In brief:
• Royalties are dutiable only when they relate to imported goods and are a condition of their sale.
• The case shows that importers can reduce customs assessments by properly separating royalties attributable to imported goods from those related to locally manufactured products.
• Clear agreements, supporting documentation, and robust royalty allocation analyses can help importers manage customs exposure and challenge overly broad assessments.
Royalty payments remain one of the most closely scrutinized areas in customs audits, often resulting in significant duty and tax assessments. However, not all royalties are dutiable. Under customs valuation rules, royalties should only be added to the customs value when they relate to the imported goods and constitute a condition of their sale for export to the importing country.
The main issue in dispute is whether the royalty payment is connected to the importation of the goods. The Post Clearance and Audit Group (PCAG) of the Bureau of Customs (BoC) frequently requires importers to submit trademark, technology, and intercompany royalty arrangements and often proceeds on the assumption that all royalties paid by the importer should be added to the transaction value of imported goods.
WHEN ROYALTIES BECOME A CONDITION OF SALE
The issue arose in a case involving a multinational consumer products company and the Commissioner of Customs. The company imported products from related foreign entities and paid royalties to its parent company under patent and trademark agreements. These agreements allowed the company to use the parent company’s intellectual property in the Philippines in exchange for royalties equivalent to 5% of the net sales of licensed products.
Following a post-entry audit, the BoC issued an assessment involving several matters, among which the royalty treatment was the main topic. The BoC maintained that the company should have included the royalty payments in the transaction value of its imported goods.
The company argued that the royalties were paid for the use of patents, trademarks, and know-how in the Philippines, rather than as a condition for importing or purchasing the goods. It submitted a letter from its parent company stating that royalty payment was not a condition of sale, but the courts gave the statement little weight and instead looked to the parties’ licensing agreements.
Under those agreements, non-payment of royalties could result in termination. The courts also noted the lack of evidence that the company could obtain or sell the imported goods under another brand without paying royalties. On this basis, they concluded that the royalty payments were a condition of sale of the imported goods and were therefore dutiable.
SEPARATING DUTIABLE FROM NON-DUTIABLE ROYALTIES
At first glance, the ruling appears unfavorable to importers because the Supreme Court (SC) affirmed that royalties are dutiable when they relate to imported goods and constitute a condition of sale. However, a closer look shows how the importer established that only part of the royalties related to imported goods, substantially reducing the original assessment.
The company showed that the BoC’s royalty base was overstated because the royalties were computed on net sales of both imported and locally manufactured licensed products. An independent CPA analysis demonstrated that a substantial portion related to products manufactured in the Philippines, which could not form part of the customs value of imported goods.
The courts agreed that only the royalties attributable to imported products sourced from the parent company should be included in the transaction value for customs purposes, while royalties attributable to locally manufactured products should be excluded.
Hence, the key issue in the case is not actually the existence of royalty payments, but the extent to which those payments are connected to imported goods. The analysis of the independent CPA proved to be valuable not because it established that the royalties were entirely non-dutiable, but because it provided a reasonable basis for allocating the royalties between imported and locally manufactured products. This ultimately led to a substantial reduction in the assessment, as the courts declined to fully adopt the BoC’s blanket assumption and instead relied on the allocation supported by the independent CPA.
BUILDING A STRONGER DEFENSE AGAINST ROYALTY ASSESSMENTS
Perhaps the most important lesson from the case is that although royalties may be dutiable in principle, importers can successfully challenge customs assessments that broadly assume all royalty payments are dutiable. Importers may do so by demonstrating which portions of the royalties are connected to importation and which are attributable to other activities. This can be achieved through clearly drafted royalty and license agreements, evidence showing that the royalties relate to activities other than imported goods, such as local manufacturing know-how, technical assistance, or marketing intangibles, documentation establishing that the purchase of imported goods is not contingent upon the payment of royalties, and analyses that segregate dutiable and non-dutiable royalty components.
The decision also addressed the treatment of wharfage and arrastre charges, holding that these fees are necessary expenses incurred in moving imported goods from the vessel to the consignee prior to their release from customs custody. Accordingly, the court ruled that such charges form part of the “other charges” which should be included in computing VAT on importation.
KEY TAKEAWAYS FOR IMPORTERS
The recent SC decision in this multinational consumer products company’s case against the Commissioner of Customs marks a significant development in Philippine customs jurisprudence on royalties. More importantly, it serves as a reminder that the best defense against royalty-related customs assessments begins long before a customs audit.
Through clearly drafted royalty and license agreements, together with documentation that properly segregates dutiable and non-dutiable royalty components, importers can strengthen compliance and reduce the risk of unwarranted or excessive assessments.
This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. The views and opinions expressed above are those of the author and do not necessarily represent the views of SGV & Co.
Stephanie Vicente Nava is a tax principal of SGV & Co.