Let’s Talk Tax
By John Paulo D. Garcia
The royalties that you pay relating to the goods that you import may be subject to Customs duties as part of the dutiable value of the importation. Have you made this evaluation? Are you paying duties on those dutiable royalties? Is there a risk that this will be uncovered during a customs audit?
When goods are imported, the dutiable value is determined by the importers themselves based on their assessment. Following the Transaction Value Method of determining the dutiable value prescribed under Customs Administrative Order (CAO) 04-2004, the dutiable value for an imported article is the price paid or payable for the goods, when sold for export to the Philippines after considering several adjustments.
One of these adjustments is royalties and license fees being paid to the seller related to the goods being valued.
Royalties or license fees are normally paid by importers to the offshore supplier for the use of certain intellectual property rights on the imported products. More often than not, royalties, even if they qualify as an adjustment to the transaction value, are not usually declared by the importers as part of dutiable value upon importation mainly because they are being paid or remitted after the importation is completed. Usually, the royalty to be paid is determinable only after the subsequent sale of the imported goods.
However, not all royalties qualify as adjustments. Royalties are only considered dutiable when all of the three conditions are met.
First, royalties or license fees should be related to the imported goods being valued. One example is when the royalties paid are for trademark, copyright or other intellectual property rights that are necessary for the marketing or distribution of imported goods. Also, royalties are related to imported goods when the royalty is computed based on the sale of licensed products.
The second condition is that the royalties and license fees should be paid by the importer, directly or indirectly, to the offshore seller. This requirement is quite simple. To be dutiable, the royalties paid should ultimately accrue to the benefit of the seller.
Finally, the payment of royalties and license fees should be a condition of the sale of the goods to the importer. The importer cannot purchase the goods without paying the royalty. If a buyer imports a product under a specific trademark and has to pay royalties to the offshore seller, without which the licensed product cannot be purchased then subsequently sold in the Philippines under that specific trademark, then the payment of royalties is considered a condition of sale.
All the above conditions must be met; otherwise, there is room to argue that the royalties should not be dutiable.
Now, some of you may wonder how will the royalty be declared as a component of dutiable value when the actual royalty is determined and remitted to the seller only after the importation is complete. As provided under CAO 04-2004, the importer must declare the adjustments to transaction value in regard to royalties and accordingly pay the additional duties within 45 days from the time of payment of the royalties. However, under CAO 01-2019, it was provided that Customs duties on royalties should be paid within 30 days from the date of payment or accrual of royalties which can be considered an adjustment to the transaction price under the Bureau of Customs’ (BoC) Prior Disclosure Program (PDP) so no administrative fines and interest will be imposed.
If the importer fails to do so, will his failure be discovered by the BoC? Can the duties still be assessed? Will he be penalized?
It is mostly during post-clearance audits that the BoC discovers unpaid duties on the royalties.
The BoC’s audit function, formally known as “post-clearance audit,” has been revived and institutionalized through CAO 01-2019 which was signed by the Secretary of Finance in January.
During post-clearance audits, one of the issues that may arise is the valuation of the imported goods for Customs duty purposes.
Royalties tend to be a usual subject of inquiry by the examiners during post-clearance audits. By default, the examiner usually considers any royalties recorded in the books as dutiable and have the burden shifted to the importers to prove otherwise. In one Court of Tax Appeals (CTA) case, the examiner even computed the ratio of imported licensed goods to the total importations to approximate the portion of the importer’s total net sales of the imported licensed goods. The percentage rate of royalty was then applied on the approximated total net sales of the imported licensed goods to determine the royalty fees from which the deficiency customs duties (plus value-added tax) were computed. The CTA ruled that only the actual royalty fees related to the sale of licensed goods should be dutiable. The petitioner, though, was not able to sufficiently support the actual quantity of licensed goods imported and the actual amount of sales of the licensed goods; thus, the assessment was upheld.
Considering the above, importers must ensure that all relevant documents including licensing agreements/contracts related to royalties, invoices, pertinent schedules, and other documents, are kept and maintained. Of course, you would not want to be heavily penalized — administrative fines range from 25%/125% in cases of negligence to 600% in case of fraud, plus interest of 20% per annum for non-payment of customs duties.
It is best practice as well for importers to regularly conduct a study of their customs operations, either through self-assessment or with the help of consultants, to determine the level of compliance. If there were royalties not declared for Customs duties, importers can still consider availing of BoC’s prior disclosure program (PDP) even upon failure to pay within 30 days. The royalties can be declared and duties paid without an administrative fine but with interest if no audit notification letter has been received. On the other hand, a 10% administrative fine and interest will be imposed if an audit notification letter has been received by the importer.
With the formal roll-out of post-clearance audits, we can expect that an increasing number of audit notification letters will be sent out by the BoC. We should not worry though, but only if we make being always prepared a royal duty to ourselves.
Let’s Talk Tax is a weekly newspaper column of P&A Grant Thornton that aims to keep the public informed of various developments in taxation. This article is not intended to be a substitute for competent professional advice.
John Paulo D. Garcia is a manager of Tax Advisory & Compliance division of P&A Grant Thornton, the Philippine member firm of Grant Thornton International Ltd.