Development of case law concerning the inclusion of royalties in the customs value of imported packaging

3 August 2022
Tax Messenger
On 20 July 2022 the Ninth Arbitration Appeal Court adopted a ruling on case No. A40−281 305/2021, which concerned a dispute over whether amounts of royalties for the right to use trademarks, processes and know-how should be included in the customs value of imported goods.

The ruling overturned the decision of the trial court and fully upheld the importer’s claim for a refund of overpaid customs payments and penalties.
Facts of the case

A Russian importer ("the Importer") imported packaging materials bearing trademarks ("Packaging") into the territory of the EAEU for use in packaging confectionery products in Russia. The Packaging was manufactured outside the EAEU and was not sold separately in Russia.

The Importer was also a party to several licensing agreements under which it was granted exclusive rights to use particular trademarks, processes and know-how in manufacturing and selling confectionery products in the territory of Russia. However, the trademarks provided for in the licence agreements were not registered in relation to the Packaging.
The Importer did not include amounts of royalties for the right to use intellectual property in the customs value of imported Packaging.

After carrying out an in-house customs audit, the customs authorities decided that royalties should be included in the customs value of the Packaging.

Believing that the payment notices served on it were unlawful and that it should be refunded for overpaid customs payments and penalties, the Importer filed an arbitration appeal. The trial court rejected the Importer’s claims.

However, the appellate court upheld the Importer’s claims in full. The position taken by the court is set out in detail below.
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The court’s position

The appellate court took the Importer’s side, basing its decision on the following arguments:

The royalties do not relate to the imported Packaging:
a) The Importer does not manufacture Packaging in Russia or sell it separately from confectionery products, i.e., the Packaging is not a separate product for the Importer.
b) The goods covered by the licensing agreements are confectionery products bearing the trademarks in question, not the imported Packaging. The trademarks do not relate to the Packaging. The trial court incorrectly interpreted the subject of the licensing agreement.
c) The licensing agreements do not require the approval of or consultation with the licensors for the use of a particular brand, model or item of packaging or packaging that is manufactured or sold by particular persons.

The payment of royalties by the Importer is not a condition of sale of the Packaging in order for it to be exported to Russia:
a) The foreign manufacturers of the Packaging are not parties to the licensing agreements.
b) The provisions of the licensing agreements and foreign trade agreements do not indicate any control on the part of the licensors over the manufacture or sale of the Packaging beyond quality control:
  • The territorial scope of the licence is limited to Russia and CIS countries (i.e., control over production can only be exercised in those states), while the Packaging is produced in other states, making it impossible for the licensor to exercise any control over the production of the Packaging.
  • The Importer is free to choose the brand, model, item, manufacturer and supplier of the Packaging independently based on parameters for the Packaging which have been agreed upon with the rights holder and which relate exclusively to quality control of the finished products (confectionery). It is interesting to note the court’s opinion that agreeing on the parameters of the Packaging does not go beyond the scope of quality control.
  • The licensors do not and cannot exert any influence or pressure in relation to transactions entered into by the Importer to purchase the Packaging (including the terms of purchase, prices, basic parameters, etc.). The Importer provided a letter from the licensor confirming that this was the case.
c) The supply contracts and licensing agreements do not contain provisions requiring the payment of royalties for the Packaging. The licence agreements relate to other products, and specifically confectionery and toys produced in Russia.

It is also worth mentioning that the court cites the Explanatory Notes to paragraph 3 of Article 8 of the Agreement on the Implementation of Article VII of GATT 1994, which state that, "if the royalty is based partially on the imported goods and partially on other factors which have nothing to do with the imported goods (such as when the imported goods are mixed with domestic ingredients and are no longer separately identifiable, or when the royalty cannot be distinguished from special financial arrangements between the buyer and the seller), it would be inappropriate to attempt to make an addition for the royalty".

In particular, the court observed that royalties could not be added to the structure of the customs value by reason of the following considerations:
  • The Packaging is sold exclusively with finished confectionery products manufactured in Russia.
  • The royalties are paid specifically in connection with the sale of finished products (i.e., they are dependent on sales of finished products).
  • There are no separately identifiable royalties for the imported Packaging.
  • The customs authorities failed to specify an amount of royalties that could be lawfully calculated specifically for the Packaging separately from the finished products.
Current trends

The fact that the customs authorities improperly interpreted the subject of the agreement and the trial court rejected the Company’s claims shows the importance of taking a clear and thorough approach in formulating the provisions of licensing and foreign trade agreements (particularly with regard to the subject of the agreement, the limits of rights conferred, the licensor’s control over the licensee and other provisions that may be of key relevance to the customs authorities’ conclusion on whether the criteria for including royalties in customs value are met).

Given the constant changes in administrative practice in relation to licensing arrangements, which currently tends to be unfavourable to companies involved in foreign trade, as well as judicial case law, we consider it essential for companies to keep track of trends and adjust their licensing arrangements from time to time to reflect changing realities in the customs environment.

It is well known that the customs authorities currently pay particular attention to matters of whether royalties for the use of trademarks and other intellectual property (manufacturing / organisational / marketing know-how, patents, inventions, business names, software, et al.) should be included in the customs value of imported goods.

Nevertheless, the question of whether royalties should be included in customs value has to be dealt with on a case-by-case basis, and we therefore advise companies to consider in detail whether royalty payments relate to imported goods, and if necessary to prepare a legal position demonstrating that the payments should not be included in the customs value of imported goods. We recommend providing that legal position at the inspection stage (i.e., together with the response to the customs authorities’ first inquiry / request).
How we can help

  • Assessing whether royalties and other intra-group payments should be included in customs value and related risks.
  • Formulating recommendations on modifying the provisions of licensing and other intra-group agreements to minimise adverse legal consequences.
  • Preparing a legal position to support the non-inclusion of royalties and other intra-group payments in the customs value of goods.
  • Developing approaches to the inclusion of royalties and other intra-group payments in the structure of customs value (including analysing whether the mechanism of deferred determination of customs value could be applied).
  • Providing support with the inclusion of royalties in customs value (including the preparation of amendments to goods declarations).
  • Full or partial support during customs inspections on the matter of the inclusion of royalties in customs value.
  • Representing your company’s interests in the pre-litigation and litigation stages of appealing against decisions of customs authorities.

Authors:
Inna Elisanova
Director
Global trade and Customs
Alexandra Gorokhova
Senior
Global trade and Customs
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