The Customs Authority for Advance Rulings (CAAR), Mumbai, has held that royalty paid to its German group company for technical know-how used in manufacturing explosion-protected electrical equipment in India is not required to be added to the transaction value of imported goods under Rule 10(1)(c) of the Customs Valuation (Determination of Value of Imported Goods) Rules, 2007. 

The applicant, an Indian subsidiary of Germany-based R. Stahl Aktiengesellschaft, manufactures explosion-protected electrical and electronic equipment at its facility in Chengalpattu, Tamil Nadu. For manufacturing these products, the company uses technical know-how licensed by its group entity, R. Stahl Schaltgeräte GmbH (RS SG), Germany. 

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The company entered into a Licence Fee Arrangement Letter dated June 26, 2023, providing for lump-sum licence fees covering FY 2015-16 to FY 2022-23; and a Licence Agreement dated June 23, 2023, effective from April 1, 2023, under which royalty is payable at 3.5% of the net sales of finished products manufactured in India. 

Seeking certainty on customs valuation, the applicant approached CAAR asking whether lump-sum royalty paid for earlier financial years; and periodic royalty calculated on net sales, should be included in the assessable value of imported goods under Rule 10(1)(c). 

The company argued that the royalty payments were solely for the use of manufacturing technology in India and had no direct relationship with the imported components.

According to the applicant the licensed know-how relates exclusively to the production and manufacturing process of finished goods; royalty is computed on the net sale value of finished products, not on imports; the royalty calculation expressly excludes the value of imported components purchased from the German licensor; there is no contractual requirement obliging the Indian company to procure materials only from the German supplier; and royalty remains payable even if no imports are made during a particular period. 

The applicant also relied on several judicial precedents, including its own earlier litigation before the Customs, Excise and Service Tax Appellate Tribunal (CESTAT), where a similar lump-sum technical know-how fee had been held not includible in the assessable value of imported goods. 

The jurisdictional Customs Commissionerate examined the licence agreement and observed that the royalty was payable at 3.5% of net sales of finished products.

It further noted that the licence agreement did not make payment of royalty a condition for the sale of imported goods; there appeared to be no direct nexus between imported goods and the royalty payment; and consequently, the essential conditions prescribed under Rule 10(1)(c) for addition of royalty to the transaction value were not satisfied. 

However, the Commissionerate observed that any future changes in contractual terms or payment structure would require fresh examination under the Customs Valuation Rules. 

CAAR examined Section 14 of the Customs Act, 1962 and Rule 10(1)(c) of the Customs Valuation Rules, 2007.

The Authority noted that royalty can be added to the assessable value only when both statutory conditions are fulfilled the royalty must be related to the imported goods; and payment of royalty must be a condition of sale of those imported goods. 

The ruling also referred to CBEC Circular No. 38/2007-Cus., which explains that post-importation royalty may be added only when these statutory conditions are satisfied. 

After examining the licence agreement and the factual matrix, CAAR concluded that the royalty paid by the applicant failed to satisfy the twin requirements of Rule 10(1)(c).

The Authority found that the royalty relates to manufacturing know-how used after importation; it is calculated on sales of finished products rather than imports; imported components are excluded from the royalty base; there is no contractual obligation requiring imports exclusively from the licensor; and payment of royalty is independent of the import transactions and therefore cannot be regarded as a condition of sale of imported goods. 

CAAR held that neither the lump-sum licence fee nor the running royalty payable under the licence agreement is liable to be added to the transaction value of imported goods under Rule 10(1)(c).

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