WAS THE MATTEL FEDERAL COURT ROYALTY DECISION CORRECT?

This post examines two royalty cases involving the multinational company "Mattel Inc". One court case in Australia determined the Royalty was dutiable whilst the court cases in Canada concluded the Royalty was non-dutiable.
Why is the Mattel royalty dutiable in one customs territory and non-dutiable in the other when both countries are signatories to the WTO Valuation Code.

WAS THE MATTEL FEDERAL COURT ROYALTY DECISION CORRECT?

The Federal Court of Australia heard the Mattel Royalty case on appeal from the AATA and adjudicated that the Mattel Royalty payment should be included in the Customs Value. Was the Federal Court of Australia decision correct?
It has always perplexed me as to why the Australian legislative draughtspeople; when re-writing the Australian Customs valuation legislation in the late 1980’s; only drafted the four exclusions (i) to (iv) when referring to Royalties and Licence Fees in ss154(1) Price Related Costs at paragraph (e) of the Australian Customs Act 1901 (CA).
The overemphasis of mathematically worded legislation; which incorporates anti-avoidance statutes to counteract scams and catch all schemes to ensure that every potential dutiable charge was caught and non-dutiable charges were limited to those nominated within the Australian legislation.
If the draughtspeople had incorporated a fifth exclusion at ss154(1) Price Related Cost paragraph (e) for example “(v) that are payable for the right to distribute or resell the imported goods, and are not payable under the import sales transaction”; then I contend most of the Australian Royalty and Licence Fee Customs Court cases would not have been litigated in Australia.
In practical business terms; importers worldwide; are concerned with the question of when a payment for the rights to use, royalties or licence fees; which are not already included in the price paid or payable for the goods; is to be added to the price under S157 and ss154(1) Price Related Costs paragraph (e) (CA) in arriving at the customs value of imported goods.
Sherman and Glashoff claimed “.... there is no part of the Code where so much is left to interpretation and implementation, and so little can be derived from the literal reading of the words used”, (Sherman and Glashoff, 1980, p45). The issue of royalties and licence fees was concluded late in the Geneva negotiations as a result of significant differences between the negotiating governments.
Royalties and licence fees is an extremely complex area of Customs Law and the full meaning of this area based on the WTO Valuation Code will only emerge over time as a result of litigation in each Custom’s territory based on a case-by-case

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basis to determine the administrative interpretation of the Customs Law that applies to royalties and licence fees, (Sherman and Glashoff, 1980, p45).
“Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade or WTO Valuation Code:
Part 1:
Rules on Customs Valuation:”
“Article 8 Paragraph 1 (c)”

“royalties and licence fees related to the goods being valued that the buyer must pay, either directly or indirectly, as a condition of sale of the goods being valued, to the extent that such royalties and fees are not included in the price
Actually paid or payable;”

WTO Valuation Agreement . Annex 1 Interpretative Notes (extract):
The equivalent provision in the Agreement regarding the addition to the price actually paid or payable for royalty and licence fees is found in Article 8, paragraph 1(c).
“1. The royalties and license fees referred to in Article 8.1(c) may include, among other things, payments in respect to patents, trademarks and copyrights. However, the charges for the right to reproduce the imported goods in the country of importation shall not be added to the price actually paid or payable for the imported goods in determining Customs Value.

2. Payments made by the buyer for the right to distribute or resell the imported goods shall not be added to the price actually paid or payable for the imported goods if such payments are not a condition of the sale for export to the country of importation of the imported goods.


Article 8, paragraph 3, allows for the addition to the price actually paid or payable only on the basis of objective and quantifiable data.”

The WTO Valuation Code does not define either royalties or licence fees. It has been left up to each Customs territory to define the definition of the royalties and licence fees in their own legislation which Australia did within ss157(1) CA. Additionally, the royalty payment must be related to the goods being valued but although the WTO Valuation Code does say there must be some relationship it does not say how close the relationship must be. The buyer MUST PAY the royalty directly or indirectly to avoid scams and it must be paid as a condition of
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sale of the goods being valued. The WTO Valuation Code does not define the “condition of sale” for that is left up to each Customs territory to include in its legislation if it so decided which in Australia’s case it has not been defined or included in the Customs legislation as distinct from Canada, South Africa, India and the European Union.

If an importer must make a payment for the right to reproduce the imported goods in the country of importation, as stated in the WTO Valuation Code Interpretative Note to Article 8 1(c) 1.; then it should not be included in the customs value. Thankfully this exclusion is actually included in the Australian Customs Act at ss154(1) Price Related Cost paragraph (e) (iii).

Similarly the buyer’s payment for the right to resell or distribute the imported goods; provided the payment is not a condition of sale; should not be included in the price paid or payable; which is stated in the WTO Valuation Code Interpretative Note Article 8 1(c) 2.; and is almost identical to the
circumstances surrounding exclusive distributorship agreements. However, the Australian Customs Service’s intransigent attitude towards exclusive distributorship agreements by constantly maintaining that these types of arrangements should be included in the customs value has demonstrated the constant overlooking of the application of this WTO Valuation Code Interpretative Note because it has paradoxically been omitted from the Australian Customs legislation.

Furthermore, the Australian Royalty Customs legislation also transgresses the WTO Valuation Code in ss154(1) Price Related Costs paragraph (e) in its opening clause. Briefly this sub-section can be summarised as royalties or licence fees; as defined under ss157(1); paid or payable by or on behalf of the purchaser to the vendor or third party under the import sales transaction. The Australian legislation states “under the import sales transaction” which the Australian courts declared is equivalent to “pursuant or in accordance with the import sales transaction”. The “import sales transaction” is defined in ss154(1) which has as its focus “contracts of sale”. Alternatively the WTO Valuation Code Article 8 1(c) refers to; amongst other things; royalties or licence fees that must be paid or payable under the “condition of sale” and related to the goods should be included in the price for customs purposes. The term “condition of sale” refers;

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in Australian common law and sale of goods law; to conditions and stipulations that may or may not apply to a contract of sale.


Therefore the Australian legislative focus on a royalty payable is under a contract of sale rather than as a condition of that sale and clearly highlights the significant difference between the WTO Valuation Code and the Australian legislation to the degree where the Australian legislation contravenes the WTO Valuation Code.

This contravention is perhaps best illustrated by analysing two Court cases surrounding the one multinational company in two Customs territories. Royalties and licence fees has proved to be a contentious issue worldwide and has been subject to much litigation as evidenced by Mattel Pty Ltd in Australia and Mattel Canada Inc court cases.

PART 1: ANALYSIS OF THE MATTEL CASES IN CANADA AND AUSTRALIA.

1 Canada (Deputy Minister of National Revenue v Mattel Canada Inc [2001] 2 S.C.R. 100; 2001 SCC 36 (June 7, 2001). The Supreme Court of Canada is equivalent to Australia’s High Court. In the Mattel Canada Inc (MC) court case there was a dispute whether two royalties; being a direct royalty and an
indirect royalty; were to be included in the price as claimed by the Canadian Deputy Minister of National Revenue. This dispute was heard by nine judges.

Initially the dispute was heard by the Canadian International Trade Tribunal (CITT) who held that MC did not make direct royalty payments as a condition of sale of the goods for export to Canada. There was not a sufficient nexus between the direct and indirect royalty payment and the payment for the imported goods, because the payment for the rights was based on resales in Canada and some goods are imported without the royalty payment being made. Furthermore, the CITT invoked the control test stating that MC made royalty payments to a third party licensor, who was unrelated to the vendor of the goods, (J.M. Wilks, 2001, p1576).

The Canadian Deputy Minister of national Revenue then appealed the CITT decision to the Canadian Federal Court of Appeal (CFCoA) who agreed with the CITT decision for the direct royalty payments based on the control test in which the control exercised by the licensor was “not associated with an
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importation of the goods to Canada, but rather with their subsequent sale in Canada”, (J.M. Wilks, 2001, p1577).

Reversing the CITT’s decision on indirect royalty payments, the CFCoA found these payments were subsequent proceeds accrued for Mattel Inc USA’s benefit based on the Canadian Customs Act. Following the split decision by the CFCoA the Canadian Deputy Minister of National Revenue decided to seek the ultimate precedent in Canadian Customs Law and appealed the CFCoA decision to the Supreme Court of Canada, (SCoC).

In adjudicating both direct and indirect royalty payments being non-dutiable the SCoC dismissed the sufficient nexus and control tests used by both the CITT and CFCoA and applied the “condition of sale of goods” test relying on traditional legal principles under common law and relevant sale of goods legislation, (J.M. Wilks, 2001, p1577).

In the case of direct royalty payments the SCoC held that the sale contract and the royalty were separate agreements between different parties and the royalty is not paid as a condition of sale. Similarly the SCoC decided the indirect royalty payments are not paid as condition of sale under the Canadian Customs Act and thus Mattel Canada’s appeal was allowed. No reference was necessary for subsequent proceeds to be considered, (J.M. Wilks, 2001, p1577-1578).

Based on the SCoC’s unanimous judgement in the Mattel Canada case the importer should not pay the royalty as a condition of sale because they have separate contracts for the intellectual property and goods and are therefore non-dutiable. Alternatively, if the vendor can rescind the sales contract and refuse to sell the goods to the importer if the importer fails to pay the royalties, the payment of those royalties are then considered to be a condition of sale and will be dutiable, (J.M. Wilks, 2001, p1584).

Canada Customs and Revenue Agency (CCRA) issued a revised policy document on royalties indicating the document trails of a sales contract and separate royalty contract must be explicit in addition the vendor must NOT have the right to rescind or repudiate the sales contract if the royalty is not paid for a royalty to be non-dutiable, (J.M. Wilks, 2003, p78).



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2 MATTEL AUSTRALIA PTY LIMITED.

Mattel Australia did not have a royalty contract with the owner of the Intellectual Property Rights (IPR). Within the Mattel Group it was Mattel Inc in the USA who had a royalty contract. The licence agreement was entered into with Mattel Inc and the Walt Disney Company (Disney) in which Mattel Inc was licensed to reproduce Disney characters on its products and Mattel Inc was to pay Disney a royalty when goods have actually been sold to Australian consumers.

Australian Customs Service (ACS) maintained that if a royalty is paid directly or indirectly to the vendor or to relieve the vendor of an obligation to a third party; then the royalty becomes part of Price and not Price Related Costs when the royalty contract is between the licensor overseas and the vendor overseas as in the Mattel Australia case, (ACS Manual Volume 8A, 2005, p131).

Mattel Australia placed orders on other Mattel subsidiary companies who manufactured the products bearing the Disney characters and trademark and they sold them to Mattel T in Hong Kong who then on sold them to Mattel Australia; who also paid 8% royalty based on actual sales to Australian consumers. Based on Australian Customs interpretation of these facts they maintained the importer is not “party principle” to the royalty contract.

Since the vendor pays the royalty, finances the payment, the vendor passes on the royalty obligation to the purchaser and therefore the royalty payable forms
part of the price of the goods, (Australian Customs Manual Vol 8A, 2005, p132). Mattel Inc in USA makes a profit on manufacture of the goods, which in this case is in Mexico and the royalty payment is made to a related party of the manufacturer.

The Federal Court of Australia (FCA) upheld the Administrative Appeals Tribunal (AAT) judgement finding that the payment of the royalty was indirectly for the benefit of Mattel T because if it was not paid by Mattel Inc then Disney could terminate the licence arrangement to the detriment of the whole Mattel Group, which included Mattel T. Therefore the FCA concluded based on the controlling aspects of the manufacturing process and royalty payments by Mattel Inc in USA that in reality the role of Head Office is one of vendor and the holder of intellectual property rights.

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Consequently Customs, AAT and FCA all maintained the royalty payable to Mattel T was dutiable. Additionally, it is certainly arguable that; in my opinion under current Australian Customs law; the intellectual property rights payable to Mattel T cannot be separated from the import sales transaction and therefore is dutiable.

The question then becomes why is the royalty dutiable under Australian Customs Law and non-dutiable under Canadian Customs Law when both countries Customs legislation is based on the WTO Valuation Code?

The SCoC rejected the sufficient nexus and control tests and instead applied Canadian common law principles surrounding the settled case law of “condition of sale of goods” and concluded that both the direct and indirect royalty payments were separate from the sale of goods payments and therefore the royalty payments should not be included in the customs value.

Conversely, the FCA agreed with Australian Customs and the AAT decision on the grounds that the royalty payment could not be separated from the import sales transaction and therefore the price of the goods; thus the royalty should be included in the customs value.

Is the Australian decision correct or the Canadian decision correct?

Based on the WTO Valuation Code there are two basic tests to determine if the royalty or licence fee is a payment made for the rights to use, to produce or sell
a given product substantiated on objective and quantitative data. Both tests must apply in the positive for a royalty or licence fee to be dutiable. In other words if one of the tests are not applicable then the royalty or licence fee payment is non-dutiable.

TEST 1. “Is the royalty or licence fee directly related to the imported goods?”
TEST 2. “Is the royalty or licence fee payable as a condition of sale of the goods being valued?”

Within the Australian context there is an Australian constitutional prohibition on intangible services because the constitutional requirement under Section 55 is for a duty of customs to be on goods and not on services, (E.J. Cooper, 1984, p216). This is supported by the European Court of Justice which also refused to extend the inclusion of intangibles beyond the strict letter of the statute. In
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other words if the legislation specifically refers to goods then clearly the statute is limiting the royalty or licence fees payable as a condition of sale in reference to the imported goods, (E.J. Cooper, 1984, p216). Furthermore, when a royalty or licence fee payment is not so closely related to the imported goods this will result in the royalty or licence fee being non-dutiable, (Sherman and Glashoff, 1980, p46).

Therefore within the framework of the WTO Valuation Code the Mattel Canada and Mattel Australia Pty Ltd’s payments for the royalty demonstrates that they are closely related to the imported goods under the aforementioned first test because Mattel Inc cannot have the goods manufactured without the Disney trademark.

However, will the second WTO Valuation Code royalty test apply or not apply to both the Mattel Australia or Mattel Canada transactions?

The structures of both the Mattel Australia and Mattel Canadian transactions are very similar; to the degree of being almost identical; in that the royalty in both instances, is being paid to Mattel Inc in the USA and then on payable to the Master Licensor who is Disney. Furthermore, the invoicing and payment for the goods in both the Mattel Australia and Mattel Canada case is through an intermediary “Mattel T”. Within the Australian context both the FCA and AATA maintained the royalty was part of the contract of sale and indeed because of the inter-relationship between Mattel Australia, Mattel T and Mattel Inc in
USA the FCA at paragraph 16 held Mattel Australia would reduce the reliability of the Mattel Group by ensuring that payment for the Disney trademark was made, (Federal Court of Australia, 1994, paragraph 16).

The WTO Valuation Code does not specify which “sale” is meant, except that it should be the sale for export to the country of importation of the goods being valued.” There is not a single clear meaning of the condition of sale except that the terms can most appropriately be interpreted to refer to the separability or inseparability of the purchase of the goods being imported from the payment of the royalty for the intellectual property rights.

If the contract of sale for the goods and the intellectual property contract for the royalty are sufficiently separable the royalty should not be included in the customs value. The factor of contracted separability is important in determining whether a royalty is payable under the condition of sale of the imported goods and is dependent upon the structure of the import transaction between all parties involved so that the monetary trail is consistent with the paper trail, (Sherman and Glashoff, 1980, p47). It is arguable that under the WTO Valuation Code Mattel Australia pays Mattel T separately for the goods and once the imported goods are sold under wholesale sales in Australia there is a separate payment of the royalty to Mattel Inc in USA.

The mere fact that the payment of the royalty or licence fee is a clause within the contract between some of the parties does not mean that the royalty was a condition of sale within the meaning of Article 8(1)(c) of the WTO Valuation Code if the importer can demonstrate they separately paid for the goods; which Mattel Canada did by paying Mattel Inc in USA; compared to separately paying for the royalty to the “Trademark Licensor”, (Sherman and Glashoff, 1980, p47).

In applying the WTO Valuation Code principles to the Mattel Canada case it is arguable that the SCoC was correct in interpreting that the contract of sale for the imported goods is totally separate from the contract of the royalty payment to the intellectual property owner and therefore the royalty payment is not a condition of sale and not to be included in the customs value. Therefore the Australian and Canadian Mattel transactions; based on the WTO Valuation Code; are assertable that the royalty payments are not a condition of sale and therefore should not be included in the customs value.

By Fred Gibson, B.A., B.Litt, Grad Dip Ed, FCBFCA, Licensed Customs Broker.

Bio Notes: Fred Gibson is currently teaching the National Customs Brokers Course with the CBFCA, and TAFE’s in Victoria specialising in Valuation since 1988. He worked with Begley Hobba & Manton as a Licensed Customs Broker for thirty years and was directly involved with the Ninette Trading and Marym Australia Licence Fee court cases. He has a Bachelor of Arts and Letters Degrees and is currently completing a Masters in Adult Education at Monash University.