3 February 1999

Royalties — Are They Dutiable? The Federal Court of Appeal Sets the Rules

by

Richard G. Dearden
Gowling Strathey & Henderson
Ottawa, Ontario

The following article is reprinted, with the author's permission, from volume 107, number 4, of "Import Week", dated 27 January 1999. We are grateful to Mr. Dearden for his co-operation.

Importers who have been paying customs duties on royalties should reconsider their liability in light of two recent decisions of the Federal Court of Appeal. In Nike Canada Ltd. v. Deputy Minister and Mattel Canada Inc. v. Deputy Minister, the Federal Court of Appeal found that the royalties paid by those importers were not dutiable because they were not paid as a condition of the sale of the goods for export to Canada as required by subparagraph 48(5)(a)(iv) of the Customs Act.

The Federal Court of Appeal has removed the uncertainty created by Justice Mackay's decision in Reebok Canada v. Deputy Minister. The decision was interpreted by Revenue Canada to mean that the actual value of trademarked goods was dutiable, and this included valuable intellectual property rights paid for in royalties by the importer/purchaser for the use of the trademarks.

Both Nike Canada Ltd. and Mattel Canada Inc. were argued at the same time before Justices Létourneau, Strayer and Robertson. Mr. Justice Létourneau set down the following principles in Mattel Canada Inc. These were incorporated as part of the reasons for judgment in Nike Canada Ltd.

1. "there is no requirement under subparagraph 48(5)(a)(iv) of the Customs Act that the royalties be paid to the vendor."4

2. not every payment of royalties is dutiable "under the Customs Act;"

3. the requirement that the royalties be paid by the purchaser "as a condition of the sale of the goods for export to Canada" requires "more than a simple connection of the royalties with the goods imported;"

4. the requirement that the payment of the royalties be a condition of the sale of the goods for export to Canada is a "stringent condition;"

5. "the payment of the royalties pursuant to subparagraph 48(5)(a)(iv) is a condition of the sale of goods for export. First it appears as such in the contract of sale between the vendor and the importer. Second, it is also a condition of the sale of these goods for export if either the licensor because it owns or "controls" the vendor, or the vendor when it holds the trademark rights or copyrights, can prevent the importation of the goods by the purchaser or seriously compromise the ability of the purchaser to buy the goods for export in cases where he has failed to pay the royalties;"

6. "the word [condition] is used in its ordinary and common sense way to mean that the payment of royalties has to be made as a prerequisite or requirement for the export of goods;"

7. the determination of whether the royalty payment is a condition of the sale for export can be made by measuring the control over the importation of the goods "as long as it is understood that such control must be capable of jeopardizing the importation;"

8. "the words ‘directly or indirectly' refer to the payment made by the purchaser;"

9. the requisite "control" does not exist because the Licence Agreement grants the Licensor "control over the quality o the products, which takes the form of preproduction approvals and an inspection of the material used as well as the production facilities and processes;"

10. the requisite "control" does not exist because the Licensor can exert control over the Licensee or because the Licence Agreement gives the Licensor a right to terminate the Agreement for failure to pay the royalties — "such control is not associated with an importation of the goods to Canada, but rather their subsequent resale in Canada. It cannot be said that such Licensor's right is a condition of the sale of the goods for export to Canada."

In Nike Canada Ltd. Justice Létourneau held:

"For the reasons given in the Mattel Canada Inc. case and in view of the findings by the Canadian Inter