Be aware on the issue of customs royalties

recently, in practice, the author has encountered many import and export enterprises being inspected by customs authorities and requested to pay the overdue duty and value-added tax on royalty. After receiving the inspection notice, the enterprises are often unable to understand why customs is in charge of the assessment of taxes on imported and exported goods, and why it checks the expenses paid under non-trade items and requests them to pay overdue taxes.

They are also unable to understand why customs authorities can impose administrative penalties on the enterprise. In order to make enterprises fully aware of customs royalties and avoid similar legal risks, the author summarizes some key points, common problems and coping strategies.

Customs examines and approves the prices in the import and export links mainly in accordance with the Measures of the Customs of the People’s Republic of China for the Determination of the Customs Value of Imported and Exported Goods. Although customs can only collect taxes on tangible goods, the customs value is usually calculated based on the transaction price declared by the import enterprise.

However, if the import enterprise pays the royalties related to the imported goods to the exporter or its affiliates directly or indirectly, customs may impose additional taxes related to royalties on tangible goods.

The contents of common taxable royalties overlap with the concept of intellectual property rights that we usually understand, but there are differences, mainly including the fees used to pay for: (1) patent right or know-how use right; (2) trademark right; (3) copyright; and (4) distribution right, sales right or other similar rights.

Taxation type

Royalties must be correlated to imported goods, and the payment of royalties should constitute a necessary condition for the goods to be sold in China, that is, the buyer cannot purchase imported goods without paying royalties, or the goods cannot be sold under the conditions agreed in the contract if the buyer does not pay royalties.

When determining the correlation between royalties and imported goods, the following criteria for determining royalties are different:

Patent right or know-how use right: (1) the goods containing patent or know-how at the time of import; (2) the goods produced with patented method or know-how; and (3) the goods specially designed or manufactured for the implementation of patent or know-how.

Trademark: (1) the goods originally attached with trademarks; (2) the goods that can be sold directly with a trademark attached after they are imported; and (3) the goods that contain trademark rights at the time of import, and can be sold after being lightly processed and attached with trademarks.

Copyright: (1) imported goods containing software, text, music, pictures, images or other similar contents including magnetic tapes, magnetic disks, optical disks or other similar carriers; and (2) imported goods containing other copyrighted contents.

Distribution right, sales right or other similar rights: (1) the goods that can be sold directly after import; and (2) the goods that can be sold after light processing.

In practice, sometimes royalties are not necessarily paid directly to overseas sellers, and even if they are paid indirectly, there will be taxes imposed on them.

Matters in declaration

In accordance with Announcement No. 58 [2019] of the General Administration of Customs, enterprises shall fill in whether there are taxable royalties in the column of “Confirmation of payment of royalties” when declaring imports. However, many enterprises don’t know what royalties are, and their tax standards, so they fill in “no” or just don’t fill in the column when making their declaration.

In this regard, the announcement provides that where any tax is underpaid or unpaid due to a taxpayer’s failure to fill in the column of “Confirmation of payment of royalties” in accordance with the regulations, customs may, during the period from the date when taxes are paid, or goods are released, to the date when customs discovers the violation of provisions, impose a late payment penalty at 0.5% of the amount of underpaid or unpaid tax per day.

In addition, in accordance with the Regulations on the Implementation of Customs Administrative Penalties, if an enterprise is to pay overdue royalties, the above-mentioned behaviour of filling in “no”, or not filling in at all, may also be regarded as the enterprise’s false declaration, and customs may impose on the enterprise a fine at 30% or up to twice the unpaid tax.

Coping strategies

Enterprises should strengthen the study of customs laws and regulations, and understand and master the legal system of customs valuation. When setting prices and royalties between buyers and sellers, or when setting transfer pricing strategies within a multinational group, it is necessary to introduce third-party professional institutions to issue legal opinions based on the provisions of customs valuation and determination of prices.

If the enterprise has implemented a pricing strategy, it should actively carry out self-inspection, voluntarily disclose problems to customs with the assistance of a third-party professional institution, and make timely payment of tax.

Even in the event of inspection by customs, an enterprise should not panic, but should actively seek the help of professional lawyers to get accurate guidance and risk judgment at the first instance, and make more effective communication plans and coping strategies accordingly. In the author’s practical experience, there are legal claims in many cases that can avoid paying overdue tax to customs.

Pan Jia is an associate at Dentons