As a result of a comprehensive review and clarification of the interpretation of when royalties and licence fees become subject to customs duty, HM Customs and Revenue are now focussing in on this area and importers are likely to see significant additional import and retrospective customs duty demands.
In this article we look at:
- Why are royalty payments and licence fees added?
- Why is this now so important?
- Whether you are likely to be affected?
- What you can do about it
Why are royalty payments and licence fees added?
Most importers are familiar with the fact that their tangible imports are subject to customs duties. The ephemeral nature of intellectual property leads many businesses to think that royalties and licence fees are outside of the scope of customs duties, a mistake that could prove very costly in the future.
Most imports are valued according to:
“…the price actually paid or payable for the goods when sold for export to the European Community, subject to adjustments under Articles 32 & 33 of the Customs Code…”
Article 32(1)(c)of the Customs Code requires you to add certain royalties and licence fee payments to the customs value.
Why it this important now?
The customs rules on intellectual property rights are complex and both the customs authorities and importers have shied away from this matter in the past. In fact, this area of law was left to the very end of the General Agreement on Tariff and Trade (GATT) valuation negotiations because of its controversial and complex nature.
However, a recent EC Customs Code Committee paper has attempted to clarify the legal position of when such payments are due and has focussed attention on this issue. Unfortunately from the business community’s point of view, the report advocates a much wider interpretation of the charging clauses than previously so. The scope for collecting duties has therefore increased as the customs authorities have greater direction in and understanding of this area of law. Subsequently this is now a high-profile issue in contemporary Customs law and practice.
What is its impact?
In the modern “Information Age” the value of intangible goods often exceeds the value of tangible goods. The importance of protecting and capturing the value of brands through trademarks for example, has led to an increase in the number and value of rights covered by royalty and licence agreements.
This disparity can be seen in the everyday example of the cost of a T-shirt from Primark compared to an Armani T-shirt. It is hard to argue that the difference in price is purely down to the quality of the materials and workmanship!
The risks of having royalty fees and licence fees added to the customs value are significant. It is common to see royalty’s payable on 10% of sales values. However, given that gross margins on t-shirts are often in the region of 50%, this would equate to an increase of 20% to your duty costs.
Furthermore, if your royalty or trademark agreement is brought within the charge to duty then the tax authorities have the power to retrospectively recoup up to three years of previous underpayments. These one-off demands will put significant pressure on your cash-flow and weaken your balance sheet.
Are you affected?
The customs duty charging provisions for royalties and licence fees are set out in Article 32(1)(c) of the Customs Code. In order for any intellectual property right to be subject to customs duty it must:
- Fall within the meaning of royalty of licence fee
- Relate to the imported goods
- Be a condition of sale of the imported goods
The term royalty and licence fee is not defined in the Customs Code but has a wide meaning and includes patents, trade-marks, technical know-how and copyright. (For a general definition see Article 12(2) of the OECD Model Double Taxation Convention Income and Capital (1977).
The intellectual property rights may be related: (a) in part to the imported goods (for example, where components are imported for incorporation into finished articles which are themselves subject to intellectual property rights), (b) to all of the imported goods if sold on in the same state and subject to intellectual property, or © not be related to imported goods at all (i.e. relating to intangibles or locally sourced goods). This point is often self- evident.
Most arguments and disputes centre on whether the royalty or licence fees are a condition of sale of the imported goods. Customs Code Committee Commentary No.11 focuses on this issue and states:
“…Even if the actual sales contract between the buyer and seller does not explicitly require the buyer to make the royalty payments, the payment could be an implicit condition of the sale if the buyer was not able to buy the goods from the seller and the seller would not be prepared to sell the goods to the buyer without the buyer paying the royalty fee to the licence holder…”
The paper goes on to say that when royalties are paid to a party which exercises direct or indirect control over the manufacturer (essentially anything that goes beyond purely quality control checks by the licensor) then such payments are regarded as a condition of sale.
What Can You Do About It
Tax planning usually involves looking at the conditions that must be met for a tax charge and then legitimately arranging your affairs in such a way as to ensure one of those conditions is not met.
There are a number of steps businesses can take to minimise the risk or exclude royalty and licence fees from the customs value.
“Prior sale planning” allows you to use an earlier sale in the supply chain as the basis for customs valuation if certain conditions are met. If this earlier sale takes place without any royalty or licence fees becoming payable then such costs can be excluded. Prior sale also strips out any intermediaries profits from a charge to customs duty and can produce significant cost savings.
Restructuring of licence agreements can often result in such payments falling outside the scope for duty. Many agreements bundle up a number of intellectual property rights and set out various scenarios of when payments must be made. It is common for some of these rights to be dutiable but when structured in this way it is difficult to attribute an acceptable value to the dutiable item. Businesses may then run the risk of all payments under such agreements being subject to duty.
International Trade Solutions can work with you to review current or proposed royalty arrangements, comment on whether they are subject to duty and where appropriate, help you arrange your customs affairs to reduce or exclude these payments from duty.