21 June 2013
payment towards royalty and fees for technical services (FTS) to non-resident companies has always been a subject matter of litigation under various tax legislations. Where payment towards royalty or FTS to a non-resident could attract withholding tax implications under the Direct tax regime, it could have multiple tax implications under the Indirect tax regime such as Customs, Service tax, Research & Development Cess etc. Under this article, we would be briefly discussing the Indirect tax implications of Royalty/FTS under the Customs Laws and the legal position related thereto after the introduction of Customs Valuation (Determination of the price of imported goods) Rules, 2007.
Before we proceed to analyze the implications of Customs Valuation Rules, 2007 on payment towards royalty and FTS, let us recollect the settled position of law prior to introduction of these rules.
Royalty/FTS attract Customs Duty if they are included in the assessable value of imported goods. The erstwhile Customs Valuation Rules, 1988 have prescribed that under the following situation, payment towards royalty would be added to the assessable value of imported goods:
“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”
The abovementioned provision of the erstwhile Customs Valuation Rules had provided that royalty and licence fee would be included in the value of imported goods only in the following conditions:
++ The royalty/license fee is in relation to imported goods; and
++ The royalty/license fee is a condition to the sale of imported goods
The abovementioned provision had given rise to enormous litigations under the Customs laws as the revenue authorities have started including royalty/license fees paid/payable by the importer to the supplier virtually in all the cases. Subsequently, the Apex Court had formulated certain guiding principles in various rulings from time to time in order to settle down the legal position. Let's have a cursory look at some of the important rulings pronounced by the Apex Court:
In the matter of CC vs. M/s. J.K. Corporation Limited (2007-TIOL-15-SC-CUS) the Apex Court held that assessment of customs duty must have a direct nexus with the value of goods which was payable at the time of importation. If any amount is to be paid after the importation of the goods is complete, inter alia by way of transfer of licence or technical know-how for the purpose of setting up of a plant from the machinery imported or running thereof, the same would not be computed for the said purpose. Any amount paid for post-importation service or activity, would not, therefore, come within the purview of determination of assessable value of the imported goods so as to enable the authorities to levy customs duty or otherwise.
Also, in the matter of CC vs. Toyota Kirloskar Motor Private Limited (2007-TIOL-94-SC-CUS), the Apex Court held that the royalty was paid in relation to manufacturing of goods in India with the help of imported capital goods. The royalty was not paid in relation to the use of imported capital goods. Therefore, in absence of any direct nexus of the royalty with the imported capital goods, the same cannot be included in the transaction value.
The above two landmark judgements have almost settled the legal position in so far as it relate to payment of royalty/license fee on imported goods. In the above rulings, the Apex Court laid down the basic principal that if the royalty is in relation to any activity done after importation, the same would not be included in the assessable value of imported goods.
The above mentioned legal position seems to have got unsettled after the introduction of Customs Valuation Rules, 2007. A new explanation has been inserted in the Customs Valuation Rules which provides that where the royalty, licence fee or any other payment for a process, whether patented or otherwise, such charges shall be added to the price actually paid or payable for the imported goods, notwithstanding the fact that such goods may be subjected to the said process after importation of such goods.
It is also important to refer the interpretive notes given under the Valuation Rules. Interpretive notes to Rule 10(1)(c) provides that “the royalties and licence fees referred to in rule 10(l)(c) 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 shall not be added to the price actually paid or payable for the imported goods in determining the customs value”.
To sum up, in accordance with the Customs Valuation Rules, 2007; royalty and license fee is includible in the assessable value of the imported goods if the following conditions are satisfied.
++ The royalty and license fee is not included in the price actually paid or payable;
++ The royalty and license fee relates to the imported goods and is payable as a condition of the sale of the goods being valued; and
++ If the royalty and license fee is payable in relation to a process , whether patented or otherwise, such royalty or license fee shall be included in the assessable value notwithstanding the fact that such process takes place after the importation of goods;
++ The royalty and license fee may include payments in respect to patents, trademarks and copyrights in relation to the imported goods; however, the same shall not include the amount paid or payable as royalty or as the case may be license fee for reproducing the imported goods in India .
Customs valuation in India is covered by the Customs Valuation Rules, which are modelled on the World Trade Organisation (WTO) valuation rules.
The WTO valuation rules provide that all payments made by the buyer as a condition of sale of the imported goods should be added to the transaction value for purposes of Customs valuation. Therefore, charges such as royalties and licence fees if paid by the buyer as a condition of sale would be added to the import price. The Indian Customs valuation rules have similar provisions.
A reading of the above provision would indicate that there are two conditions for inclusion of such payments to the transaction value:
(a) Such payments should be in relation to goods being imported, and
(b) The payment should, directly or indirectly, be made as a condition of sale of imported goods.
In many cases that have come up before the tribunals and the courts, it is the second condition has been emphasised by the revenue authorities. Even within the second condition, the crucial words ‘as a condition of sale’ have been largely ignored. The position of the department appears to be, if there is a royalty or technical service fee payment made to the supplier, such payment constitutes evidence that it is a condition of sale of the goods that are supplied.
As a result, there has been a considerable amount of litigation on this issue as well. Beginning with the landmark judgment by the Apex court in Collector of Customs (Prev.), Ahmedabad v. Essar Gujarat Ltd. in 1996 to date the different courts including the Apex court itself have issued contradictory rulings on this issue, under similar sets of facts.
The apex court in the Essar Gujarat case followed by Associated Cement Companies Ltd. v. Commissioner of Customs(‘CC’) (2001 (128) ELT 21) and Matsushita Television & Audio (I) Ltd v. CC (2007 (211) ELT 20) ruled in favour of the revenue and added royalties and licence fees to the transaction value of imported goods.
However, the apex court ruled in favour of the importer in several other cases, including CC v. Birla Tyres (2002 (143) ELT A183), CC, New Delhi v. Prodelin India (P) Ltd (2006 (202) ELT 13) and CC v. Toyota Kirloskar Motor (p) Ltd (2007 (213) ELT 4). In these cases, the court held that the royalty and technical service fee payments are not to be included to arrive at customs assessable value. While adjudicating on a number of other disputes, the lower courts and tribunals have selectively based their opinion on whichever of the apex court’s rulings best suited their interpretation.
In some contradictory decisions, there were indeed some differences in the underlying facts that explain the way the relevant tribunal or court made its ruling. However, there are many other rulings that are contradictory with no apparent reason for the deviation from each other.
The most common fact pattern is where an importer imports parts of the goods that he manufactures, along with technology.
For example, an automobile manufacturer manufactures a car in India and imports the fuel injection system from the parent company, which has also supplied the technology for the manufacture of the car.
Currently, the importer contemplating such a transaction has a situation of virtual certainty that he will be subject to a demand for additional customs duty and will have to go into various levels of appeal, the outcome of which is uncertain.
Therefore, it seems both desirable and feasible from the viewpoint of both the government and the industry that this issue should be clarified and the possibility of litigation and disputes minimised or eliminated.The key principle seems to be whether the royalty relates to the imported goods.
Using my hypothetical example of fuel injection pumps and cars, if there is a royalty payable (in addition to the price for the goods) at a particular rate on each fuel injection pump, this would qualify as a payment in relation to the goods that are imported. However, as noted earlier, the most common fact pattern deals with import of a component (such as a fuel injection system or an engine block) and payment of a royalty on manufacture of the entire automobile. Additionally, this royalty is typically paid as a percentage of the sale value of the car.
This method of calculation further lends credence to the importer’s position that this transaction is independent of the import of parts.
Therefore, the issue of a circular or clarification that the technology fee should be added to the import value of goods only where it relates to the goods that are imported would relieve importers of a considerable amount of uncertainty.
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