GuruSpeak: Customs treatment of royalties becomes a little clearer

This article appeared in the February 14, 2012 issue of the The Nation .

Source: The Nation Website (Eng)

By  Paul Sumner


The appropriate customs duty treatment of royalties has always been a challenge. There are many reasons why companies pay royalties - for example for patented products, trademarks, copyright and access to technology and know-how. Royalties need to be added to the customs value if they related to the imported goods and are paid as a condition of sale of those goods. Royalties are a main focus area for Customs audits in Thailand, and hundreds of millions of baht are collected every year in back duties and penalties.

The first criterion is relatively objective, as it is possible to determine if the imported goods contain any intellectual property (although disputes with Customs on this issue are still common). The second criterion is more subjective, and it can be very difficult to prove that the royalty is not a condition of sale. The Technical Committee on Customs Valuation of the World Customs Organisation (WCO) meets twice a year, each time for a week, to discuss issues such as royalties. Even though it is more than 30 years since the current Customs laws were written, there is still debate about the correct Customs treatment of royalties. The WCO wanted to adopt some case studies that would provide clear guidance, but found it was very difficult to reach a consensus, so instead a two page Commentary was released on royalties paid to third parties.

It gives examples of when a royalty may be a condition of sale, but it is not an exhaustive list, and so Customs administrations can still argue that other factors prove that the condition of sale test is met.

A recent Supreme Court case on third party royalties was won by the plaintiff, as the Court determined that third party royalties do not need to be added to the Customs value of the imported goods in the commercial circumstances of the case. One of the critical factors is the level of control the Intellectual Property holder has over the manufacturer. The Supreme Court decided that the circumstances were similar to WCO Advisory Opinion 4.8, in that the licence holder has no direct control over the seller of the goods, and the sales contract does not contain a requirement for the importer to pay the royalty. Therefore although the royalty is related to the imported goods (the trademark was affixed at the time of importation), it is not a condition of sale of the goods.

There are a number of other third party royalty cases where Thai Customs has previously determined that the royalty is dutiable, and therefore the licence holder has control over the sale of the goods. There are some clear-cut cases where the licence holder has a lot of influence over the manufacturer, and can prevent the manufacturer selling the licensed goods if the royalty is not paid.

However, many cases are not clear cut, and fall into the grey area of "how much influence creates a condition of sale?". The examples in the WCO Commentary refer to explicit documentary evidence of control, such as if the contract of sale mentions the royalty. The control can also be implicit. The European Union has published guidance (EU Commentary 11) that provides a list of 14 evidential criteria of control that may occur in practice. This includes the licensor selecting the manufacturer, restricting the quantity of goods that can be manufactured, or being able to examine the records of either the manufacturer or the buyer. Whilst this list is helpful, there is no attempt to highlight which are the more important examples, or how many examples need to be met before the control condition is met.

It is inevitable that royalties will continue to be a major area of contention between Customs and importers, and even between different Customs administrations. The typical reaction of most Customs officers, particularly in audit or investigation, is to argue that most royalties are dutiable. However, cases such as the Supreme Court ruling give greater guidance to importers and Customs advisers. It also gives importers more confidence to challenge Customs rulings in the courts.

It would be helpful if Thai Customs started a precedent system of rulings already made, to give even more guidance. Systems such as CROSS (Customs Ruling Online Search System) in the US have a wealth of precedent information (some of it seemingly contradictory!), and it is a great resource. However, the most important issue will always be the precise circumstances of each case, and no amount of guidance and precedent will ever be able to cover every situation. Duty assessments of royalties can never be automated, and importers should review any royalty now, regardless of whether duty is being paid already or if it is still undiscovered by Thai Customs.

Paul Sumner is a partner at Worldtrade Management Services at PwC Thailand. He can be reached at