Clothes Line Apparel (“CLA”) is an interesting Canadian International Trade Tribunal (“CITT”) decision concerning the value of duty for goods of various articles of apparel and accessories bearing the trade-mark “Diesel” or “Diesel for Successful Living”. It is of particular interest because it is an example, increasingly rare, of dutiable royalties and commissions. It’s a poster child for poor customs planning and on how to not prepare for trade litigation. The Diesel line of products was created by Diesel SpA, who owned and controlled the use of the Diesel trade-mark worldwide. Diesel SpA manufactured the goods in question in over 100 factories around the world. According to CLA, it held the rights for importation and sale of Diesel brand goods in Canada from a U.S.-based subsidiary of Diesel SpA, Diesel U.S.A. Inc. (Diesel U.S.A.). The goods destined for Canada were ordered through Diesel U.S.A. by CLA , and 20% or 25% of the price paid to Diesel USA was for certain “commission” charges. The invoices between Diesel U.S.A. and CLA also identified amounts for royalties equal to 8% of the invoiced cost of goods.
Significantly, there was no written royalty or distribution agreement in place during the relevant period; however, a “buying agreement” between CLA and Diesel U.S.A. was in force between July, 1995 and May, 1996 whereby CLA appointed Diesel U.S.A. as its representative to purchase products on its behalf and agreed to pay a commission of 10%. In addition, while CLA occasionally ordered certain Diesel brand goods directly from other sources, CLA indicated that at least 80% of its purchases were made through Diesel U.S.A. during the relevant period. An important factor in this case was the pattern of confusing facts, inconsistencies in testimony, lack of legal documentation and significant disputes between CLA and CBSA about the evidence.
At issue was whether certain commissions and royalties paid by CLA to Diesel U.S.A., in connection with the importation of the goods in issue during the relevant period, should be added to their pre-adjustment value and, therefore, included in their value for duty.
1) Buying Commissions
CLA argued that the commission fees should not be added to the price paid or payable for the goods in issue, pursuant to subparagraph 48(5)(a)(i) of the Customs Act. Commissions incurred by the purchaser must be added to the price paid or payable for the purposes of determining their value for duty unless the fees are paid or payable by the purchaser to “an agent for the service of representing the purchaser abroad in respect of the sale” (“buying agent” services).
CLA took the position that a vendor-purchaser relationship existed between CLA and the manufacturer of the goods (Diesel SpA) and that Diesel U.S.A. was merely its buying agent or a facilitator, by virtue of an unwritten relationship. CBSA’s position was that Diesel U.S.A. purchased the imported goods, paid for them, and consequently assumed the responsibility that a purchaser would normally assume before reselling them to CLA.
The Tribunal found that the arrangements in place in 2003 were significantly different from those found in the terms of the expired “buying agreement” from 1995. As a result, given the absence of a written agreement, the Tribunal based its decision on the extraneous “evidence” regarding CLA’s business relationships. The Tribunal found that there were two sets of invoices because the invoices in question had different payment terms (one from the manufacturers to Diesel U.S.A. as the buyer; and one from Diesel U.S.A. to CLA where royalties were included as part of the total due on the invoice). Diesel U.S.A. secured more advantageous payment terms from Diesel SpA and this was inconsistent with the view that CLA exercised significant control over Diesel U.S.A, a requirement of an agency relationship.
The Tribunal concluded that Diesel U.S.A. was the vendor of the goods in issue and the sale for export was the sale from Diesel U.S.A. to CLA. In the absence of a written agreement, the fact that the shipping and importation documents indicated Diesel U.S.A. as the vendor with CLA as merely the consignee and the fact there was no control over the “agent” by CLA confirmed this conclusion. A rate of 25% for “commissions” seemed high. The fact that the “commissions” were included with the invoices for the goods and that the favorable payment terms from manufacturer were not extended to CLA, were also inconsistent with the assertion it was the buyer.
The Tribunal indicated that if this relationship was an agency relationship at law (the requirement), the transactions would be structured with a single invoice, from the manufacturer to CLA, with CLA paying the manufacturer directly. The fact that this was not the case indicated that Diesel U.S.A. was not acting as a buying agent but rather was the vendor of goods. Moreover, the Tribunal noted that CLA’s insurance policy designated Diesel U.S.A. as the “insured party”.
The Tribunal, therefore, concluded that Diesel U.S.A. was the vendor of the goods in issue and that the sales for export were sales from Diesel U.S.A. to CLA. Therefore, the commissions could not be fees for buying agent services and the commissions were added to the price paid or payable for the goods.
Subparagraph 48(5)(a)(iv) of the Act, provides for the addition of royalties to the price paid or payable for imported goods to the extent that they are paid “... as a condition of the sale of the goods for export to Canada”. CLA argued that the royalties should not be added to the price paid or payable for the goods in issue because they were not paid as a condition of the sale of goods for export to Canada. CBSA argued that CLA could not purchase Diesel brand goods without paying royalties to Diesel U.S.A. Based on the Mattel case, there were three conditions that must be met in order for the Tribunal to conclude that the royalties were dutiable:
- the payments must in fact be royalties or licence fees;
- the payments must be in respect of the imported goods; and
- the payments must be made by the purchaser as a condition of the sale of the goods for export to Canada.
The first two conditions were clearly met and, therefore, the Tribunal’s analysis focused on the third requirement: whether the payments were made by the purchaser as a condition of the sale of the goods for export to Canada.
CLA’s argument was premised on its view that Diesel SpA was the vendor of the goods in each individual transaction and therefore the royalties paid to Diesel U.S.A. were not a condition of the sale. However, in analyzing whether to include commissions in the price paid or payable, the Tribunal had already concluded that Diesel U.S.A. owned the goods before it sold them to CLA; that is, Diesel U.S.A. was the vendor. The Tribunal found that Diesel U.S.A. held the North American rights to the Diesel trade-mark for the goods in issue and agreed to permit CLA to use the trade-mark for the purposes of CLA’s sales in Canada. Even though the payments were remitted by Diesel U.S.A. to Diesel SpA, this did not affect the analysis because this fact did not make the payment of royalties any less of a condition of sale.
In addition, the Tribunal also relied on the evidence that the royalties were billed to CLA from Diesel U.S.A. on the same invoices as the cost of goods themselves. All the invoices filed in evidence referring to Diesel brand goods included royalties, with the exception of invoices from Diesel SpA for advertising purposes and promotional material.
There was no written contract governing the payment of royalties to support a conclusion that the payment of royalties was not a condition of sale as in the Supreme Court of Canada case, Reebok. The Tribunal concluded that unless CLA paid these amounts, which were part of the “Total Due” on the invoice, CLA could not have purchased the goods from Diesel U.S.A. Therefore the royalty payments were a condition of the sale and the royalty payments were added to the price paid or payable for the goods.
3) Lessons Learned
This case makes it clear that, contrary to popular belief, there are still dutiable royalties. It also emphasizes that non-dutiable commissions are the exception, not the rule.
The starting point of the analysis is to determine who is the vendor to the purchaser in Canada (importer/ user). Then one can examine any additions or subtractions from the price paid to the vendor to determine the value for duty. The legal documentation should set out the legal relationships. It is also important to get the facts straight when preparing a case for the CITT or the Courts. Clearly, the inconsistencies in the evidence caused the Tribunal to disbelieve CLA’s evidence.
It is important to obtain expert legal advice from experienced customs law practitioners when structuring these relationships. This can be just as important, or even more important than income tax structuring in these days of merging corporate tax rates. Customs duty, particularly on high rate items such as apparel, shoes, jewellery and so forth, can be more significant than income taxes. Embedded GST that cannot be recovered because of the way the transaction is structured, can also be more significant than any income tax savings.