The dutiability of royalty payments to foreign suppliers is a complex issue in China and an ongoing concern for companies importing into that country. China Customs has been conducting a variety of audits on this issue over the past two years and is methodically expanding this initiative to ensure duties are properly paid. Sandler, Travis & Rosenberg’s China-based professionals have been closely involved in these audits and can offer valuable counsel.

In reviewing the royalty arrangements of numerous companies, ST&R’s analysis of the relevant China customs valuation laws and regulations has led to the conclusion that royalty payments for the transfer of production technology or knowhow to manufacturing operations in China should generally not be listed separately on the customs declaration and are not subject to duty assessment. However, consultants with more of a financial or corporate tax background may assess the matter differently and determine that such royalties are dutiable and should be included in the value of the imported goods.

This divergence has posed a problem for importers in light of China Customs’ nationwide audit initiative on royalty payments, which was launched in May 2016. During the first phase of this initiative, which lasted through mid-2017, many importers had difficulty making the case that the royalties they paid were not dutiable due to the limited availability of supporting documentation. In many of these cases, rather than electing to undertake a legal assessment of all the facts, importers accepted that the royalty was dutiable or admitted to a failure to make a proper royalty declaration. This opened them to liability for up to three years’ worth of duties and taxes, prospective duties on future royalty payments, and potential penalties at a later stage, but often the duty assessments were viewed as just another cost of doing business.

Other importers, however, maintained that there is no legal basis to include the royalty in the dutiable price and insisted on a review with China Customs of the whole transfer price of the imported goods. In some of these cases Customs has negotiated with the importer. However, these reviews also give Customs the opportunity to examine whether the buyer and seller in a given transaction were related. If so, and if that relationship is found to have affected the import price, Customs can recoup up to one year’s worth of duty and tax (but no penalty).

In the second phase of the royalty audits, which is still underway, importers are invited to meetings hosted by the local China Customs bureau and asked to conduct a self-review of their royalty payments and report back (with support) on whether those payments are dutiable. If appropriate, the importers are requested to prepare a voluntary disclosure with an estimate of duty liability. While this method does offer importers some benefits, it also exposes them to liability for penalties and frees Customs of the requirement to prove its case.

These royalty audits are continuing to expand and pose a challenge for importers given the complexity of the underlying laws. For more information or assistance in developing an effective defense strategy, please contact Colbert Lam in Hong Kong or Harry Zhang in Shanghai. You can also click here for information on ST&R’s on-demand webinar on China customs valuation issues.

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