To include or not to include, that is the question: whether royalties for manufacturing know-how should be included in the customs value of imported goods

On 15 March 2023, the cassation court in the second round of adjudication on case No. A70−785/2021 upheld an importer’s claims that a customs authority had acted wrongly in ordering royalties paid for know-how for the manufacture of a finished product to be included in the customs value of imported equipment used in building a process line for the manufacture of that product.

The dispute has been going on for a little over two years. Initially, the trial and appellate courts rejected the importer’s claims. In the second round of adjudication all three court instances upheld the importer’s claims in full.

We believe that the cassation court’s ruling contains a number of important conclusions and positions which will be relevant to similar disputes over whether royalties should be included in the customs value of imported goods. Below, therefore, we present a detailed summary of the circumstances of the case and the factors that contributed to the favourable resolution of the dispute.

Facts of the case

According to the case file, the importer, a large hydrocarbon processing enterprise, imported various types of equipment ("Equipment") into Russia in order to build plants ("Plants") for the manufacture of chemicals ("Finished Products").

A Plant consists of multiple process lines, some of which are used to carry out a licensed manufacturing process, the others to carry out non-licensed auxiliary processes.

The Equipment was imported under a foreign trade agreement on the design, construction and supply of materials and equipment for the Plants. According to the preamble to the agreement, it was concluded on the basis of patented licences received under licensing agreements with an entity other than the seller of the Equipment.

The licensing agreements give the importer (the licensee) the right to use know-how for the manufacture of Finished Products on the Plants and the right to use know-how information for the creation of Plants, including the acquisition of Equipment needed to build them from any suppliers.

In this respect, the licensing agreements provide that the licensor’s know-how covers several types of equipment which constitute components of the licensed part of a Plant.

The foreign supplier supplied Equipment for both the licensed and auxiliary parts of the Plants. However, the supplier’s scope of work did not cover construction and maintenance of the licensed part of the Plants, and Equipment supplied by it for the licensed part of a Plant was not used directly in carrying out the licensed manufacturing process.

Following an inspection, the customs authority concluded that the know-how royalties must be included in the customs value of the Equipment by reason of the following factors:

• The Equipment is specifically designed for the implementation of the know-how, i.e., for the manufacture of Finished Products on a Plant, and therefore the Equipment has no consumer value without the licences.
• The supplier sells the Equipment exclusively for the purposes of the implementation of the know-how on a Plant.
• The supplier does not have the right to sell the Equipment without paying royalties since the foreign trade contract is directly linked to the licensing agreements.

The court’s decision

The three court instances concluded that there was no need for royalties for know-how relating to the manufacture of the licensed Finished Product on a licensed Plant to be included in the customs value of the Equipment from which that Plant was assembled by reason of the following:

1. The royalties do not relate to the imported Equipment:

• The imported Equipment was not designed under the licences and is not mentioned in the licensing agreements.
• The Equipment is not specialised and designed exclusively for building a Plant and manufacturing Finished Products on it using the know-how.
• The Equipment and materials for the Plants were acquired from various suppliers, including domestic manufacturers.

2. The payment of royalties is not a condition of the sale of the Equipment by the foreign supplier:

• The licensing agreements do not state that sellers from the countries of consignment (Poland, Germany, France, et al.) are prohibited from selling (manufacturing) the goods at issue if royalties are not paid.
• The licensor has no legal leverage over sellers from the countries of consignment since the territorial extent of the licences does not include the countries of consignment of the goods at issue.

3. Adding royalties to the customs value of the Equipment is unreasonable since it is impossible to quantify precisely the ratio and (or) economic value of the know-how for this purpose:

• The Plants were built out of imported and Russian goods, besides which further expenses were incurred to engage independent contractors for the construction work itself.
• The ratio of the cost of the imported Equipment to the cost of Finished Products, sales of which form the basis for the royalty amount, is 35%, i.e., a small proportion.

Outlook

We hope that the decision on this case will influence the course of future case law on disputes relating to customs value and over whether payments for the use of manufacturing know-how should be included in customs value.

In the case described, rulings made by the courts right up to the second round of adjudication of the case by the cassation court contained no references to or conclusions regarding circumstances that were directly relevant to the resolution of the dispute.

However, there is no reason to believe that those facts and circumstances were presented only in the second round of adjudication and only to the cassation court.

This highlights more clearly than ever the importance of the thorough and professional preparation of a legal position and the effective presentation of that position in court.