Section 8 of the Special Economic Measures (Iran) Regulations provides that any person in Canada an any person outside Canada is prohibited from "doing anything that causes or assists or promotes, or is intended to cause, assist or promote, any act or thing" that is prohibited elsewhere in the regulations. This provision is contained in other Canadian economic sanctions legislation; however, Canada's business with Iran in the oil & gas sector (and other sectors) highlights the problem in a new light.

Does an in-house legal counsel risk a prosecution by being the one to interpret the law and provide guidance on how to engage in transactions with Iran? Possibly - it will depend upon the facts. It is possible that a prosecutor may lay charges if the in-house legal counsel blesses certain activities that could be viewed as prohibited. It is possible that in-house legal counsel will be more generous in their interpretation of the law in order to please the persons who sign their pay cheques. It is possible that prosecutors will make an example of an in-house legal counsel who did not exercise the most cautious approach.

This does not mean that outside counsel are immune from prosecution under the same provision. However, outside counsel may be more objective. Outside counsel may have different experience that could help. Outside counsel may be in a better position to discuss obvious concerns with higher management (or the sale force in an organization whose compensation is commission-based).

Yes, it should be that legal counsel should be entitled under the law to interpret the law - that is what legal counsel do. However, in this world and at this time in the history of the world, errors in judgement can have catastrophic effect. If something goes terribly wrong, governments will want someone to blame. As a result, the chill effect spills on to the activities of lawyers.

Cyndee Todgham Cherniak is an export controls and economic sanctions lawyer in Canada.  She can be reached at 416-307-4168.  Cyndee is a vice chair of the American Bar Association, Section of International Law, Export Controls & Economic Sanctions Committee and recently co-chaired and moderated a lunch program on economic sanctions against Iran.

1. Regulations Amending the Regulations Implementing the United Nations Resolutions on Iran, SOR/2010-154 (June 17, 2010);

2. Special Economic Measures (Iran) Regulations, P.C.2010-952 (July 22, 2010) (to be published in the Canada Gazette on August 3, 2010 as SOR/2010-165)

3. Special Economic Measures (Iran) Permit Authorization Order, P.C.2010-953 (July 22, 2010) (to be published in the Canada Gazette on August 3, 2010 as SOR/2010-166)

Only part of each of these regulations are aimed specifically at the oil & natural gas sector. That being said, the prohibitions may have a serious impact on existing and future business arrangements. Business is conducted in a variety of ways and the new prohibitions may be broad enough to cover a business activity.  Therefore, the new export controls & economic sanctions must be reviewed carefully and if there is any doubt as to whether the new prohibitions apply, questions should be raised sooner rather than latter.

A) Special Economic Measures (Iran) Permit Authorization Order

I will start with the good news - there may be relief available. This regulation allows for Canada's Minister of Foreign Affairs to grant a special permit to conduct any activity that is prohibited pursuant to the Special Economic Measures (Iran) Regulations. The Special Economic Measures (Iran) Permit Authorization Order provides as follows:

Her Excellency the Governor General in Council on the recommendation of the Minister of Foreign Affairs, pursuant to subsection 4(4) of the Special Economic Measures Act, hereby authorizes the Minister of Foreign Affairs to issue to any person in Canada or any Canadian outside Canada a permit to carry out a specified activity or transaction, or any class of activity or transaction, that is restricted of prohibited pursuant to the Special Economic Measures (Iran) Regulations.

Based on the foregoing, even if the discussion in section (B) below applies to prohibit certain activities, there may be an opportunity to obtain an export permit to authorize such activities in the oil & natural gas sector.

I have spoken with a representative of the Department of Justice and he has informed me that the Government of Canada understands that Canadian businesses have been engaged in legal business activities with persons in Iran and the new export controls and economic sanctions represent a significant change. The Government of Canada is willing to consider applications for permits to conduct positive business activities. However, no promises are made since the economic sanctions are being put in place for a reason --- to change behaviour determined to be a serious concern in Iran.

No process has yet been developed at this time for such permit applications. That being said, permits applications would be filed with the Department of Foreign Affairs, Export Controls Division (ECD)

(B) Special Economic Measures (Iran) Regulations

The Special Economic Measures (Iran) Regulations are made pursuant to the Special Economic Measures Act (Canada) and establish a number of new prohibitions that go further than the United Nations Security Council Resolutions 1929 (2010), 1803 (2008), 1737 (2006), and 1747 (2007). The Special Economic Measures (Iran) Regulations establish new prohibitions that affect Canadian suppliers in the oil & natural gas sector.

The new prohibitions are:

1. Paragraph 3: Any person in Canada and any Canadian outside Canada is prohibited from engaging in certain activities with specified persons in Iran that are listed in Schedule 1 to the Regulations;

2. Paragraph 4(1)(b): Any person in Canada and any Canadian outside Canada is prohibited from exporting, selling, supplying, or shipping to Iran or any person in Iran any goods used in the refining of oil or the liquefaction of natural gas;

3. Paragraph 4(1)(b): Any person in Canada and any Canadian outside Canada is also prohibited from dealing with any goods used in the refining of oil or the liquefaction of natural gas where the goods are destined for Iran or any person in Iran;

4. Paragraph 4(1)(c): Any person in Canada and any Canadian outside Canada is prohibited from exporting, selling, supplying, or shipping to Iran or any person in Iran any of the goods listed in Schedule 2 to the Regulation;

5. Paragraph 4(1)(c): Any person in Canada and any Canadian outside Canada is also prohibited from dealing with any of the goods listed in Schedule 2 to the Regulation where the goods are destined for Iran or any person in Iran;

6. Paragraph 4(1)(d): Any person in Canada and any Canadian outside Canada is prohibited from exporting, selling, supplying, or shipping to Iran or any person in Iran any of the goods listed export control list (excluding certain goods);

7. Paragraph 4(1)(d): Any person in Canada and any Canadian outside Canada is also prohibited from dealing with any of the goods listed export control list (excluding certain goods) where the goods are destined for Iran or any person in Iran;

8. Subsection 4(2): Any person in Canada and any Canadian outside Canada is prohibited from providing any financial or other service to or for the benefit of, or on the direction or order of any person in Iran in respect of any of the goods in prohibitions 2-7;

9. Subsection 4(2): Any person in Canada and any Canadian outside Canada is prohibited from acquiring any financial or other service from or for the benefit of, or on the direction or order of any person in Iran in respect of any of the goods in prohibitions 2-7;

10. Subsection 4(3): Any person in Canada and any Canadian outside Canada is prohibited from transferring, providing or communicating to Iran any technical data required for the processing, storing or handling of liquid natural gas;

11. Subsection 4(3): Any person in Canada and any Canadian outside Canada is prohibited from transferring, providing or communicating to Iran any technical data in respect of goods in prohibitions 2-7;

12. Paragraph 5(a)(i): Any person in Canada and any Canadian outside Canada is prohibited from providing or acquiring financial services or any other services to, from or for the benefit or on the direction or order of any person in Iran for the purposes of establishing a financial institution in Canada or a Canadian financial institution in Iran;

13. Paragraph 5(a)(ii): Any person in Canada and any Canadian outside Canada is prohibited from providing or acquiring financial services or any other services to, from or for the benefit or on the direction or order of any person in Iran for the purposes establishing a branch, subsidiary or representative office or an Iranian financial institution in Canada or a Canadian financial institution in Iran;

14. Paragraph 5(a)(iii): Any person in Canada and any Canadian outside Canada is prohibited from providing or acquiring financial services or any other services to, from or for the benefit or on the direction or order of any person in Iran for the purposes of acquiring a significant interest in an Iranian or Canadian financial institution;

15. Paragraph 5(c): Any person in Canada and any Canadian outside Canada is prohibited from purchasing any debt obligation issued by the government of Iran;

16. Subsection 6(1): Any person in Canada and any Canadian outside Canada is prohibited from making an investment in an entity in Iran that is owned or controlled by another entity in Iran and is engaged in the oil or natural gas industry;

17. Subsection 6(2): Any person in Canada and any Canadian outside Canada is prohibited from providing financial or other services to or for the benefit of or on the direction or order of a person in Iran for the purposes of investing in the oil or natural gas industry in Iran;

18. Subsection 6(2): Any person in Canada and any Canadian outside Canada is prohibited from acquiring financial or other services from or for the benefit of or on the direction or order of a person in Iran for the purposes of investing in the oil or natural gas industry in Iran;

19. Section 7: Any person in Canada and any Canadian outside Canada is prohibited from knowingly providing a vessel that is owned or controlled by, or operating on behalf of, the Islamic Republic of Iran Shipping Lines with insurance services, or stevedoring, bunkering and lighterage and similar services for the vessel’s operation or maintenance; and

20. Section 8: Any person in Canada and any Canadian outside Canada is prohibited from doing anything that causes or assists or promotes, or is intended to cause, assist or promote, any act or thing prohibited by the above prohibitions.

These prohibitions are effective as of July 22, 2010.

These new measures are broad in their application in certain respects and limited in others. While there may be legal arguments whether a particular good is captured by a prohibition (e.g., the good is used in the oil and natural gas sector, but is not used in the refining process), the Canada Border Services Agency (CBSA) is stopping most (if not all) goods destined for Iran (and intermediary shipping points, such as the United Arab Emirates). The CBSA is the gate-keeper and will require detailed technical data concerning the goods, the buyer, the end-use, etc. Even if the end use is not in a specific industry (e.g. refining of oil), if the good may be used in a manner that is prohibited, it may be caught by the new prohibitions.

As a result, we recommend that Canadian oil and natural gas businesses take a conservative approach and engage in discussions if they plan to export goods to Iran. We recommend that such businesses obtain pre-approval by way of a ruling or an export permit prior to attempting to export a good without a permit. The upfront request and permission process may be controlled better than reversing a detention by the CBSA. Further, if a mistake is made, penalties may be imposed and, depending on the activity, a prosecution may ensue. In addition, if the CBSA has a record of a breach of any of the prohibitions by a company/individual, they may detain goods destined for other locations in order to determine whether the goods are ultimately destined for Iran.

(C) Regulations Amending the Regulations Implementing the United Nations Resolutions on Iran

On June 17, 2010, the Government of Canada added goods that are subject to United Nations Security Council Resolution 1929 (2010) to the existing list of prohibitions in the Regulations Implementing the United Nations Resolutions on Iran made pursuant to the United Nations Act (Canada). Few of these goods are connected to the oil and natural gas industry.

The new prohibitions are:

1. Paragraph 3(a): Any person in Canada and any Canadian outside Canada is prohibited from knowingly selling, supplying or transferring to any person in Iran, directly or indirectly, wherever situated, products that appear in sections 2 to 7 of Annex B of Information Circular INFCIRC254/Rev. 9/Part 1, entitled “Communication Received from Permanent Mission of Brazil Regarding Certain Member States Guidelines for the Export of Nuclear Material, Equipment and Technology";

2. Paragraph 3(a): Any person in Canada and any Canadian outside Canada is prohibited from knowingly selling, supplying or transferring to any person in Iran, directly or indirectly, wherever situated, products that appear in Security Council on the United Nations document S/2010/263;

3. Paragraph 3(g): Any person in Canada and any Canadian outside Canada is prohibited from knowingly selling, supplying or transferring to any person in Iran, directly or indirectly, wherever situated, any battle tanks, armoured combat vehicles, large caliber artillery systems, combat aircrafts, attack helicopters, warships, missiles or missile systems as defined for the purposes of the United Nations Register of Conventional Arms, or related material including spare parts or other items as determined by the Security Council or the Committee established pursuant to Security Council Resolution 1737;

4. Paragraph 3(h): Any person in Canada and any Canadian outside Canada is prohibited from knowingly selling, supplying or transferring to any person in Iran, directly or indirectly, wherever situated, any technology in respect of any activity related to ballistic missiles capable of delivering nuclear weapons, including launches using ballistic missile technology;

5. Section 7: Any person in Canada and any Canadian outside Canada is prohibited from knowingly procuring arms and related material or any items that appear in INFIRC/254/Rev.9/Part 1. INFCIRC/254/Rev.7/Part 2 or United Nations Security Council documents S/2010/263, wherever situated, from any person in Iran or any person acting on behalf of, at the direction of, or for the benefit of, Iran;

6. Section 8: No owner or master of a Canadian vessel, within the meaning of section 2 of the Canada Shipping Act, 2001, and no operator of an aircraft registered in Canada and no Canadian owner or master of a vessel or operator of an aircraft shall knowingly carry, cause to be carried or permit to be carried arms and related material or any of the items that appear in INFIRC/254/Rev.9/Part 1, INFCIRC/254/Rev.7/ Part 2 or United Nations Security Council documents S/2010/263, wherever situated, destined for any person in Canada and procured from any person in Iran or any person acting on behalf of, at the direction of, or for the benefit of, Iran;

7. Paragraph 9(d): Any person in Canada and any Canadian outside Canada is prohibited from knowingly making any property or financial or other service or other related service available to a designated person, to a person acting on behalf of, or at the direction off, a designated person, to a person owned or controlled by a designated person or to a person determined by Security Council of the United Nations or by the Committee of the Security Council to have assisted a designated person in evading the sanctions or violating the provisions contained in the Security Council Resolutions;

8. Section 9.1: Any person in Canada and any Canadian outside Canada is prohibited from knowingly making any property available to (i) Iran, (ii) any person in Iran, (iii) any body corporate incorporated in Iran or subject to its jurisdiction, (iv) any person acting on behalf of or at the direction of a person in (ii) or (iii), or (v) any person owned or controlled by Iran or by a person in (ii) or (iii)for the purposes of investing in any commercial activity in Canada involving uranium mining, production or use of nuclear material and technology listed in INFIRC/254/Rev.9/Part 1;

9. Section 9.1: Any person in Canada and any Canadian outside Canada is prohibited from knowingly making any financial service or other related service available to (i) Iran, (ii) any person in Iran, (iii) any body corporate incorporated in Iran or subject to its jurisdiction, (iv) any person acting on behalf of or at the direction of a person in (ii) or (iii), or (v) any person owned or controlled by Iran or by a person in (ii) or (iii) for the purposes of investing in any commercial activity in Canada involving uranium mining, production or use of nuclear material and technology listed in INFIRC/254/Rev.9/Part 1;

10. Subsection 9.2(1): Any person in Canada and any Canadian outside Canada is prohibited from knowingly providing a vessel that is registered in Iran or that is contracted to Iran with goods, materials or services for the vessel’s operation or maintenance, including in respect of insurance, stevedoring, bunkering and lighterage if there is reasonable grounds to believe that the vessel is carrying prohibited products; and

11. Section 8: Any person in Canada and any Canadian outside Canada is prohibited from doing anything that causes or assists or promotes, or is intended to cause, assist or promote, any act or thing prohibited by the above prohibitions.

It is important to note that these prohibitions are not made pursuant to the Special Economic Measures (Iran) Regulations and, therefore, cannot be the subject to an authorization by the Minister of Foreign Affairs under the regulations discussed in (A) above.  In other words, it is unlikely that the Minister would override these prohibitions if asked as he does not have legal authority to do so. This makes sense because the United Nations is concerned about Iran'a nuclear ambitions.

It is also important to note that the existing export controls rules with respect to goods on the Export Control List continue to apply. The new regulations add to the existing rules and do not override them to permit more exports. The purposes of the regulations is to restrict exports further by establishing an outright prohibition on certain exports that previously could have been approved by way of a specific export permit.

If you are in the Canadian oil & natural gas business, we would be pleased to discuss your export plans with you and our discussions will be subject to solicitor-client privilege. Please call Cyndee Todgham Cherniak at 416-307-4168.

The Stewardship Ontario programs have come under fire, and rightly so.  What is interesting is the extent to which the activities diverge from the legislative authority under the Waste Diversion Act, 2002.  In this post, the first of many, I will start with some of the basic aspects of the actual legislation in order to start to highlight the problems that must be corrected.

Waste Diversion Act, 2002

The Waste Diversion Act, 2002 (“WDA") sets out to promote reducing, reusing and recycling waste. The WDA provides for the development, implementation and operation of waste diversion programs.

a) What are Waste Diversion Programs?

According to the WDA, waste diversion programs may include:

• activities to reduce, reuse, and recycle waste;

• research and development activities;

• activities to develop and promote products that result from waste diversion programs; and
• educational and public awareness activities to support waste diversion programs.

The WDA does not state what types of activities must be included within a waste diversion programs. As a result, waste diversion programs may be developed in a flexible manner, but must be developed to meet the objectives and purpose of the WDA. If the programs do not meet the above criteria (that is, fit within the parameters of the WDA), arguably the programs are inconsistent with the WDA and ultra vires (meaning without legislative authority).

b) Who is Responsible for Developing Waste Diversion Programs?

As set out by the WDA, Waste Diversion Ontario (“WDO") is responsible for developing, implementing and operating all waste diversion programs that are created under the authority of the WDA.

When requested to do so by the Minister of Environment and Energy (“Minister") or another designated cabinet minister, WDO must develop a waste diversion program in co-operation with an industry funding organization (“IFO") (see below for a discussion of IFOs).

Together, the IFO and WDO draft and submit a program proposal to the Minister. The proposal ought to set out the objectives of the waste diversion program and is to include a detailed breakdown of all costs associated with the program, including an outline of who will bear the costs. Ultimately, the Minister must decide whether or not to approve the proposed program.

Along with developing and implementing the programs, WDO must enhance public awareness of the programs and ensure the programs affect Ontario’s marketplace in a fair manner.

(Note: a copy of the Minister’s program request letter addressed to WDO for the municipal hazardous or special waste program can be found on WDO's website at: www.wdo.ca/content/. The corresponding proposal prepared by WDO and the IFO, Stewardship Ontario, can be found on WDO's website at: http://www.wdo.ca/content/?path=page80+item125629.)

There are three IFOs established to date:

1. Stewardship Ontario
2. Ontario Tire Stewardship
3. Ontario Electronics Stewardship

c) What is Stewardship Ontario?

Stewardship Ontario is the IFO designated by Ontario Regulation 28/08 for waste diversion programs dealing with municipal hazardous or special waste and blue box waste. According to Ontario Regulation 542/06, municipal hazardous or special waste includes waste that consists of corrosive materials, flammable materials, toxic materials, aerosols, fertilizers, paints, lubricants, etc. Neither the WDA nor any of its regulations define the term “waste".

d) What legal powers does Stewardship Ontario have?

All of Stewardship Ontaro's powers are traceable to the WDA and regulations made pursuant ot the WDA (Ontario Regulation 28/08 and Ontario Regulation 542/06) According to the WDA, Stewardship Ontario as an IFO can make rules:

(a) designating persons or classes of persons as stewards in respect of the designated waste;

(b) setting the amount of the fees to be paid by stewards or prescribing methods for determining the amount of the fees;

(c) prescribing the times when fees are payable;

(d) requiring the payment of interest or penalties on fees that are not paid;

(e) exempting stewards or classes of stewards from paying fees subject to conditions and restrictions as may be prescribed by the rules;

(f) requiring stewards to keep records prescribed by the rules and governing the submission of those records to persons specified by the rules and the inspection of those records by persons specified by the rules;

(g) requiring stewards to provide reports and other information to persons specified by the rules.

According to the WDA, a person who is designated under the rules as a steward must pay to the IFO any required fees as set out by the rules. However, the WDA does not give an IFO the power to impose fees. That power is missing in both the WDA and the regulations. Stewardship Ontario does not have the legal power to give itself the power to impose ecotaxes,

Provincial officers may investigate offences under the WDA and anyone who is in breach of the WDA or the rules is liable to a maximum fine of $100,000.

e) Who is a Steward?

I will start with who is not a steward - Stewards are not the general public and, arguably, are not retailers of new goods, importers of new product or manufacturers of Canadian-made goods.

The WDA makes it clear that to be a steward, one must have a commercial connection to the waste. The term “commercial connection" is not defined in the WDA, however, for the purposes of the municipal hazard and special waste program, Stewardship Ontario provides a definition within the rules and the definition is paraphrased as follows:

A person has a commercial connection with municipal hazard and special waste if they derive an economic benefit from the waste when it is sold, leased, donated, disposed of, used, transferred possession of or title in, or otherwise made available or distributed for use in the Province of Ontario.

It is questionable whether Stewardship Ontario’s definition of commercial connection is legally valid as the WDA does not confer upon Stewardship Ontario the power to define terms within the WDA.

Whether a company or person is a steward is determined by IFO rules.

f) Who Has to Pay Fees to Stewardship Ontario?

The WDA sets out that stewards are to pay the fees (or ecotaxes) as set out in the IFO rules. The WDA does not impose a payment obligation on anyone who is not a stewards (and therefore, does not impose payment obligations on consumers). The WDA does not grant stewards the authority to pass on the ecotaxes payable by stewards to consumers.

It is important to note that the WDA explicitly states that IFO rules that designate a company of a person are not valid unless the steward has received a copy of the rules or has written notice of how to obtain a copy of the rules. This leaves an important due process question as to whether Stewardship Ontario has taken the legally mandated steps required to communicate its rules in a transparent manner. If any stewards did not receive a copy of the rules, an argument may be made that they do not have to pay the ecotaxes and any penalties for failure to pay ecotaxes are ultra vires.

Stewards may have an opportunity to recover ecotaxes (and any penalties) paid to Stewardship Ontario since the start of the blue box and municipal hazardous waste/special waste programs. We would be pleased to discuss this further. Please call Cyndee Todgham Cherniak at 416-307-4168.

Anyone who imports textile or wearing apparel products knows that achieving 100% regulatory compliance has been challenging for both Customs and the trade community. In a recent presentation, Janet Labuda, the U.S. Customs and Border Protection (CBP) Director of Textile Enforcement, reminded the audience just how daunting that challenge remains. Textiles (including wearing apparel) continue to account for approximately 40% of all duties collected and about 22% of all import entries filed. Customs’ focus remains on preference claims where a 45% rate of non-compliance is not surprising. At the same time, CBP is also examining short supply fabric claims which recently resulted in $2 million in denied claims when such commonly available fabrics as cotton were claimed to be in short supply!

In addition, to short supply concerns, CBP has also been validating free trade agreement claims and again here, too, massive non-compliance has supposedly been found. For that reason, CBP is in the process of developing a training regimen for its own staff in order to make sure CBP’s personnel understand FTA claims. Part of CBP’s concern is the gross lack of knowledge about valid FTA claims, but CBP has also discovered yarn and fabric affidavits which are forged, altered and/or used multiple times to qualify goods which do not otherwise qualify. Who prepares your certificates of origin? How often are they validated and what means are used to validate them? While at least initially CBP has been focused on CAFTA claims, we can expect all FTA claims to be under suspicion and subject to audit.

Looking at the numbers and other intelligence, Ms. Labuda and her team came to suspect entry declarations were wrong on a grand scale. To go about confirming that suspicion, CBP assembled a cross-functional team from various geographic locations which was tasked to review textile and wearing apparel imports from China. To reach a statistically valid sample, it was determined 181 companies would have to be visited. Since that was quite a task. Ms. Labuda explained CBP decided to start with 60 and see what sort of results they got. The fact that in the end the team visited 60 companies in Los Angeles, another 60 in Manhattan and another 61 throughout the rest of the country tells you that extensive non-compliance was found. It was apparently quite common to find out the address given for a specific importer of record simply did not exist. It was also common place to find the address was valid but the importer had long ago relocated or the person there was not really the importer, although his company name was used. One not so humorous anecdote Ms. Labuda told about the difficulties Customs was encountering involved a company that was originally located in New York. When CBP started asking questions about its transactions, the company relocated to Houston. However, when the address was checked out, it was non-existent. In other words, the street existed but not the number. As CBP became more aggressive, the company quickly relocated again, this time to Denver!

Another illustration of what Customs is facing was the example of goods worth $33 million being imported by one company, but the person acting as importer of record was getting paid just 1¢ per garment. In other words, this person did not qualify to act as importer of record and the value being declared at time of entry was significantly underreported. In other examples, a shipment was originally offered for entry with a value of $200,000. When Customs refused the entry, the corrected entry reflected a value of $1.7 million and miraculously expanded from one importer to 5. Another entry originally submitted at $250,000 was ultimately revised to a value of $1.5 million. In yet another instance, brand name high end coats were imported at values as low as $6.95 each, but retailed for $600 each! According to Ms. Labuda, more than half the importers interviewed did not have the right to make entry. They had no knowledge about the goods and also had no interest in those goods.

While these CBP efforts may be focused on importers, it is clear that CBP considers the customs brokers to be the "linchpin" and recognizes that freight forwarders are also involved. As such, CBP and the Federal Maritime Commission are cooperating as these investigations continue.

For Customs, the issue is a simple one - supply chain security. Who are the real parties to the transaction? Without knowing that fact, risk at all levels cannot be properly measured or addressed. From the trade’s perspective, many honest importers are getting stuck in the middle. They file an entry, it is refused on the grounds the value is too low, despite proof of payment. A significantly higher value is then arbitrarily set by CBP. Do you challenge CBP or do you pay the duty, get your goods and argue about it later? Not surprisingly, most choose to secure the goods and argue about valuation later. Should the fact there are some dishonest importers mean that everyone who imports from China should be treated with the same heightened skepticism and close scrutiny? It is also worth remembering that when CBP sets the value based on the transaction value of identical or similar merchandise, an importer is unable to learn the basis for the value set unless in litigation as Customs is relying on values which were validated from transactions by other importers. As such, the only way to learn any details is through the discovery process once in litigation - in short, good luck challenging CBP’s value determination!

One last word of warning on this topic – if you are purchasing branded merchandise on a DDP or LDP basis, you may not be off the hook. Although many in the trade would question this conclusion based on a straightforward understanding of what DDP and LDP mean as a term of sale, from CBP’s perspective, as the owner of the brand name, you may well have some form of liability if the seller does not make proper entry. Does this mean that as the DDP or LDP buyer, you should demand to get a copy of the 7501 from your seller? CBP says yes, but is that realistic? Even if you elect to do so, does getting a copy of the 7501 mean the document you are provided is authentic? How are you supposed to make that determination? Each company will have to answer these questions for itself. What do your SOPs require?

Finally, keep in mind that civil penalties may be the least of anyone’s concerns. CBP says it is facing millions of dollars in lost revenue and so it was not surprising to hear that criminal penalties are being considered. For these purposes, think in terms of money laundering, RICO and 18 U.S.C. 1001 (lying to a government official) and 18 U.S.C. 1002 (submitting a false, altered, forged, or counterfeited writing or document in order to defraud the U.S.). Given the staggering numbers of dollars apparently involved with these importing schemes, it is not surprising that CBP wants to see people spend time in jail. How are you vetting your business partners in order to make sure you do not get sucked into such a scheme?

As CBP is developing this policy, it begs the question of what will happen to those cases under review where CBP Forms 28 and 29 have already been issued, the Port has taken the position prior disclosure rights are cut off, the importer has objected, and the matter is under review at CBP Headquarters. The significance of a CBP Form 29 in terms of prior disclosure rights also remains under consideration. At a time when CBP keeps saying that trade facilitation is a critical mission, it makes you wonder what these folks are really thinking.

Once a shipment is presented for examination, i.e., the boxes are out of the container, the five (5) business days for CBP’s detention period begins. CPSC has set as a goal for itself the same time limit in which to issue its Notices of Detention. There is no specific regulation or statute which contains CPSC’s detention procedures, although CPSC promises to post Questions and Answers on its website shortly. Those whose goods are subject to CPSC jurisdiction should make sure they have provided their customs broker with the email address of the correct person to receive such notices. CPSC has been very clear about wanting to communicate in the most efficient way possible and email is preferred.

The Notice of Detention will be sent to the broker, the importer, and CBP. It is supposed to include the name and contact details for CPSC’s Compliance or Field Investigator handling the specific entry. In response, the importer is expected to provide information and documents. If the CBP thirty (30) day period expires and a CBP violation is found, the goods will be seized. If that happens, CBP will require satisfaction of any CPSC issues prior to releasing the goods at the end of the mitigation process. On the other hand, if the sole violation has to do with CPSC issues, then CPSC and CBP will consult before the petition decision is made, although CPSC’s advice is not binding on CBP according to how the law is written. On the other hand, if a shipment is conditionally released to the importer, then ordered redelivered by CBP, but the importer fails to timely comply, the resulting liquidated damages case will be issued for three times the value of the goods. When it comes to making decisions on petitions submitted for these types of violations, CPSC does get the final word; see 16 C.F.R. 1500.271(b).

There are a host of questions which remain to be answered. First, when will we see something in writing from CPSC detailing how the detention process will work? CPSC’s right to obtain samples is stated at 15 USC 1273 and 2066, but what is the legal authority for CPSC to issue its own detention notices? In the absence of proper legal authority, will the detention process withstand an Administrative Procedures Act challenge? When will the Questions and Answers be posted on the CPSC website? How will the procedure be affected by the fact that CPSC has Compliance or Field Investigators only at the ten (10) largest ports, but not at all ports of entry? Also, experience tells us that, if a given CBP inspector is out for any reason, his coworkers are loathe to handle his cases in his absence. How will that impact communications between CBP and CPSC? During the detention period, CPSC will be looking for documents and information from the importer. What happens if the importer needs to obtain test results from a foreign lab? How will that slow down the process? What steps is CBP taking to make sure its staff and CPSC are on the same page and communicating efficiently?

The imported shipment will remain under CBP’s custody and control during detention, unless CPSC and CBP agree to conditional release, which means under the importer’s bond. Unlike FDA, where conditional release is the accepted norm, CPSC will need experience before allowing conditional release as a matter of routine, if ever. At the same time, conditional release of goods thought to present a significant health hazard is unlikely at any time. It is also worth noting that, under the CPSC laws and regulations, the default with noncompliant goods is destruction, while export comes in second. If export is allowed, it will have to be under government supervision.

There are a couple of additional points which are critical. First, this new detention procedure applies to all CPSC regulations, not just those related to the CPSIA. In other words, CPSC will be implementing detention for issues arising out of the CPSIA (children’s products) plus Consumer Product Safety Act (e.g., lighters, toys, and children’s products), Federal Hazardous Substances Act (e.g., fireworks), Flammable Fabrics Act (e.g., sleepwear and mattresses), Poison Prevention Packaging Act, Refrigerator Safety Act, Virginia Graeme Baker Pool and Spa Safety Act, and the Children’s Gasoline Burn Prevention Act.

The other interesting complication which comes out of the CPSIA is that it is now a prohibited act to place an unauthorized safety mark on a good. We are all used to seeing an unauthorized UL or ATSM mark on electric goods or toys offered for import. Going forward, not only can seizure for the trademark violation occur, followed by a civil penalty for importing counterfeit goods, but on top of that, a civil penalty may also be imposed under the CPSIA! Time to beef up your intellectual property rights and consumer product safety standard operating procedures.

It has become commonplace for Customs to issue a 1099-C debt cancellation form in circumstances that have tax lawyers shaking their heads in disbelief. Here is the scenario using a liquidated damages case as the example, although this is being done across the board with various categories of monetary penalty that have been issued and forgiven. It is also being applied whether the matter gets resolved through the reduction of the fine via the mitigation process or pursuant to an Offer in Compromise.

We will presume the Notice of Liquidated Damages involves a late-filed entry. The amount of the claim will typically be issued for the face amount of the bond, say $100,000. Because this is such a routine violation, Customs issues the Notice with the Option 1 calculation right on it, which will be $100 plus an interest amount. Of course, Option 1 only applies if the entry has been filed and all the duties and user fees were already paid. For purposes of this illustration, we will presume the Option 1 amount totals $125. The importer pays the fine and that ends the penalty case, but now a 1099-C is issued for $99,875, the supposed amount of the forgiven debt!

A 1099-C is issued pursuant to IRS regulations (see IRC 6050P and Treasury Regulation 1.6050P-1) when a debt in excess of $600 is involved and it is forgiven. The sort of debt envisioned by these laws and regulations is a student loan or mortgage; in other words, a situation where there is a fixed and final amount agreed to by the parties. The CBP mitigation process clearly does not fit this criteria. If you receive a 1099-C, you should immediately give it to your CPA so that it accompanies your tax return, and the IRS should be notified that Customs was in error when it issued the 1099-C and so the amount purportedly forgiven is not being declared as income. Just as when the IRS reduces or cancels a penalty, no debt forgiveness results, no debt forgiveness results when Customs reduces or cancels a fine.

The issuance of Form 1099-C has become so widespread that we have approached  CBP’s upper management and requested that Customs put a stop to this action or, failing that, explain the legal thinking behind it, since the tax law experts with whom we have consulted are stumped.

Under Ms. Labuda’s direction, CBP has assembled a cross-functional team to review textile and wearing apparel imports from China. Over a relatively short period of time, the team visited 60 companies in Los Angeles, another 60 in Manhattan, and another 61 throughout the rest of the country. The result confirmed CBP’s worst fears. In one example, goods worth $33 million were imported by one company, but the person acting as importer was getting paid just 1¢ per garment. In other words, this person did not qualify to act as importer of record, and the value being declared at time of entry was significantly underreported. In other examples, a shipment was originally offered for entry with a value of $200,000. When Customs refused the entry, the corrected entry reflected a value of $1.7 million. Another entry originally submitted at $250,000 was ultimately revised to $1.5 million. According to Ms. Labuda, more than half of the importers interviewed did not have the right to make entry. They had no knowledge about the goods and also had no interest in those goods.

While these CBP efforts may be focused on importers, it is clear that CBP considers the customs brokers to be the “linchpin” and recognizes that freight forwarders are also involved. As a result, CBP and the Federal Maritime Commission are cooperating as these investigations continue.

For Customs, the issue is supply-chain security. Who are the real parties to the transaction? Without knowing that fact, risk at all levels cannot be properly measured or addressed. From the trade’s perspective, many honest importers are getting stuck in the middle. They file an entry; it is refused on the grounds the value is too low, despite proof of payment. A significantly higher value is then arbitrarily set by CBP. Do you challenge CBP; or do you pay the duty, get your goods, and argue about it later? Not surprisingly, most choose to secure the goods and argue about valuation later. Should the fact there are some dishonest importers mean that everyone who imports from China should be treated with the same heightened skepticism and close scrutiny?

One last word of warning – if you are purchasing branded merchandise on a DDP or LDP basis, do not think you are off the hook. From CBP’s perspective, you may well have some form of liability if the seller does not make proper entry. Does this mean that as the DDP or LDP buyer, you should demand to get a copy of the 7501 from your seller? CBP says yes, but is that realistic? Even if you elect to do so, does it mean the document you are given is authentic? How are you supposed to make that determination? Each company will have to answer these questions for itself. What do your SOPs require?

In short, related parties (parties operating at non-arms length) may see their tax planning challenged by the Canada Revenue Agency and additional assessments of harmonized sales tax (HST) levied where the Minister believes there is a tax benefit flowing from a transaction with no bona fide business purpose.  The HST anti-avoidance rules do not appear to apply to non-arm's length parties.

First, the time frames - the HST anti-avoidance rules apply to transactions that occurred after March 26, 2009 (the date of Ontario's HST budget announcement). In particular, Part 5 of the Regulations provide:

• Section 35 applies to any agreement varied,
  altered or terminated on or after March 26,
  2009 and to any new agreement entered into on
  or after that day.
• Section 36 applies to any agreement varied,
  altered or terminated on or after April 6,
  2010 and to any new agreement entered into on
  or after that day.
• Section 37 applies to any transaction made
  on or after March 26, 2009.

My first reaction is - poor souls in British Columbia.  The drafters of the Regulations are mistaken and must believe that the B.C. HST announcement occurred at the same time as Ontario and not on July 23, 2009.

Next, what appears to be covered:

• Arm's length transactions entered into between March 26, 2009 and July 1, 2010 that are altered or varied or terminated
• Arm's length transactions entered into after a tax rate change announcement that are altered or varied or terminated
• Arm's length transactions or series of transactions would in the absence of this section result, directly or indirectly, in a tax benefit to one or more of the persons involved in the transaction or series of transactions it may not reasonably be considered that the transaction, or the series of transactions, has been undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit, arising from a harmonization event, for one or more of the persons involved in the transaction or series of transactions.

I would like to highlight something that is written in the Regulatory Impact Statement (at the end of the Regulation) after reading the part under "Consultations"

The Regulations are designed to reflect previous HST announcements of proposed rules by Ontario and British Columbia on October 14, 2009 and by the Government of Canada on February 25, 2010.

I must have missed the anti-avoidance rules announcement.

Finally, after re-reading the Regulatory Impact Statement regarding the anti-avoidance provisions, businesses that have expanded into another province after March 26, 2009 may find their business activities under a CRA microscope and will have to prove their legitimate business purpose to an auditor:

The Regulations also set out rules to prevent persons from improperly taking advantage of a change in the new harmonized value-added tax system under the Excise Tax Act. Such changes include the addition of a province to the system, a change to the tax rate of a participating province or a change to a rebate of the provincial component of the HST.

The anti-avoidance rules in these Regulations apply where persons not dealing at arm’s length with each other enter into transactions to obtain a tax benefit as a result of a change in the new harmonized value-added tax system and not primarily for bona fide purposes other than to obtain the tax benefit. In these circumstances, the Regulations allow the Minister of National Revenue to assess the participants in the transactions in order to deny the tax benefit. Generally, the aim of the harmonization anti avoidance rules is to prevent persons not dealing at arm’s length from attempting to avoid the HST simply to obtain a tax benefit and for no bona fide purpose.

Here are the HST anti-avoidance rules (which are long and difficult to read):

The anti-avoidance rules are:

34. This Part applies despite any provision of the Act.

35. If
(a) at any time before the harmonization date for a participating province, a supplier and a recipient enter into an agreement for a taxable supply of property or a service,
(b) the supplier and the recipient at a later time either directly or indirectly
(i) vary or alter the agreement for the supply,
or
(ii) terminate the agreement and enter into one or more new agreements with each other or with other persons and under one or more of those agreements the supplier supplies, and the recipient receives, one or more supplies that includes all or substantially all the property or service referred to in paragraph (a),
(c) the supplier, the recipient and, if applicable, the other persons are not dealing with each other at arm’s length at the time the agreement referred to in paragraph (a) is entered into or at the later time,
(d) tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply referred to in paragraph (a) would have been, in the absence of the variation, alteration or termination of the agreement, calculated at the tax rate for the participating province on all or part of the value of the consideration for the supply attributable to the property or service,
(e) tax under subsection 165(2) or section 218.1of the Act or Division IV.1 of Part IX of the Act in respect of the supply made under the varied or altered agreement or made under any of the new agreements, in the absence of this section, would not apply to, or would be calculated at a rate that is less than the tax rate for the participating province on, any part of the value of the consideration for the supply, attributable to any part of the property or service, on which tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply referred to in paragraph (a) would have been, in the absence of the variation, alteration or termination of the agreement, calculated at the tax rate for the participating province, and
(f) the variation or alteration of the agreement or the entering into of the new agreements may not reasonably be considered for both the supplier and the recipient to have been undertaken or arranged primarily for bona fide purposes other than to, directly or indirectly, reduce, avoid or defer tax or any other amount payable under Part IX of the Act or benefit in any manner from the participating province becoming a participating province, tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply made under the varied or altered agreement or made under any of the new agreements shall be calculated at the rate at which tax would have been calculated under paragraph (d) on any part of the value of the consideration, referred to in paragraph (e), attributable to any part of the property or service.

36. If
(a) at any time before the particular date on which a change in the tax rate for a participating province applies in respect of a taxable supply of property or a service, a supplier and a recipient enter into an agreement for a taxable supply of the property or service,
(b) the supplier and the recipient at a later time either directly or indirectly
(i) vary or alter the agreement for the supply,
or
(ii) terminate the agreement and enter into one or more new agreements with each other or with other persons and under one or more of those agreements the supplier supplies, and the recipient receives, one or more supplies that includes all or substantially all the property or service referred to in paragraph (a),
(c) the supplier, the recipient and, if applicable, the other persons are not dealing with each other at arm’s length at the time the agreement referred to in paragraph (a) is entered into or at the later time,
(d) tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply referred to in paragraph
(a) would have been, in the absence of the variation, alteration or termination of the agreement, calculated on all or part of the value of the consideration for the supply attributable to the property or service at the tax rate (in this section referred to as the “higher rate”) for the participating province that is the greater of
(i) the tax rate for the participating province that applies immediately before the particular date in respect of a taxable supply of the property or service, and
(ii) the tax rate for the participating province that applies on the particular date in respect of a taxable supply of the property or service,
(e) tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply made under the varied or altered agreement or made under any of the new agreements, in the absence of this section, would not apply to, or would be calculated at a rate that is less than the higher rate on, any part of the value of the consideration for the supply, attributable to any part of the property or service, on which tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply referred to in paragraph (a) would have been, in the absence of the variation, alteration or termination of the agreement, calculated at the higher rate, and
(f) the variation or alteration of the agreement or the entering into of the new agreements may not reasonably be considered for both the supplier and the recipient to have been undertaken or arranged primarily for bona fide purposes other than to, directly or indirectly, reduce, avoid or defer tax or any other amount payable under Part IX of the Act or benefit in any manner from the rate change, tax under subsection 165(2) or section 218.1 of the Act or Division IV.1 of Part IX of the Act in respect of the supply made under the varied or altered agreement or made under any of the new agreements shall be calculated at the rate at which tax would have been calculated under paragraph (d) on any part of the value of the consideration, referred to in paragraph (e), attributable to any part of the property or service.

37. (1) The following definitions apply in this section.

“harmonization event” means the transition by a province to the new harmonized value-added tax system or any change referred to in paragraph 277.1(3)(a) of the Act as “provincial tax policy flexibility”.

“person” does not include a consumer.

“tax benefit” means a reduction, an avoidance or a deferral of tax or other amount payable under Part IX of the Act or an increase in a refund or rebate of tax or other amount under that Part.

“transaction” has the same meaning as in subsection 274(1) of the Act.

(2) If
(a) a transaction, or a series of transactions, involving property is made between two or more persons, all of whom are not dealing with each other at arm’s length at the time any of those transactions are made,
(b) the transaction, any of the transactions in the series of transactions or the series of transactions would in the absence of this section result directly or indirectly in a tax benefit to one or more of the persons involved in the transaction or series of transactions, and
(c) it may not reasonably be considered that the transaction, or the series of transactions, has been undertaken or arranged primarily for bona fide purposes other than to obtain a tax benefit, arising from a harmonization event, for one or more of the persons involved in the transaction or series of transactions, the amount of tax, net tax, input tax credit, rebate or other amount payable by, or refundable to, any of those persons under Part IX of the Act, or any other amount that is relevant for the purposes of computing that amount, shall be determined as is reasonable in the circumstances in order to deny the tax benefit to any of those persons.

(3) A tax benefit shall only be denied under subsection (2) through an assessment, reassessment or additional assessment under Part IX of the Act.

(4) If, with respect to a transaction, a notice of assessment, reassessment or additional assessment involving the application of subsection (2) with respect to the transaction has been sent to a person, any person (other than a person to whom such a notice has been sent) is entitled, within 180 days after the day on which the notice was mailed, to request in writing that the Minister make an assessment, a reassessment or an additional assessment, applying subsection (2) with respect to that transaction.

(5) On receipt of a request by a person under subsection (4), the Minister shall, with all due dispatch, consider the request and, despite subsections 298(1) and (2) of the Act, assess, reassess or make an additional assessment under Part IX of the Act with respect to the person, except that the assessment, reassessment or additional assessment may be made only to the extent that it may reasonably be regarded as relating to the transaction referred to in subsection (4).