Developments in customs case law regarding withholding VAT on royalties

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.

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).