Developments in customs case law regarding withholding VAT on royalties

21 December 2022
Tax Messenger
On 8 November 2022, the Moscow Arbitration Court upheld claims brought by an importer in case No. A40−154 659/220−93−1198 for the invalidation of a customs authority’s decisions to include amounts of VAT on royalties in the customs value of imported goods.
Facts of the case

  • A Russian importer ("the Importer") imported cosmetic products into Russia.
  • The Importer was also a party to trademark licensing agreements. Royalties were calculated as X% of sales of imported goods in Russia.
  • The Importer included royalties in the customs value of imported goods, but based on estimated (projected) values, applying the mechanism of deferred determination of customs value (since the exact amount of royalties was unknown at the time of importation).

Question frequently asked by companies involved in international trade: "How should royalties be included in customs value if the exact amount of the royalties is unknown at the time of importing goods (for example, if it is calculated as a % of sales of imported goods or of a company’s revenue)?"

Answer: "Use the mechanism of deferred determination of customs value provided for in Decision No. 103 of the Board of the Eurasian Economic Commission of 19 June 2018".

  • The mechanism of deferred determination of customs value also requires goods declarations in which the customs value includes provisional amounts of royalties to be adjusted once the exact amount becomes known. That adjustment is needed in order for additional customs charges to be paid or for a refund to be claimed depending on the amount of royalties actually paid.
  • Thus, in accordance with the law, once the exact amount of royalties became known the Importer submitted an application to the customs authority for amendments to be made to the goods declaration with a view to obtaining a refund of overpaid customs charges.
  • The customs authority adjusted the goods declaration but refunded a lesser amount of customs charges than was requested since it took the view that, besides the exact amount of royalties, withholding VAT paid by the Importer on the royalties as a tax agent should also have been included in the customs value.
However, the court ruled that the customs office’s decision was unlawful and overturned it insofar as it concerned the inclusion of withholding VAT in the customs value of the imported goods. More detailed information on the position taken by the court in case No. A40−154 659/22−93−1198 follows below.
This case continues the positive trend in disputes over whether amounts of VAT on royalties should be included as a part of those royalties in the customs value of imported goods.

The court’s position broadly reiterates the arguments previously used by the appeal court in a case involving the same importer regarding the inclusion of royalties and VAT on royalties in the customs value of imported goods (case № А40−286 907/2021, cassation court hearing scheduled for 10.01.2023) and by courts in cases №№ А56−114 310/2021, А40−3225/2022, А40−4727/2022, А35−1670/2022, А40−33 892/2022, А14−2192/2022 and А40−79 711/2022).

What is most interesting, however, is the court’s argument that "royalties in respect of goods manufactured in Russia should not be included in customs value since they cannot be regarded as imported goods and no customs administration should take place in relation to such goods in general".

This is the first time that a court has directly expressed the view that royalties paid for the right to use IP in connection with the manufacture of finished products in Russia should not be included in the customs value of inputs imported for use in manufacturing those products.

At the same time, other courts dealing with disputes over whether royalties for IP used in connection with the manufacture of products in Russia should be included in the customs value of inputs are not adopting the same position and continue to rule against importers. See our previous alert for details of the divergent approaches taken by courts on this issue.
The court’s position

VAT on royalties should not be included in the customs value of imported goods for the following reasons:

  • From a tax law perspective, VAT does not affect the core price of a service (tax law views the transfer of licence rights as a service).
Thus, VAT payable to the Russian budget has no bearing on customs matters in terms of the determination of the customs value of imported goods.

  • VAT is a form of withdrawal to the budget, not an economic benefit accruing to the licensor.
VAT is an indirect tax (unlike profits tax), i.e., a tax on consumption, which is effectively collected from the buyer of goods (work or services) in addition to the cost of the goods (work, services) being sold and is remitted to the budget by the seller. In other words, VAT is added to the cost of a product and does not form part of the price of the product, which may be considered as economic income/revenue of the licensor.

  • According to Article 40(1)(7) of the EAEU Customs Code, royalties are included in the customs value where they are a payment which the buyer must make, directly or indirectly, as a condition of sale of imported goods. However, VAT payable to the Russian budget is not a payment (or part of a payment) required to allow goods to be imported from the country of export.
  • At the same time, Article 40(2)(3) of the EAEU Customs Code provides that taxes and levies charged in connection with the importation and sale of goods in the territory of the EAEU (i.e., Russian domestic taxes in the case at hand) should not be included in the customs value of imported goods.
Thus, current customs law does not establish that taxes charged in the country of import (i.e., Russia in the case at issue) should increase or reduce the customs value of imported goods. The customs value should include the amount of the royalty itself which is determined in accordance with the terms of the licensing agreement.

  • The importer (licensee) should add VAT to the royalty amount only for the purposes of calculating the tax base for VAT according to Article 161(1) of the Tax Code.
This entails not a change (increase) in the amount of royalties under the licence agreement, but rather the making of an artificial/technical addition to the remuneration solely for the purpose of determining the tax base for VAT and for the purpose of paying VAT.

  • Including VAT in the customs value of the imported goods results in tax being charged on tax: (i) withholding VAT is charged on the royalty, after which (ii) import VAT is charged on the customs value of the imported goods which includes that withholding VAT on the royalty.
Furthermore, a situation where VAT on royalties forms part of the royalties themselves (from a civil law standpoint) would also lead to profits tax being paid on VAT (i.e., another instance of the payment of tax on tax).
How can we help?

  • Assessing the appropriateness and risk of the inclusion of royalties and other intra-group payments in the customs value of imported goods.
  • 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.

  • Alexandra Gorokhova
    Global trade and Customs
  • Vladislava Gritskova
    Assistant Manager
    Global trade and Customs
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