“Are your royalty payments dutiable?” by Mark Anthony P. Tamayo (December 13, 2010)
SUITS THE C-SUITE By Mark Anthony P. Tamayo
Business World (12/13/2010)
Under the current import valuation (Transaction Value System) rule enshrined under Republic Act (RA) Nos. 8181 and 9135, royalty payments made by importers to their foreign suppliers may not only be subject to final withholding tax and value-added tax (VAT), but they may also be subject to customs duties. This is due to the Transaction Value (TV) system, which became effective on Jan. 1, 2000. Various customs issues have then arisen, particularly on how to properly value imported goods for duty purposes.
Traditionally, importers would compute the customs duty of their imported goods based on the amount appearing on the commercial invoice. This, however, is not necessarily correct under the TV system which looks primarily at the price agreed upon between the buyer and the seller and essentially captures all payments related to the imported goods. Thus, the transaction value is not necessarily equal to the invoice value, unless the invoice reflects all the dutiable adjustments.
The Bureau of Customs (BoC) is closely scrutinizing adjustments such as royalty (and license fee) payments (for intangibles rights such as, patent, trademark or copyright) made by importers to their foreign suppliers.
Royalty payments are dutiable when:
• They are related to the goods being valued (Relationship Test);
• Paid by the buyer, directly or indirectly, to the seller (Payment Test); and
• The payment is a condition for the sale of imported goods (Condition Test).
In applying this test, there must be a careful examination of what exactly the royalty is being paid for. Hence, there is a need to analyze the relationship between the royalty payments and the imported goods. The most essential point in assessing this relationship is whether the importer could have purchased the tangible goods without the purchase of the intangible rights. If there is no connection, then the two should be considered unrelated and thus, not part of the transaction value.
The payment test determines whether the royalty fees were directly or indirectly paid by the buyer to the seller. This is relevant because adjustments to the transaction value due to royalty payments are made to the extent that they are actually paid or payable to the supplier. Hence, in order to be dutiable, the requirement that the royalties must be paid directly or indirectly to the seller presupposes that such payment ultimately redounded to the benefit of the seller. Without such benefit, any royalty payment should not be considered as part of the transaction value, and therefore, not dutiable.
Notably, when a buyer makes a payment to a party related to the seller, there arises a presumption that the payments are part of the price actually paid or payable to the seller. Such presumption may, however, be overturned through the presentation of contrary evidence.
Generally, the clause that “the buyer must pay (the royalty) as a condition of sale” can most appropriately be interpreted to refer to the separability or inseparability of the purchase of the imported goods from the payment of the royalty for the rights. This factor of separability may depend on, among others, technological facts, methods of doing business, or the terms of the contract between the parties. The mere fact that the payment of the royalty is a term of the contract between the parties does not mean that payment of the royalty is a condition of the sale if the buyer genuinely had a choice whether to take the goods with or without the rights. Thus, the question is whether the purchase could have been made without the royalty.
The above tests must be satisfied separately. The absence of any one of these conditions should result in the non-dutiability of the royalty payment.
The BoC remains under pressure to increase revenue levels even further. During post-entry audits, the Post-Entry Audit Group (PEAG) of the BoC usually includes royalty payments made by importers as a definite target area with the end goal of assessing (and collecting) deficiency duties and taxes. Given this situation, importers are advised to take a proactive stance and should undergo self-evaluation of their level of compliance with, among others, valuation rules.
Under Customs Administrative Order (CAO) 4-2004, importers are required to pay additional duties pertaining to royalties within 45 days from the date of importation or 45 days from the time payment was made. Failure to pay such additional duties may, during a BoC post-entry audit, unreasonably expose an importer to an administrative fine to as much as eight times of the revenue loss. This penalty, however, may be waived if qualified importers avail of the Voluntary Disclosure Program (VDP) of the BoC under CAO No. 5-2007. It should be noted, however, that if there are arguments that can be put forward to justify the non-dutiability of royalty payments, it is worthwhile for importers to contest this issue if challenged by the BoC.
(As of publication, Mark Anthony P. Tamayo is a tax partner and indirect tax practice head of SGV & Co.)
This article was originally published in the BusinessWorld newspaper. It is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinion expressed above are those of the author and do not necessarily represent the views of SGV & Co.