Fulfilling one's royal duties to Customs

Did your company recently remit royalty payments or any amount to an offshore supplier or brand holder for the use of certain intellectual property rights on imported products? If so, were duties paid on them or were these reported at all to the Bureau of Customs? Whether your answers are yes, no, or unsure, you would do well to read on and revisit the interface between customs duties and post-importation payments.

A commonly overlooked cost item in customs valuation are royalty payments for imported products. Since these payments are remitted after importations are done and are usually based on domestic sales, companies may not readily acknowledge its customs implications. Also since these royalty payments are oftentimes already assessed (internally or externally) from the point of view of internal revenue/direct taxes, companies may inadvertently assume that all tax implications on the said royalties have already been covered and settled – to the dangerous exclusion of indirect taxes (e.g. customs duties and import value-added tax).

It may initially come as a surprise to hear that payments made after importations should still be subject to customs duties. However, since royalties or related fees can be regarded as part of the total import cost of a product, the World Trade Organization (WTO) agreement on customs valuation, in particular instances, regards the same as subject to customs duties. The agreement requires all member countries to use the transaction value as the principal basis for customs duties and defines this as “the price actually paid or payable” of an imported product when sold for export. Since royalties would arguably form part of a product’s cost, it can therefore be considered as part of the price “payable” on an imported product.

A corollary question to this would be: If royalties are remitted after importation, how then will customs know about any unpaid duties and assess penalties on these? The simple answer: Post Entry Audits (PEA). There is a specialized group within Customs known as the Post Entry Audit Group (PEAG) that performs these audits. Members of this group have received rigorous international training from governments of more developed countries such as Japan, which was among the pioneers of the PEA system. We understand that, recently, issues pertaining to royalty payments have frequently surfaced during their audits.

The introduction of the PEA system into the Philippines less than a decade ago caused a major shift in the role and powers of Customs. In the past, as some companies may still perceive it, the payment of duties and taxes at the border already signified the close of a transaction and the final liquidation of an import entry. However, with the country’s adoption of the transaction value system several years ago, this paradigm has changed. Today, the payment of duties and taxes upon importation (which are now based primarily on the importer’s self declaration) is all but tentative since Customs now reserves the right to examine an importer’s records as far back as three years. This would allow Customs to check license/royalty agreements and the company’s book of accounts to verify if royalties were paid, how much and whether these are dutiable or not. If found to be dutiable, Customs will assess deficiency duties, import value-added taxes and penalty amounts which could reach as high as eight times the revenue loss.

On that note, it is important to consider that not all forms of royalties or post-importation remittances should be considered dutiable. There are specific conditions and criteria, based on the WTO Agreement as well as pertinent commentaries and interpretations thereof, which should be met before a certain royalty payment can be regarded as dutiable. According to the WTO Agreement, in order for a royalty to be dutiable it would have to be:

• Related to the imported goods

• Paid directly or indirectly as a condition of the sale

• Not already included in the price paid or payable.

To illustrate, a royalty payment for an intangible item such as the design and concept of a retail outlet may arguably be considered as unrelated to the imported goods and therefore not subject to duties. As another example, fees paid for the right to distribute imported products domestically may be considered non-dutiable if these are not paid as a condition of the import sale. These examples, however, are general and are neither binding nor definitive. It must be considered that customs jurisdictions around the world had different interpretations of this and had, in fact, arrived at varying and even conflicting interpretations of the WTO Agreement as it applies to identical commercial scenarios. Most of the time, resolutions to contentious interpretations can only be arrived on a case-to-case basis, upon a detailed analysis of the facts.

At any rate, if royalty payments are made by a company, the present rules require it to declare these to Customs within 45 days of remittance and thereafter undertake to pay the pertinent duties and taxes.

A company may therefore want to prioritize conducting a thorough self assessment of their post-importation remittances ahead of any possible PEA. It may revisit the terms of its royalty or license agreements to evaluate if the post-importation remittances made pursuant to these agreements should have been subject to duties. If these royalties are indeed dutiable, and no duties have yet been paid, the company should consider availing of Customs’ Voluntary Disclosure Program (VDP). This program is comparable to a tax amnesty measure whereby, if approved, a waiver of penalties may be granted to the importer and only back duties and taxes would be assessed.

Making a proactive self-assessment now and taking corrective action in advance is better and more comforting than being caught off guard when that audit notification letter from PEAG arrives.

(Raphael B. Madarang is a Manager for Business and Financial Advisory Services of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. The views and opinions expressed herein are those of the author and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected] or [email protected]).