Shmuel Grossman, Grossman, Cordova, Gilad & Co, Israel
A ruling given a number of days ago in the Israeli Supreme Court, demonstrates how the legislation governing the requirements to pay customs duty is to be interpreted.
This relates to a dispute between a number of importers and the Customs Department over the question of whether it is appropriate to impose customs duty on royalties that are paid in respect of fashion items that are imported to Israel.
The issue is of the payment of royalties to someone who owns the rights in the trademarks which relate to merchandize. For example, payment of royalties to the owner of the “Disney” brand in addition to payments payable to the manufacturers of the fashion items which carry the name “Disney” (or brands which it owns), when the manufacturers are supplying merchandize to importers.
The Customs Department claims that these royalties are subject to customs duty at a rate of 12%. Against this, the importers have appealed for a declaratory relief to be given, according to which such royalties are exempt from customs duty.
The relevant legal provision is section 133(a) (3) of the Customs Ordinance which determines that “for the purpose of determining the value of a transaction as stated in section 132, to the price of the transaction there should be added “royalties and licensing fees which relate to the merchandize which the importer is required to pay, directly or indirectly, as a condition of its selling the merchandize in Israel”.
The question of interpretation which the Supreme Court was to deal with, was – which royalties and licensing fees are subject to customs duty because of the fact that the importer is required to pay them as a “condition for selling the merchandize in Israel”.
There are two possible ways of interpreting the provisions of this section:
According to one interpretation, the interpretation which the importers are claiming, these are royalties and licensing fees which the importer is required to pay to enable it to buy the merchandize being imported by it from the supplier in the exporting country.
According to the second interpretation, the interpretation which the Customs Department is alleging, customs duty should be imposed on the royalties and licensing fees whenever someone who is entitled to payment of royalties can prevent the sale of merchandize in Israel if the royalties are not paid.
The starting point for interpreting a legislative issue, including tax legislation, is the language of the law. Possible interpretations are derived from the language of the law and from all these possibilities the interpretation which best reflects the purpose of the legislation, will be extracted.
It is clear that the language of the law seems to support the interpretation proposed by the Customs Department, namely that the law says that royalties are chargeable on the condition that they constitute a condition for the “sale of the merchandize in Israel”, i.e. a sale made after the process of importing into Israel.
Nonetheless, the Supreme Court preferred the second interpretation, even though it was very remote from the language of the law, and it ruled that royalties and licensing fees would only attract customs duty when their payment constituted a condition for the sale of merchandize in Israel, i.e. only the royalties the payment of which constitutes a condition for a transaction of importing to Israel and not for marketing/selling the merchandize in Israel.
The Supreme Court gave preference to the interpretation that is more remote from the language of the law (though this is also still a “tolerant” interpretation of the language of the law), because this interpretation best realizes the intent of the legislation.
What is the intent of the legislation?
The Supreme Court looked at the intent of the legislation from a series of sources.
First, section 133(a)(3) of the Customs Ordinance is intended to provide the basis in Israeli legislation for one of the rules set out in the international Customs Treaty to which Israel is a party, and therefore that section should be interpreted in relation to such Treaty and to the interpretations which are specified therein.
These interpretations make it clear that in order for the royalties to be included in the price of the merchandize for the purpose of customs duty, it is necessary that the payment of royalties constitutes a condition for the sale of the merchandize to an importer in Israel, in the context of the relationship between the manufacturer and the importer (as opposed to the relationship between the importer and anyone who is entitled to the royalties).
It transpired from a survey carried out by the Supreme Court that “in all the legal systems in the member-countries of the Treaty which we reviewed, it was an accepted rule that for royalties to be included in the price of merchandize for the purpose of customs duty, it was necessary for the payment of royalties to constitute a condition of sale, in the context of the relationship between the manufacturer and the importer”.
The Supreme Court ruled that, as far as possible, we should strive for an interpretation which conformed with the interpretive response given by the international consultative bodies set up by virtue of the international Treaty, and with the interpretation given by other countries who were signatories to that Treaty.
The Technical Committee of the International Customs Organization has published an explanatory opinion on the subject of imposing duty on royalties and licensing fees, in the context of which they opined that the issue of chargeability is to be resolved by considering all the circumstances relating to an importing transaction (as opposed to the circumstances relating to the sale of merchandize in the importing country). A similar interpretation to that of Technical Committee of the World Customs Organization has also been given in the USA and in the EU.
These interpretations lead to the conclusion that it is the import transaction that should be referred to (as opposed to the possibility of the importer selling merchandize in Israel), and priority should be given to the broad view which examines all the circumstances around the import transaction, and not just to the language of the agreements between the importer and the supplier/exporter.
The question that needs to be clarified is “whether the importer has a realistic option of buying the merchandize being imported by it, without being obligated to pay royalties or licensing fees”. If he has no such “realistic option”, customs duty can be imposed on the royalties or licensing fees which the importer pays. But if the importer has a realistic option of importing the merchandize without paying royalties or licensing fees, such royalties do not attract the payment of customs duty.
The Supreme Court’s ruling leads to the conclusion that even if the language in which the Law’s provisions are couched, deviates or is “remote” from the language of the international Treaty which Israel has sought to adopt, and in consequence, the language of the provisions of the law favours the Customs Authority, the Court will not accept that interpretation. The Court prefers an interpretation which conforms with the language of the Treaty and its interpretation by the international consultative bodies and the interpretations of other countries which have adopted it.