Royalty and Customs Valuation

[Dinesh Kumar Agrawal, Grad CWA, ACA]

Royalty is the sum of money paid to the proprietor ('the Licensor') of Intellectual Property (IP) Rights for the benefits derived, or sought to be derived, by the user ('the Licensee') through the exercise of such rights. Royalties may be paid for the use of copyright, patent, registered design, knowhow, trademark or a combination of them.

The express rights granted to the licensee, and the amounts to be paid to the Licensor for the exercise thereof, are set out in a documented LicenseAgreement. The agreement specifies the method of calculating the royalties and the period over which the payments become applicable.

The royalty amount can be one time lump sum payment or may be based on a formula specified in the licence agreement which defines the royalty rate and the unit base on which it is to be applied. Unit base can be value or volume of production of the licensed products.

Generally, the Licensee will import capital goods in the form of plant and machinery to create manufacturing base of the licensed product. Sometimes proprietary products are also imported to be used in manufacture of licensed products.

On importation, customs duty is required to be paid on the capital goods as well as other products. Duty of customs may be specific or ad valorem. Specific rate of duty means that duty is fixed on the basis of quantity or volume of the imported goods and expressed in the form of Rs XXX per unit. On the other hand, most of the time, custom duty is levied ad valorem which means that duty is calculated on the basis of value of the imported goods and expressed in percentage.

Section 14 of the Customs Act, 1962 deals with valuation of the imported goods, as per which the value goods is the price at which such or like goods are ordinarily sold, or offered for sale, to unrelated parties for delivery at the time and place of importation in the course of international trade and the price is the sole consideration for the sale or offer for sale. Royalty is paid to the supplier or a third party consequent upon the import of goods or technology and therefore, it may be possible that price is not the sole consideration to the buyer and a part of the consideration may be paid by way of royalty.

As per Rule 9(1)(c) of the Customs Valuation (Determination of Price of Imported Goods) Rules, 1988, ('the Valuation Rules') royalties and licence 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 the extent that such royalties and fees are not included in the price actually paid or payable is required to be added in the price of the goods. 

Further, as per as per Interpretative Notes to the Valuation Rules, the royalties and licence fees may include among other things, payments in respect to patents, trademarks and copyrights. However, the charges for the right to reproduce the imported goods in the country of importation are not required to be added to the price for the imported goods. Further, payments made by the buyer for the right to distribute or resell the imported goods are not required to be added to the price of the imported goods if such payments are not a condition of the sale for export. 

In view of the above, following conditions are required to be fulfilled, if the payments for the royalty or licence fees are added in the price of the imported goods:

· Royalty payments are pursuant to the conditions of sale

· Such payments are not included in the price

· Royalty payments should have a direct nexus to the imported goods

· Payment does not pertain to right to produce goods in India

· Payment does not pertain to right to resell or distribute 

To bring royalty payments within the dutiable event, all the above conditions are to be fulfilled. It is immaterial as to whether the payment for royalty or licence fee or technical know-how has been in lump-sum or on regular basis. 

Once it is established that royalty is includible in the price, only to that extent payment towards royalty will be added in the price to which it directly relates to the imported goods. Such addition has to be made on the basis of quantifiable data and not on presumptions.  

Royalty payments are pursuant to the conditions of sale 

To bring within the mischief of the Rule 9(1)(c) of the Valuation Rules, it has to be established that one of the condition of the sale is payment of royalty. Generally, following conditions are required to be satisfied to allege that royalty payment is the condition of the sale:

· Goods under import is proprietary product

· Proprietary product has to be exclusively procured from the Licensee or his agent

· Proprietary product is essential for the manufacture of licensed product

 Royalty payments should have a direct nexus to the imported goods

What is assessed to the customs duty is goods under import. Therefore, it is essential to establish that there is a nexus between royalty and imported goods. If nexus is not established, value can be loaded under Rule 9(1)(c) of the Valuation Rules.

 Why it is difficult to establish that royalty payment is a condition of sale

 Generally, the IPR holder and the Licensor enter in to a multiple but separate agreements for various activities. Following are the typical agreements:

·  Agreements for supply of know-how

·  Agreement for supply of capital goods from the IPR Holder

·  Agreement for supply of capital goods from the associate entities of the IPR Holder

·  Agreement for erection and commissioning of the plant

·  Agreement for supply of proprietary product from the IPR Holder

·  Agreement for supply of proprietary product from the associate entities of the IPR Holder

·  Agreement for supply of non-proprietary product from the IPR Holder

·  Agreement for supply of non-proprietary product from the associate entities of the IPR Holder

·  Agreement for supply of non-proprietary product from the other entities

·  Agreement for technical training of the staff

In plethora of these various contracts entered at different dates, the obligation for payment of royalty will be in only one agreement i.e. Agreements for supply of know-how. Therefore, it is always difficult to establish that royalty payment is one of the conditions of sale of capital goods/components/raw material. In the case of UOI vs Mahindra & Mahindra Ltd 1995 -TMI - 43961 - (SUPREME COURT OF INDIA), the Apex Court held that ordinarily the Court should proceed on the basis that the apparent tenor of the agreements reflect the real state of affairs. Therefore, it is all the more difficult  for the Customs to load value in absence of an explicit condition in the agreement.