Royalty – an unending litigation

[K. Senguttuvan]

Royalty – an unending litigation

For the purpose of collection of customs duties, valuation of imported goods or exported goods has to be arrived based on the provisions of section 14 (1) of Customs act 1962. As per subsection 1(A) of section 14, the ‘price’, referred in subsection (1) of section 14, in respect of imported goods, shall be determined in accordance with the rules, that is, Customs valuation (Determination of prices of imported goods) rules 2007. The value referred, both in the section 14 and valuation rules, is ‘transaction value’. What is ‘transaction value’ has been defined both in the section 14 and rule 4 of valuation rules.

But in layman understanding, it is the value or price which is not influenced by any extraneous factor and the price is the sole consideration.

Further, for determining the final transaction value of the imported goods Rule 10 of the Rules 2007 has also to be taken into account. In as much as the Rule 10 says that “in determining the transaction value there shall be added to price actually paid or payable for the imported goods”.

We are concerned with sub rule 10 (1) (c). As per this  sub rule, royalties and license fees related to the imported goods that the buyer is required to pay directly or indirectly as a condition of the sale of the goods being valued to be added, to the extent that such royalties and fees are not included in the price actually paid or payable. Again, interpretative notes on rule 10 (1) (c), which is forming part of the rule, explains as under:

Rule 10 (1) (c)

1. The royalties and license fees referred to in rule 10 (1) (c) may include among other things, payment in respect to patents, trademark and copyrights. However, the charges for the right to reproduce the imported goods in the country of importation shall not be added to the price actually paid or payable for the imported goods in determining the customs value.
2. Payments made by the buyer for the right to distribute or resell the imported goods shall not be added to the price actually paid or payable for imported goods if such payments are not a condition of the sale for export to the country of importation of the imported goods.

Both rule 10 (1) (c) and interpretative notes on the said rule speak of ’condition of the sale of the goods being valued’.

Another interesting aspect is that the note 1 did not talk about even the ‘“condition of sale”’. In other words if the charges i.e. royalties and license fees etc., shall not be added to the price actually paid or payable when the imported goods are used for manufacture in the country of importation. In short it is very clear, as per the notes 1, if the imported goods are used for reproduction (manufacture) under proper license by paying royalty; the same shall not be added to the value of imported goods.

Despite clear cut notes on rule 10 (1) (c) and various judicial pronouncements, there is unending litigation on the issue of includability or non-includability of the royalty and license fees to the value of the goods i.e. raw materials/components imported from the foreign collaborator for reproduction (manufacture) of the goods on obtaining patent rights, either by paying lump sum payment or running royalty payment or both.

The main area of disagreement between the department and importer is on the issue of ‘“condition of sale” of the goods being valued’. The words ‘goods being valued’ used in rule 10 (1) (c) is very important. ‘The goods being valued’ referred to the goods under importation. Again interpretative notes (1) says that royalties payment shall not be added to the value of the goods under import, if the same are imported for reproduction (i.e. manufacture under Central Excise provisions) in the country of importation. If the above provisions are read together that royalties and license fees shall not form part of the assessable value of the imported goods for the purpose of Customs valuation, because it has been held by various judicial forums including the apex court that such payments related to the net sale of goods produced locally, would fall under post importation. Legally also, for adding any charges to the value of imported goods, the factors namely ‘time and place of importation’ shall be taken into account.

But this issue refused to die down even today. The situation is still worse where the seller (foreign collaborator) and the buyer are related persons. Though the license and technical agreement are very clear on the payment of royalty (i.e. payment of royalty is linked to the net sale of indigenous goods excluding the landed cost of imported goods and excise duty), still suspicious needle is pierced into the eyes of the importer, the result of which the importer is forced to cough up lakhs of rupees to get his goods cleared from the Customs Department.

However this article will not be complete without referring to some important decisions on this issue gist of which are mentioned in the following paragraphs:

(i)   MARUTI UDYOG LTD. Versus COMMISSIONER OF CUSTOMS, MUMBAI - 2013 (12) TMI 90 - CESTAT MUMBAI. The Tribunal Mumbai, in a recent decision, in the case of Maruti Udyog Ltd versus CC Mumbai, relying on the apex court decisions in 1989 (41) ELT A 615 (SC) and COMMISSIONER OF CUSTOMS, NEW DELHI Versus PRODELIN INDIA (P) LTD. 2006 (8) TMI 186 - SUPREME COURT OF INDIA, held that ‘technical know-how and license related to post-manufacturing activities of design, manufacture, quality control, assembly etc. undertaken for production of car manufacture in India – No nexus of royalty/license fee with import of goods established – Payment of royalty not related to imported components and not a condition for sale of goods so as to invoke provisions of rule 9 (1) (c) of customs valuation  rules 1988’.

(ii)  COMMISSIONER OF CUS. (IMPORT), MUMBAI Versus BRIDGESTONE INDIA PVT. LTD. 2013 (12) TMI 1089 - CESTAT MUMBAI . The honourable tribunal Mumbai, in the case of Commissioner of Customs (import) Mumbai versus Bridgestone India Private Limited, held that ‘royalty and license fee – Paid on net sale value of products manufactured and sold  by licensee in India – Held – Imported goods may be raw materials/com ponents for manufacture of goods in India – But royalty and license fee were on goods manufactured/sold in India – It has nothing to do with the imported goods nor was it  condition of their sale – Hence rule 10 (1) (c) of customs valuation rules 2007 was not applicable and these payments could not be added to transaction value of imported goods’.

(iii)  JOHNSON & JOHNSON LTD. Versus COMMISSIONER OF CUSTOMS, MUMBAI 2013 (9) TMI 462 - CESTAT MUMBAI . The honourable tribunal Mumbai, in the case of Johnson & Johnson Ltd versus Commissioner of Customs Mumbai, held that ‘technical know-how is for the post importation activity to be undertaken by the assesse in India – Payment of royalty is linked to value addition which takes place in India – For Payment of royalty, value of imported goods including customs duties are clearly excluded’.

(iv) TATA YAZAKI AUTO CORPN. LTD. Versus COMMR. OF CUS. (IMPORTS), MUMBAI 2006 (11) TMI 81 - CESTAT, MUMBAI.The honourable tribunal Mumbai, in the case of Taya Yazki Auto corporation Ltd, versus Commissioner of Customs Mumbai, held that ‘the amount of royalty specified under the agreement relates to the price of finished goods and not of components – Once royalty relates to the manufacture of finished goods in India, the same cannot be added to the value of the imported components’.

Conclusion:

Rule 10(1) (c) and (e) speak of ““condition of sale”” related to the goods under import. While interpretative notes 1 speaks that royalty and licence fees are not addable to the value of imported goods if the same are used for reproduction in the country of importation. If the above two provisions are read together, the conclusion is that no royalty fee is addable in the assessable value of imported goods when the imported goods are used for manufacture of excisable goods. In fact, no royalty and licence fees are addable even when the imported goods are sold as such if “condition of sale” is not attached as per note 2 of interpretative notes. Then, why is such confusion? Confusion is because of “EXPLANATION” attached to clauses (c) and (e) to rule 10 (1). The “Explanation” says that “ where the royalty, licence fee or any other payment for a process…is includible referred to in clauses (c) and (e),……notwithstanding the fact such goods may be subjected to the said process after importation of such goods”. Due to the above explanation, irrespective of the fact whether the imported goods are used for manufacture of excisable goods or not and whether “condition of sale” is attached or not, the department adds the value of royalty and licence fees to the value of imported goods and hence there is un ending litigation. Explanation cannot superimpose the rules; interpretative notes is interpreting the rules by saying “… that is to say….”.

Hence interpretative notes are superior over the explanation when both are consistent with Rule. But for 10(c) of the Rules 2007, explanation is not consistent with Rules or Notes. Explanation becomes redundant.

The best course could be the deletion of the said explanation from the rule. Even otherwise the explanation shall and should not override the provisions of rules and interpretative notes on rules.      

(Authored by: P. Ayyam Perumal IRS Retd Commissioner, K.Senguttuvan Advocate & S.Mani Shankar)