Inclusion of Royalties in the Customs Value of Transported Goods

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Aspects of including license payments in the customs value of intellectual property (IP) goods transported across the customs border have recently come to the fore. A number of litigations have revealed that there is no proper regulatory framework for these relations and that the same legal provisions of Russian legislation face different interpretations.

Royalties are fixed or contractually stipulated amounts for using IP paid periodically by the licensee to the licensor at agreed intervals.

In accordance with the provisions of the current customs legislation of the Russian Federation, payments for using IP assets are added to the transaction price if they:

a) concern goods subject to valuation, i.e., a fee for using copyright property or a license payment should relate directly to the imported goods, since these goods imply use of a brand or copyright;

b) constitute a condition for the sale and purchase transaction concluded between the seller and the buyer, i.e., purchase of the goods should include payment for using IP incorporated in these goods. In order to receive the goods, the buyer has to make the license payment.

The basic rule is that payment of royalties is made as a condition for selling imported goods.

At the same time, in certain cases when goods incorporating IP requiring payment of royalties are imported into Russia, such payments are not subject to inclusion in the customs value.

A litigation example: the claimant (licensee) entered into a license agreement with a foreign company (licensor). The subject of the agreement was the granting of rights to distribute films, in exchange for which the licensee undertook to pay part of its distribution revenues to the licensor as royalties.

Under the license agreement, a film tape was temporarily imported into Russia. The customs disagreed with the declared customs value, made adjustments by including royalties in it and demanded that additional customs payments be made on the basis of the adjusted customs value.

Having analyzed the situation, we understand that a film, which is an IP asset, was treated, in terms of legal status, as merchandise, which is inconsistent with the current legislation. As the court noted, royalties cannot be determined as of the customs clearance date, since it is impossible to predict the revenues the film will generate, while once the film distribution is over, if a decision to make adjustments is taken, the royalties would have to be calculated precisely on the basis of the executed customs freight declarations corresponding to the number of film copies imported.

Our analysis of the situation also shows that importation of a film tape does not meet the criteria for including royalties in customs value: royalties do not relate to the imported tape; the tape was not imported for sale; royalties are subject to payment for using a copyrightable item, i.e., actually for provision of film distribution services.

A list of items in respect of which civil rights may be exercised is given in article 128 of the Russian Civil Code. Article 11 of the Customs Code understands merchandise as any movable property transported across the customs border. Under article 26.2 of Federal Law No. 164-FZ, dated December 8, 2003, merchandise also includes cross-border transaction items, in particular, movable property. Intellectual products are neither property nor merchandise.

In the case at hand, the subject of the agreement is the right to provide services to distribute a film resulting from intellectual activities and, since a film is an IP asset, it is not merchandise. Given, also, that the criteria for including royalties in customs value are not met, the royalties should not be included in the customs value of the tape.

In addition, Russian Government Resolution No. 1264, dated October 17, 1994, states that public demonstration of films, i.e., demonstration of movies or feature films by cinemas constitutes a film and video service. Film distribution, as well as demonstration of film and video materials through mass media (satellite, cable TV, etc.), is the rendering of a service.

In other countries, this issue is given much attention. In particular, in the United States and the EU countries, the question of whether or not royalties should be included in customs value is dealt with on a case-by-case basis. Moreover, the legislation contains clear criteria for determining whether inclusion of such payments in customs value will be justified.

The method used predominantly is valuation of the goods by reference to the transaction price as "the price actually paid or subject to payment for the goods exported for sale in the U.S.", plus amounts charged over and above the price actually paid or subject to payment in accordance with the law. The question of whether royalties should be included in customs value is answered on a case-by-case basis and the answer depends ultimately on whether: (i) the buyer was supposed to pay them as a condition for exporting imported goods for sale in the U.S.; and (ii) to whom and under what circumstances they were paid.

For instance, if the buyer makes a payment to a third party for the right to use, in the U.S., a brand relating to imported goods and such payment was not a condition for exporting the goods for sale in the U.S., such payments will not be included in the price actually paid or subject to payment.

In principle, the US legal provisions are essentially similar to those for including royalties in customs value provided for by the Russian Law on Customs Tariffs, although in the US, unlike in Russia, these provisions are duly enforced.

As things stand now, Russian companies engaged in cross-border operations not only incur significant and unjustified losses, but also find themselves involved in protracted litigations that put their business reputation in jeopardy. When importing goods incorporating IP for which license payments are due, importers are required to pay import VAT, which they transfer to the government once again when making license payments to the IP owners. When goods that have an identical legal status are exported, such an operation is treated as provision of services and the exporter is prevented from deducting VAT by the tax legislation.

The lack of a common understanding of this issue is due to ambiguity in law enforcement and absence of explanations and practical comments on the legislation.

In order to ensure that the provisions of the Law on Customs Tariffs are consistently and legitimately enforced on the basis of fairness and an unambiguous literal interpretation of the rules of law, it is essential that legislators work through the conditions for including license payments in customs value and provide detailed criteria for determining whether their inclusion in customs value is justified and necessary.

Finding a solution to this issue is crucial for restoring the balance between the rights and legitimate interests of the business community and the state with respect to budget revenues, since today there seems to be a trend of legal provisions interpretation in favor of the authorities.