New Developments in Assessing Customs Duties on Royalty for Imported Goods in China

By R.Z. Margaret Lu and Yuping Wang
[December 2003]

Following China's accession to the World Trade Organization (WTO) in December 2001, the Customs General Administration of the People’s Republic of China promulgated Measures of the People’s Republic of China Customs on Examination and Determination of Customs Duties Levied against Imported and Exported Goods (the “Measure”). The Measure replaced two pre-WTO regulations on the same subject, and set forth the rules, among others, for assessing customs duty on royalties to be paid by buyers of imported goods and the payment of such royalties is the seller’s condition to selling the goods into China.

The concept of levying customs duty on royalties and license fees in connection with imported goods was first codified in the Interim Measures of the People’s Republic of China Customs Concerning the Levying and Exemption of Customs Duty on Software Fees for Imported Goods in 1993 (1993 Interim Measure). It contained 11 articles in very broad terms, had a limited scope of application and was virtually useless in practice. To be more in line with WTO requirements, Article 4(3) of the Measure adopted language contained in WTO’s Agreement on Implementation of Article VII of the 1994 General Agreement on Tariffs and Trade, permitting member countries to levy customs duties on royalties and license fees for imported goods to the extent that they are not already included in the sale price, if such royalty and license fees are related to the goods and the payment of the royalty and license fee is a condition to the sale. The Measure, however, is a general law which encompasses a much broader scale of matters concerning customs duties on imported and exported goods.

On May 30, 2003, the Customs General Administration of the People’s Republic of China issued a specific law – the Methods for the Assessment of Customs Duties on Royalties to Imported Goods (Assessment Method). The Assessment Method repealed the 1993 Interim Measure, and provided definitions for “royalty” which is “related to” imported goods, and the payment of which is a “condition to sale” of imported goods by seller.

What is “Royalty”

The Assessment Method defines “royalty” as fees payable by buyers of imported goods for the right to use a patent, trademark, know-how and copyright, or the right to distribute or re sell the imported goods and other similar rights (“Royalty”). Article 3 of the Assessment Method provides that the amount of Royalty shall be included in the price of the imported goods for the purpose of calculating applicable customs duties, if the Royalty is “related to” the imported goods and the payment of the Royalty is the seller’s “condition to sale” of imported goods into China.

Royalty as “Related to” Imported Goods

Relevant parts of the Assessment Method provide that the following types of Royalty to be paid for certain types of imported good are Royalty “related to” such imported goods pursuant to Article 3:

• Royalty to be paid for the right to use certain patents or know-how, where the imported goods: i) contain such patents or know-how; ii) are made by using such patents or know-how; or iii) are machinery and equipment specifically designed and manufactured for the implementation of such patents or know-how; regardless whether such patents or know-how are imported in a form of a magnetic tape, diskette, CD or other similar media, or imported by down-load or transmission through network or satellite.
  
  
• Royalty to be paid for the right to use certain trademarks, where the imported goods: i) contain such trademarks when hey are imported; ii) can be re-sold once imported with such trademarks affixed thereon; or iii) contain such trademarks when they are imported, and can be re-sold after being lightly processed with such trademarks affixed thereon.
  
  
• Royalty to be paid for copyrights, where the imported goods contain: i) software, language, music, graphics, image or other similar contents in the form of magnetic tape, diskette, CD or other media; or ii) other copyrighted contents.
  
  
• Royalty to be paid for distribution, re-sale right or other similar rights owned by sellers of imported goods in China, where the imported goods can be: i) sold directly once imported; or ii) re-sold upon light processing.

Which Royalty Payments Constitute a “Condition to Sale”

Article 9 of the Assessment Method provides that the requirement for a “condition to sale” under Article 3 is met if a Royalty payment by the buyer of imported goods is a condition precedent to seller’s selling of goods into China. In other words, the sales transaction will be impossible to close pursuant to the terms and conditions of the contract governing the sale unless buyer pays a Royalty.

Although this Article 9 seems straight-forward, the determination of whether a Royalty payment constitutes a condition to sale can be complex and is subject to the discretion of the responsible People’s Republic of China Customs at the national, provincial or city levels (Customs). According to the United States Trade Representative 2003 National Trade Estimate Report on Foreign Trade Barriers, China section, importers have reported that “many Customs officials are still inappropriately applying royalty and software fees to the dutiable value even if these fees are not a condition of the particular sale in question.”

How Customs Duties Are Assessed on Royalty Payments

Buyers and importers in China are required to declare Royalty payments for imported goods and to provide objective and quantifiable data/information for the Royalty payments at the same time they file a customs declaration for imported goods. Customs is authorized to examine and determine whether a declared Royalty payment or a portion thereof satisfies the requirements under Article 3 of the Assessment Method, based upon the objective and quantifiable data/information provided. If so, the Royalty or a portion thereof will be included in the price of imported goods for the purpose of assessing applicable customs duties.

In the event the buyer/importer fails to provide objective and quantifiable data/information, the Customs is to refer to Article 3 of the Measure and make an assessment based on the transaction price of the imported goods declared for customs. In the event it is unable to make an assessment by using this method, Customs then refers to Article 7 of the Measure to make an assessment by choosing one of the methods in the same order listed as follows: using transaction price of same types of goods, transaction price of similar types of goods, off-set price or computed price; or other reasonable methods.

Payments of fee for reproducing/copying the imported products in China, and for technical training or off-shore studying/inspection should be itemized and listed separately for verification by the Customs, and are not subject to customs duty.

Upon finding that a declared Royalty payment does not satisfy the requirements under Article 3, the Customs shall exclude the Royalty payment from the price of imported goods for the purpose of assessing applicable customs duties, or to deduct the Royalty payment if it is already included in the sales price. However, a non-itemized royalty payment included in the sale price of the imported goods will not be deducted from the price unless the Customs is able to ascertain the amount using data/information provided by buyer or importer, even if such royalty payment does not satisfy the requirements under Article 3 and should not have been included in the sales price otherwise.

Applicable Rate

Royalty payments meeting requirements under Article 3 of the Assessment Measure will be subject to customs duty at the same rate applicable to the imported goods.

Penalties

A buyer or importer will be subject to monetary penalties for failure to declare, or falsification of declarations on, Royalty payments; and will be subject to criminal penalties in the event its conduct constitutes a crime under pertinent Chinese laws. Illegal gains will also be confiscated by Customs.

Concluding Observations

It seems that in a sale transaction to import goods in China, Royalty payments are best itemized and listed separately from the prices of the imported goods to prevent the avoidable financial burden of customs duty on Royalty payments which a buyer or importer should not have to bear otherwise. Furthermore, current Chinese laws and regulations require withholding taxes on Royalty payments in foreign currency by a licensee/payer in China to a licensor/payee outside of China before such payments are remitted. Thus a Royalty payment satisfying the requirements under Article 3 may be subject to customs duty as well as withholding taxes. Even though customs duty is paid by buyers/importers whereas the withholding tax is taken from licensors/payees’ receipts, the exposure may have impact on the over-all economics of sales transactions involving importation of goods to China.

Customs decisions are subject to administrative and/or judicial review in China. Nevertheless, in light of the May 2003 Assessment Method, it is advisable for multinational companies to review their existing sales practices or devise future transactions with the goal to minimize exposure to customs duty/tax and to avoid unnecessary exposure because of inappropriate documentation.

Published by DWT's China Practice Group

For further information, please contact:

R. Z. Margaret Lu (Author), New York, (212) 603-6447, margaretlu@dwt.com
Yuping Wang (Author), Shanghai, (011) 8621-6279-8438, yupingwang@dwt.com

Rongwei (Ron) Cai, Shanghai, (011) 8621-6279-8541, roncai@dwt.com
Allen D. Clark, Shanghai, 011-8621-6279-8560, alclark@dwt.com
Zhi-Yin James Fang, Los Angeles, (213) 633-6847, jimfang@dwt.com
James M. Mei, Portland, (503) 778-5315, jimmei@dwt.com
Norman B. Page, Seattle, (206) 628-7740, normpage@dwt.com
Ronald K. Ragen, Portland, (503) 778-5301, ronaldragen@dwt.com
J. H. Jerry Zhu, New York, (212) 603-6458, jerryzhu@dwt.com

This China Practice Advisory is a publication of the China Practice/Shanghai Office of Davis Wright Tremaine LLP. Our purpose in publishing this Advisory is to inform our clients and friends of recent legal developments in China. It is not intended, nor should it be used, as a substitute for specific legal advice as legal counsel may only be given in response to inquiries regarding particular situations.

Copyright © 2003, Davis Wright Tremaine LLP.

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