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Read moreSuch under-reporting may lead to a reassessment of duties and the imposition of penalties. Overpayment of royalties and duties is another potentially costly consequence to this lack of awareness.
For example, from a duty perspective, teams should only consider the relevant portion of any intangible payments that belong to the economic value at the moment the goods cross the border, and not other intangibles the company may also be paying for. In the previous shoe example, these may include the look of the shoe stores in the market and the marketing and advertising material being used.
"Many royalty payments contain both dutiable and non-dutiable elements from a customs perspective," says Martijn Schippers, Senior Manager of Indirect Tax at Ernst & Young Belastingadviseurs LLP. "If you are not fully aware of all the royalty rules, you may add the entire royalty payment instead of assessing which parts are dutiable, and which aren't. And you can end up overstating your import duties and pay too much."
A thorough approach starts in the drafting of royalty agreements. Customs compliance requires specialists from tax and finance to work with transfer pricing experts and others with a deep understanding of economic value chains at this early point, to assess whether prospective agreements will spark a customs duty impact.
At this stage, if the agreement is set up correctly they may still have the opportunity to not include the royalty as part of the customs value. A royalty agreement can embed different value drivers, from the right to import a product, to the right to produce products in country, or to use a trademark or incur costs for marketing and sales in that territory under a product name. By conducting a thorough value driver analysis, they can see what is being paid for and determine whether it would be beneficial to apportion those payments differently.
Beyond this, the specialists need to build a holistic approach that can accommodate longer-term shifts in global royalties frameworks.
Taken together, this work comes at a cost, as it requires already stretched teams to engage in the challenging and time-consuming task of data gathering and analysis. Organizations must decide how much they can afford their tax and finance talent to deviate from core value-adding activities.
Tools such as the EY Global Trade Analytics solution can provide a single point of truth regarding a company's customs activities, a dashboard overview of the products being imported or exported, pertinent duty rate calculations, and what needs to be reported to the authorities.
It can also be prudent to hand over some or all of the work to external experts, who can conduct a qualitative review of your intangible payments and ensure the approach to royalties and related duties remain fit for purpose.
Here are five steps you can take to remain in step with royalties as the global frameworks develop:
- Understand the business through a customs lens. There's a difference between knowing what products you import and export, and having a full grasp of your global duty profile and bill.
- Know the value drivers behind the goods that are being shipped. Is it more related to production, or the distribution of finished goods? Know whether a product's price already captures compensation for intangibles, or whether there are separate payments required for things like services, royalties, and distribution rights. Is there a structure in place for paying for such intangibles? And how is transfer pricing affected?
- Assess what's expected by the customs authorities. Remember, while customs frameworks may apply internationally, businesses still need to ensure their approach is appropriate for every territory in which they operate.
- Examine royalty payments critically to ensure there's no overpayment.
- Review royalties regularly. Like many aspects of global taxation, royalties are moving fast – in terms of both value chains, and the external backdrop of regulations and scrutiny. It's critical to ensure systems and processes are flexible and remain fit for purpose.