China Customs Valuation:Software Exempted; E-Content and IP Royalties Still at Risk

China's customs rules and practices continue to converge with World Trade Organization (WTO) standards, although the New Measures retain the previous statement that valuation must be 'based on' transaction value (Article 5), where the WTO Customs Valuation Agreement states that valuation must 'be' (identical to) transaction value - unless an exception applies.

Data-processing software exempted from media duty

Computer software importers and supply chains are much better protected by the New Measures. Valuation of imported media such as CDs containing software used with data processing equipment is no longer affected by value of the software. To benefit from this new provision, the taxpayer must have itemized, or must "be able to provide" documentary proof of the respective prices of the software 'or' the media (Article 37). This change formalizes a position that was implicitly adopted by the CA after much drama in 2002/2003.¹ In late 2003, the CA suspended enforcement, but did not formally confirm cancellation, of pending demands for supplemental duty payments based on software valuations that were sometimes thousands of times higher than media valuations. The supplemental duty would have constituted double taxation where value-added tax (VAT), withholding tax and/or business tax was paid in respect of the same software. The New Measures suggest that those suspended demands will not be reactivated, while confirming clearly that future imports of computer software will not be subject to similar demands. This is highly beneficial not only to computer software importers but for many other participants in related supply chains.

Other media-contained software not exempted

Media containing fine art, photographs, sound, images, video, games or electronic publications do not enjoy the above exemption. The valuation of imported media containing these items will be based on the items' (and the media's) value - even if the items' value is excluded from the goods price and is payable in separate royalty remittances - if the royalty is related to and is a condition of the goods sale. The meaning of "related" and "condition" is determined in accordance with Articles 13 and 14 of the New Measures, which are substantially unchanged from the provisions of the Old Royalty Measures.²

Trademark, technology and distribution fees still risky

Trademark, patent and proprietary technology royalties or other fees also continue to be subject to an even broader risk of inclusion in the valuation of imported goods. Such fees will be deemed "related" to imported goods under a broad variety of circumstances, while the requirement of being "a condition of the goods sale" remains open to unpredictable interpretation.³ Inclusion of distribution rights fees also remains unchanged, but provides less fertile ground for surprises. The related provisions of Articles 13 and 14 are also substantially unchanged from the provisions of the Old Royalty Measures.

Predictability through examples

Examples are added to the New Measures to assist understanding by readers, for example, if sold goods can only be displayed, distributed as free gifts, or resold to designated third parties, then their sale will be deemed to be 'restricted', resulting in the transaction value being disregarded (Article 9). Examples are also given of the application of various valuation methods (see Articles 18, 19 and 25).

Questions & consultations

A CA investigation begins with delivery to the taxpayer of a standard form of "Customs Valuation Question Notice", which includes check-boxes to indicate the reason(s) for the query. The initial response deadline of five working days from receipt of the notice can be extended upon written application (with a valid reason) for a period that must not exceed 10 working days, unless there are special circumstances (Article 48).

Consultation with the taxpayer is the next step, if the CA intends not to accept the transaction value. This is initiated by delivery of a "Customs Valuation Consultation Notice" to the taxpayer, which must meet with CA within five workings days of the receipt of the notice (Article 51).

A standardized check-the-box record of the consultations must be prepared by the CA through filling out a "Customs Valuation Consultation Record" form, which is designed to enable a copy to be provided to the taxpayer (Article 51).

Explanations to taxpayer

The taxpayer's right to request a written explanation of the CA's valuation process is now clearly stated to arise after the CA has determined the valuation. The apparent intent of the New Measures is for the 'written explanation' to be provided by filling in a standard "Valuation Notice" form, which contains blanks with room only for relevant rule section numbers or headings, and for the name of the selected valuation method (Article 55). This does not appear to encourage disclosure of evidence relied upon, or of detailed calculations. These provisions are less helpful to taxpayers than the Old Value Measures, which did not expressly state when the taxpayer's right arose and did not provide such a brief format for the response.

Small differences in wording of the New Measures suggest closer attention to the text of the WTO Customs Valuation Agreement, and may benefit taxpayers. For example, the New Measures appear to increase the taxpayer's role by stating that a special relationship between buyer and seller should not prevent customs valuation according to transaction value if "the taxpayer can prove/demonstrate (鳔)" that the transaction value is close to similar goods' prices that are agreed between unrelated parties, or to the price that would be calculated under the computed value or reverse deduction calculation methods (Article 17).

Coordination and other taxes

Taxpayer bank account information inquiries must now be supported by the relevant CA personnel's work identification certificate, an approval from an authorized CA official, and a filled-out standard form of "Customs Notice of Account Inquiries". In keeping with China's attempts to improve supervision of banks, the CA may report its investigation results to the banking regulatory authority (Article 47(5)).

Coordination with China's domestic taxation authorities is supported by a newly express power of the CA to make inquiries with tax departments in order to obtain information on taxpayers' "import-export-related domestic tax payment circumstances" (Article 47(6)). This coordination, while tightening the net on tax-evaders, is likely to reduce the risk of double taxation on taxpayers that pay other taxes on outbound royalties.

Restatements of transaction prices between related parties, due to tax authorities' increasingly frequent 'transfer pricing' investigations, are likely to become an increasingly important part of the CA's database on arm's length prices.

Progress and precautions

The overall effect of the New Measures is to make compliance easier, evasion more difficult and double taxation less likely. But complexity remains, notably for goods-related trademarks, technology and distribution rights. Importers and all supply chain participants still need to take care with their compliance and advance planning.

Endnotes

1 The 2002/2003 drama was summarized in Stender, N. and Zhang, S., China Customs 2003: Tensions and Progress, China Law & Practice, February 2004, Vol.18, No.1.

2 The meaning and application of "related" and "condition" under the Old Royalty Measures were analyzed in Stender, N. and Wang, D., Customs Treatment of Related Fees: Tax Planning Under WTO, China Law & Practice, July/August 2003, Vol.17, No.6.

3 The application of these requirements to trademarks and technology were summarized in Stender, N. and Wang, D., Customs Treatment of Related Fees: Tax Planning Under WTO, China Law & Practice, July/August 2003, Vol.17, No.6.