A commentary on the Federal Court case of Nike Malaysia v Jabatan Kastam Diraja Malaysia by Maniam Kuppusamy and Mariam Munang.
 
On 29 May 2013, the Federal Court handed down a decision on the question as to whether royalty costs should form part of the value of imported goods to be assessed for purposes of customs duty. This question revolved around the interpretation of Regulations 4 and 5 of the Customs (Rules of Valuation) Regulations 1999.
 
BACKGROUND FACTS
 
Nike Sales Malaysia Sdn Bhd (“Nike Malaysia”) is an importer of the popular brand of footwear, apparel, sports equipment and accessories. Between January 2000 and February 2003, Jabatan Kastam Diraja Malaysia (“KDRM”) conducted an audit on the declared value of the goods imported by Nike Malaysia. The audit revealed that Nike Malaysia had not included royalty costs as part of the price paid, or payable, for the goods.
 
KDRM was of the opinion that royalty paid to a foreign brand owner was a “transaction condition” for the imported goods for the purpose of customs valuation. KDRM alleged that Nike Malaysia had underpaid customs duty on the goods and demanded unpaid duties from Nike Malaysia amounting to RM2,675,344.19.
 
Nike Malaysia lodged an appeal to the Director-General of KDRM, which was dismissed. Nike Malaysia then appealed the decision to the High Court.
 
THE BUSINESS TRANSACTION
 
The import of goods by Nike Malaysia into Malaysia involved several legal entities, namely the brand owner, Nike International Limited (“Nike International”), the exporters who were unrelated third party manufacturers and the buying agents, Nike Inc (“Nike USA”) and Nissho Iwai America Corporation (“Nissho”).
 
Nike Malaysia would place purchase orders with Nike USA, which would then pass the purchase orders to unrelated third party manufacturers. The manufacturers would then export the goods to Nike Malaysia. Invoices were issued by and payments were made through Nissho. Nike Malaysia paid royalty directly to Nike International on the basis of invoiced sales in Malaysia.
 
This business transaction was governed by three inter-related agreements:

Royalty was payable by Nike Malaysia to Nike International under the IP Agreement at the rate of 6% of net invoiced sales revenue of all licensed goods sold in Malaysia. Crucially, the IP Agreement expressly provided that non-payment of royalty shall not prevent or impede the sale. Clause 13.1 reads:
 
“... in the event of non-payment of the royalty ... the licensor [Nike International] shall not prevent or impede such supplier from selling to licensee [Nike Malaysia] licensed goods ...”
 
THE CUSTOMS LAW FRAMEWORK
 
The customs value of imported goods is assessed based on the Customs Act 1967, read together with the Customs (Rules of Valuation) Regulations 1999.
 
Regulation 4(1) states that the customs value of imported goods “shall be their transaction value, that is, the price paid or payable for the goods when sold for export to Malaysia, adjusted in accordance with Regulation 5.”
 
Regulation 5(1)(a)(iv) then provides that in determining the transaction value, the price paid or payable for the goods shall be adjusted by adding “royalties and licence fees ... that the buyer must pay, directly or indirectly, as a condition of the sale of the goods for export to Malaysia.”
 
The issue in this case is therefore whether, on the basis of the business transaction described above, royalty should be added to the value of the goods imported by Nike Malaysia for purposes of determining the customs duty payable on those goods.  
 
THE HIGH COURT’S DECISION
 
Nike Malaysia took the position that royalties should not be added to the price of the goods paid as it was not a condition of the sale of goods for export to Malaysia. The sale contract and the royalties contract were separate agreements made between different parties.
 
On the other hand, KDRM was of the view that royalty costs must be included because the royalties were, directly or indirectly, a condition of the sale of the goods for export to Malaysia. 
 
Mohamad Ariff JC (as he then was) agreed with Nike Malaysia. According to the learned Judicial Commissioner, the test to determine whether the royalty paid was a transaction condition was this:
 
“The overriding test is whether the buyer or importer has, or has not, the obligation to pay the royalty in order to purchase or import the goods. If the obligation arises from a separate agreement that is unrelated to the sale or importation of the goods, it cannot be regarded as a condition of the sale of the goods.”
 
By applying this test, the learned Judicial Commissioner concluded that the IP Agreement and the Purchase Agreement did not comprise a single transaction and that the royalty payable by Nike Malaysia to Nike International under the IP Agreement could not properly be taken as a “condition of the sale of the goods for export to Malaysia.”
 
THE COURT OF APPEAL’S DECISION
 
On appeal, the Court of Appeal reversed the High Court’s decision. It held that royalty is to be regarded as an item to be included for adjustment of the price to be paid or payable, irrespective of whether the payment of royalty is expressly stated as a condition.
 
The Court of Appeal found that “... it would be legally wrong not to make an adjustment for the price paid or payable merely because it was not expressed that the respondent must pay the said royalty as a condition of the sale of goods for export to Malaysia. Such a proposition appears to be an ingenious attempt to evade the proper customs duty on the imported goods by the respondent.”
 
THE FEDERAL COURT
 
The Federal Court considered these two questions:
 
Question 1: “Whether the royalty paid by the applicant/appellant to Nike International Ltd could be considered as a condition of sale for the goods to be exported to Malaysia and as an item for the adjustment in accordance with Regulation 4 of the Customs (Rules of Valuation) Regulations 1999 read together with Regulation 5(1)(a)(iv) of the said Regulations?”
 
Question 2: “Whether the royalty is an indirect consideration by the applicant/appellant as a condition of sale for the entry of the goods to be exported into Malaysia?”
 
“CONDITION” OF SALE: TWO ALTERNATIVE DEFINITIONS
 
Regulation 5(1)(a)(iv) was adopted from the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994 (“WTO Valuation Agreement”), to which Malaysia and many other countries are signatories. The Federal Court considered two leading authorities on condition for sale for purposes of imposing custom duty, namely Deputy Minister of National Revenue v Mattel Canada Inc. [2001] 199 D.L.R. (4^th) 598 (“Mattel Canada”) and Chief Executive of New Zealand Customs Service v Nike New Zealand [2004] 1 NZLR 238 (“Nike New Zealand”).
 
In Mattel Canada, the Canadian Supreme Court adopted the legal definition of “condition” as used in the law of contract. It adopted the definition provided by P.S. Atiyah in The Sale of Goods (8^th Edition), that a condition is a term that is “of such vital importance that it goes to the root of the transaction”.
 
The Court of Appeal of New Zealand in Nike New Zealand considered Mattel Canada but disagreed with the Canadian Supreme Court that “condition” was a legal term. Rather, the New Zealand Court of Appeal regarded it as a term used in its ordinary and common sense way to mean a prerequisite or requirement for the export of the goods. In its view, for royalty to be a condition, there had to be a combination of two features. First, the royalty had to be payable to the manufacturer or to another person as a consequence of the export of the goods. Second, the party to whom the royalty was payable must have control of the situation that goes beyond the ordinary rights of a licensor that gives it the ability to determine whether the export to the country in question could or could not occur.
 
Thus Mattel Canada and Nike New Zealand presented the Federal Court with different definitions of a “condition” of sale. 
 
OPINION OF THE WTO TECHNICAL COMMITTEE
 
The Federal Court also considered Advisory Opinion 4.13 (“Advisory Opinion”) of the Technical Committee on Customs Valuation (“TCCV”) established under the WTO Valuation Agreement.
 
The Advisory Opinion was consistent with the approach adopted by the Canadian Supreme Court in Mattel Canada. According to the TCCV, where the requirement to pay royalty results from a separate agreement unrelated to the sale for export of the goods, royalty is not a condition of the sale of the goods. Therefore, it should not be added to the price actually paid or payable as an adjustment for the purpose of assessment of customs duty.

In answering the questions on appeal, the Federal Court stated that the interpretation of Regulations 4 and 5 cannot be an isolated and domestic exercise. Mindful of Malaysia’s obligations under the WTO Agreement, the Federal Court gave due regard to the Advisory Opinion issued by the TCCV. It observed that Mattel Canada was not only consistent with the Advisory Opinion but also with the approach in the United Kingdom, Australia, India and Singapore, all of which are WTO member countries. In this respect, Nike New Zealand was viewed as inconsistent with the international approach and as such, an exception.
 
The Federal Court stressed the principle of strict interpretation in relation to revenue or taxing statutes. It referred to the Supreme Court case of National Land Finance Co-operative Society Ltd v Director-General of Inland Revenue [1994] 1 MLJ 99 which held that in taxation matters, courts would refuse to adopt a construction which would impose liability where doubt exists.
 
In view of Clause 13.1 of the IP Agreement, the Federal Court stated that the obligation to pay royalty arose from a separate agreement that was unrelated to the sale for export of the goods to Malaysia. Accordingly, it took the view that royalties paid by Nike Malaysia under the IP Agreement should not be included for duty purposes as it did not have to pay royalty in order to purchase the goods from the supplier. The Federal Court then answered both the questions posed in the negative and set aside the orders of the Court of Appeal and reinstated the High Court orders.
 
PUSHING THE ENVELOPE
 
A year after Mattel Canada was decided, the Federal Court of Appeal of Canada in Reebok Canada v Deputy Minister of National Revenue, Customs and Excise [2002] F.C.J. No. 518 extended the principles laid down in Mattel Canada by holding that royalty payment will not necessarily be a transaction condition even in a case where both the sale contract and royalty contract are made between the same parties.
 
According to the Court in Reebok Canada, the outcome will depend on the wording of the agreements. In this case, the Court held that the royalty payment was not a transaction condition even though the royalty contract and the sale contract were made between the same parties as the agreements did not contain provisions which entitled the seller to be relieved of his obligation to sell the goods if the buyer did not make the royalty payment.
 
ANALYSIS
 
The decision of the Federal Court in Nike Malaysia is a landmark decision. It authoritatively determines that for the purposes of determining the customs duty payable on goods, royalty paid is not to be included in the price paid, or payable, for the goods in the following circumstances:
 
(1)     the royalty is payable to a party who is not the exporter of the goods;
(2)     the royalty is payable under an agreement that is separate and distinct from the agreement for the sale of goods; and
(3)     the payment of the royalty is not a condition for the sale and export of the goods.
 
The decision by Mohamad Ariff JC which was approved by the Federal Court was followed in Colgate-Palmolive Marketing Sdn Bhd v Ketua Pengarah Kastam [2011] 1 LNS 1878 and Levi Strauss (Malaysia) Sdn Bhd v Ketua Pengarah Kastam, Malaysia [2011] 1 LNS 1581 (both decided by Mohd Zawawi Salleh J) where the royalty and the purchase price of the products were separate and independent transactions between different parties. These High Court decisions have very recently been upheld by the Court of Appeal.  
 
In August 2013, the decision of the Federal Court was followed in the unreported cases of EMI (Malaysia) Sdn Bhd v Ketua Pengarah Kastam (Suit No: R-25-517-2010) and Persatuan Industri Rakaman Malaysia v Ketua Pengarah Kastam (Suit No: R-25-516-2010).
 
The decisions of the High Court and the Federal Court in Nike Malaysia are to be commended as they adopt the Advisory Opinion of the TCCV and align the determination of customs duty with the practices in other WTO member countries, such as the United Kingdom, Australia, India and Singapore.
 
It will be interesting to see whether the Malaysian Courts will adopt the principles laid down in Reebok Canada in a situation where the facts are substantially similar to that case.