Recently, the High Court delivered an interesting judgment regarding the chargeability of intellectual property (IP) royalties and license fees for purposes of customs duty valuation. In the case of Republic v Kenya Revenue Authority Exparte Bata Shoe Company (Kenya) Limited [2014] eKLR the Kenya Revenue Authority (KRA) issued a partial demand notice to Bata Kenya requiring the latter to make a total payment of KES 90,489,947.00 to The Commissioner of Customs Services within 30 (thirty) days from November 24, 2010. Despite several exchanges, KRA and Bata Kenya were unable to agree on the total amount of taxes owed by the latter. Bata Kenya then moved to court under judicial review proceedings seeking for KRA’s notice to be quashed on the grounds that distribution royalties are not subject to customs duty as they are not royalties related to the goods being valued that the buyer must pay, either directly or indirectly, as a condition of the sale of the goods being valued within the meaning of Rule 9(i)(c) of the Fourth Schedule to the East African Community Customs Management Act, 2004 (EACCMA).
Bata Kenya owes its entire existence to two separate agreements namely, a Trade Mark License Agreement (TLA) with Bata Brands and an Agreement on commission/service charge with China Footwear Services Limited (CFS) and Bata Shoe (Singapore) Pte Ltd (BSS). An overview of the TLA entered on 1st January, 2006 between Bata Brands (as the licensor) and Bata Kenya (as the licensee) states that the latter is allowed to use the ‘BATA’ trademark for all its business activities in Kenya (known as the Territory). In return, Bata Kenya is required to pay 2% of the total annual sales “after all withholding and other taxes, levies or dues of all kinds imposed by any authority in the Territory”.
In clause 10 of the agreement, one of the conditions for early termination of the TLA is non-payment of the royalty. As per clause 11 the effect of termination would mean that Bata Kenya would cease trading in products with the trademark ‘BATA’.
In light of the TLA, KRA assessed the customs duty payable by Bata Kenya to include the royalties payable by the latter to Bata Brands. To support its position, KRA stated that Paragraph 9(1)(c) of the Fourth Schedule of the EACCMA provides for two conditions to be satisfied to establish chargeability of royalties namely the royalty payment relates to the goods being valued and the royalty is paid pursuant to a condition of sale. In the case of Bata Kenya, KRA argued that both these two conditions were satisfied.
In reply to KRA’s arguments, Bata Kenya asserted that Paragraph 9(1)(c) of the Fourth Schedule of the EACCMA was not applicable as the royalty payments to Bata Brands were not related to the goods being valued and that the royalty paid was not pursuant to a condition of sale. On the non-relation between the royalty and the goods being valued, Bata Kenya argued that its resale prices are different from the prices at which the products are imported. On the question whether the royalty was a condition of sale, Bata Kenya urged the court to construe the term “condition of sale” based on the legal relationship between the licensee and the licensor and third parties.
The court ruled in favour of Bata Kenya and stated in part:

The royalty fees, in my view, are paid for the use of the trademarks in Kenya and they have nothing to do with the prices of imported products. (…) I therefore agree with the Applicant [Bata Kenya] that the Respondent [KRA] is asking it to pay taxes which it is not obligated by the law to pay. As per the TLA, the royalty payments are made on the sales proceeds after tax. The royalties paid are therefore too remote from the value of the imported goods. The Respondent has therefore stepped out of its boundaries and the remedies of judicial review are available to the Applicant.

Comment:
In arriving at its decision, the court faced a formidable obstacle, namely the case of Republic v. Kenya Revenue Authority Ex Parte Beirsdorf East Africa Ltd [2011] eKLR (the Beirsdorf case), a High Court decision by Musinga J (as he then was). In the Beirsdorf case, the court found that that the manufacturing and distribution royalties payable by Beirsdorf East Africa to Beirsdorf AG should be added to the customs value of the imported products since the royalties were being paid as a condition of sale. In making this finding, the court in the Biersdorf case stated as follows:
“In my view therefore, payment of royalties by the applicant to Biersdorf is a condition of sale of their imported patented goods. I agree with the respondent that if royalties were not a condition of sale anyone would be at liberty to import, manufacture or even distribute Biersdorf’s products without permission of the patent holder. That would be an unacceptable trade practice. The relevant law must be interpreted in a manner that makes economic sense.”

The Biersdorf case would therefore appear to be a departure from other commonwealth countries where the courts have construed the term “condition of sale” in the legal sense as opposed to in the ordinary economic sense. However, in the present case of Bata Kenya, the court rightly departed from the ruling in the Biersdorf case after making a critical analysis of the relationship between the licensee and the licensor and third parties. In the Biersdorf case, there was no intermediary between the Biersdorf (parent company) and Biersdorf (subsidiary company operating in East Africa). Therefore, as a condition of the subsidiary manufacturing and distributing the parent company’s patented goods, the subsidiary company was obliged to pay to parent company manufacturing and distributing royalties. It follows therefore that if the subsidary company were to refuse to pay such royalties it would not be able to manufacture and/or distribute Biersdorf patented goods within East Africa.
Bata Kenya’s case is clearly different from the Biersdorf scenario, in that there are several intermediaries between the trade mark licensee and the trade mark licensor. According to the court in the present case, the existence of intermediaries between Bata Brands and Bata Kenya creates remoteness in the nexus between the sales and the royalty payments by the latter. This remoteness means that the the royalty payments cannot be said to be a condition of the sale.
As explained above, Bata Kenya imports its products from manufacturers in China and it pays a buying commission/service charge to BSS onward transmission to CFS. As a result, the TLA between the Bata Brands and Bata Kenya has no nexus between the purchases made by the latter from China through BSS.