and an arm's length profit for the benefit of the Parent (the "Transfer Price"). In addition to the Purchase Price paid to the Parent for the goods delivered in Canada, the Appellant also made payments pursuant to the CSA. Under the CSA, the Appellant and other Skechers affiliates compensated the Parent for the expenses it incurred for research, development, design, advertising and marketing activities that were necessary for the development and maintenance of the Skechers brand and the sale of its footwear. The portion of the Appellant's obligation under the CSA was determined on an annual basis and was calculated based on a ratio between its anticipated operating profits and the anticipated operating profits of all participants in the CSA.
In order to determine the value for duty of imported goods under the Customs Act (the "Act"), subsection 47(1) provides that the primary method that should be used by an importer is the "transaction value" method, which is based on the "price paid or payable" for the goods when they are sold for export to Canada. The term "price paid or payable" is defined under subsection 45(1) of the Act 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." (our emphasis)
In the case at hand, the Appellant used the Transfer Price to determine the "price paid or payable" pursuant to the "transaction value" method for customs valuation purposes. However, in 2012, the Canada Border Services Agency (the "CBSA") took the view that the "price paid or payable" for the imported footwear should also include a portion of the amounts payable under the CSA by the Appellant that related to research, development and design expenses incurred by the Parent (the "R&D Payments"). The CBSA's position was based on the assessment that the R&D Payments were sums actually paid "in respect of" the imported footwear for the purpose of subsection 45(1) of the Act. The Appellant appealed the CBSA's decision before the CITT.
The CITT's Decision
In December 2013, in a somewhat controversial decision, the CITT upheld the CBSA's interpretation and confirmed that the R&D Payments, in their entirety, were made "in respect of" the imported footwear and should therefore be included in the value for duty calculation under the Act. The CITT considered that the footwear in issue could not have been produced without the research and development by the Parent, and that the R&D Payments were "inseparable from the footwear products themselves."3
The CITT was of the opinion that a sufficient link existed between the R&D Payments and the imported footwear. The CITT also rejected the Appellant's arguments that the R&D Payments were general payments which were unaffected by the imported footwear. This conclusion was reinforced by the fact that the majority of the Appellant's profit was generated by the sale of footwear, and all of the footwear it purchased during the relevant period came from the Parent (even though it was possible for the Appellant to purchase footwear from third parties).
Finally, the CITT concluded that the Appellant was not providing "assists" within the meaning of clause 48(5)(a)(iii)(D) of the Act, and that the R&D Payments did not represent an indirect "assist" supplied to the Chinese manufacturers (through the Parent) because the Appellant was not providing any assistance in kind but only payments to the Parent.
Decision of the FCA
The FCA first established that the standard of review that was applicable to the CITT's decision was the reasonableness standard. This decision was based on the fact that the CITT is a court with a particular expertise regarding the application of the Act.
The Appellant pleaded that the CITT's decision was unreasonable because: (i) the burden of proof imposed by the CITT was improper inasmuch as it required the Appellant to demonstrate that the R&D Payments were not made in respect of the imported footwear, (ii) the CITT improperly interpreted both the Act and the CSA, and (iii) the CITT made several errors in its use of the relevant authorities. The President of the CBSA, for his own part, submitted that the CITT's decision was reasonable.
The FCA rejected each of the Appellant's arguments. Firstly, it agreed with the CITT's understanding of the burden of proof as requiring the Appellant to demonstrate that the R&D Payments were actually not made "in respect of" the imported footwear.
Secondly, the FCA stated that the CITT's conclusion to the effect that the R&D Payments were "in respect of" the imported footwear was reasonable. In the FCA's opinion, the evidence allowed the CITT to draw the conclusion that the Process was required to produce the imported footwear. Moreover, the FCA rejected the Appellant's argument that the purpose of the CSA was to apportion the costs of developing intangibles and that the R&D Payments were therefore "in respect of" the intangibles rather than the imported goods.
Finally, the FCA agreed with the CITT that the phrase "in respect of" had the same generic and equally applicable meaning in the context of the Act as in the Indian Act and that the CITT had relied on the appropriate case law in its analysis.
Importers should now review all payments they make to a vendor, in additions to the invoice amount or transfer price, in order to determine if any of these payments relate to research, design and development expenses incurred by such vendor. To the extent that these expenses are in respect of the goods purchased from the vendor, it is likely that they will have to be included in the value for duty of the imported goods. Based on the Skechers decision, the courts will take a very broad approach in determining whether an expense is in respect ofimported goods, with the result that even expenses that relate to goods which are not ultimately imported into Canada, or to unsuccessful designs, may have to be included in the value for duty.
The authors wish to thank Nicholas Grenier for his valuable collaboration in drafting this article.