Royalties: A Common Source of Problems in Customs Valuation

The dutiable value of imported goods is the basis on which the Customs assesses tariffs and other taxes linked to imports, and firms usually submit to Customs dutiable values based on the invoices they receive. This manner of reporting does not lead to very big problems when the transaction model is relatively simple. But for more complex transactions (such as those where other funds or goods change hands in addition to the payment made for the goods themselves), there is a risk of underreporting the dutiable value. Once a firm is found to have underreported, it will have to pay heavy fines on top of the duties it owes.

All WTO members must abide by the "Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade of 1994", (now known as the WTO Agreement on Customs Valuation) in how they treat the valuation of imported goods, and they have to incorporate its contents in their domestic laws and regulations. Article 8 of the Agreement requires that certain expenses must be added to dutiable value if they were not part of the purchase price, and equivalent language is in Article 29 of Taiwan's "Customs Act" and Article 11 of Mainland China's "Measures of the Customs of the People's Republic of China for the Assessment of Dutiable Value of Import and Export Goods". Neglecting to report these expenses is a common reason why firms underreport dutiable value.

One expense item that is particularly easy for firms to overlook is royalties. According to the relevant regulations, royalty payments made by an importer must be included in the dutiable value under two conditions: (a) the payments are in connection with the imported goods; or (b) the payment of the royalties is a condition for the sale and export of the goods to the importing country. Royalties here include money paid for the use of patents, copyrights and trademarks. However, expenses paid for the right to domestically reproduce an imported good are not included in dutiable value.

Firms neglect to report royalties for several reasons: They may have a lack of knowledge about customs duty assessment or there may be insufficient internal communication. Royalty payment amounts are generally not shown on invoices for goods, so internal staff or external customs brokers tasked with reporting to the Customs may be unaware of the transaction details. Royalty payments are usually handled by business and accounting departments, which are often unfamiliar with the customs reporting rules. And some people in financial accounting even think it is not necessary to pay customs duties because income tax is withheld when overseas royalties are paid. However, that is not the case.

When considering whether to include royalties in dutiable value, it helps to be clear about a few concepts. First, even if the royalty payment is not made to the seller of the goods, it is still possible that it needs to be included in dutiable value. Second, royalties may need to be included irrespective of whether the payment is made to a domestic rights holder (i.e., one in the importing country) or a foreign rights holder. Finally, the object of paying the royalties can bear importantly on whether they need to be included in dutiable value. For instance, where royalties are paid in connection with a patent on an imported good's production methods or the goods themselves, they usually need to be included in dutiable value, but where royalties are paid for the trademark on imported goods, there is more room for discretion since the actual use of the trademark is inside the importing country.

In terms of the two conditions mentioned above for including royalty payments in dutiable value, it is easy enough to distinguish those that are "related to the imported goods". Somewhat more contentious are those that are "a condition for the sale" of the goods, since this must be inferred from the overall structure of the transaction. Also, customs authorities around the world have different rules on what constitutes a condition for sale. Take trademarks, for example: The US Customs' position is that, if the holder of the trademark (the party receiving the royalties) is not the seller of the goods or its related party, and there is no other evidence that the trademark holder can control the transaction between buyer and seller, then it can accept that the payment of royalties is not a condition for the sale. Many customs authorities in Asia (including those in Mainland China, Taiwan and Thailand) have stricter rules, where even if there is no connection between the holder of the rights and the seller of the goods, there is a strong tendency to assume some influence on the part of the patent or trademark holder, so royalty payments are viewed as a condition of sale.

When enterprises undertake international tax planning, they often view royalties as a tool for transferring funds and repatriating profits, neglecting the customs duty considerations. This can result in higher-than-expected overall tax burdens or even stiff fines. Thus, companies planning to make royalty payments should make sure they consider whether those payments will have to be included in dutiable value calculations, or if it is not possible to adjust the transaction structure so that the payments can be legally excluded. If there are unresolvable doubts, it is important that companies communicate with the Customs or seek an official interpretation of the regulations.