The Chennai Bench of the Customs, Excise and Service Tax Appellate Tribunal (CESTAT) has held that royalty payments made to a foreign related supplier cannot be added to the assessable value of imported goods merely because the imported components are used in the manufacture of finished products. 

The Bench of Ajayan T.V.  (Judicial  Member) and Vasa Seshagiri Rao (Technical Member) accordingly held that the royalty payments under the Term Sheet, Royalty Agreement and Licence Agreement were not liable to be added to the assessable value of imported goods under Rule 10(1)(c) or Rule 10(1)(e) of the Customs Valuation Rules, 2007.

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The bench stressed that under Rule 10(1)(c) of the Customs Valuation Rules, 2007, the Revenue must establish both that the royalty is related to the imported goods and that payment of the royalty is a condition of sale of the imported goods. 

The appellant/assessee is a 100% Export Oriented Unit engaged in the manufacture of power conversion and inverter systems. The company imported components from its related foreign suppliers, CE+T SA, Belgium and Suzhou CE+T Power Solutions Co. Ltd., China. The dispute arose over whether royalty paid under technology, manufacturing and licence arrangements with the foreign collaborator formed part of the customs value of the imported goods. 

The matter originated before the Special Valuation Branch (SVB), where the Department examined the transactions between the appellant and its related overseas suppliers. In the first round of proceedings, the adjudicating authority had accepted the declared transaction value and held that royalty was not includible in the assessable value.

However, following a Revenue appeal, the matter was remanded for fresh examination. In the de novo proceedings, the adjudicating authority concluded that royalty was includible on the reasoning that the imported components constituted integral raw materials for manufacturing CE+T-branded products. This decision was subsequently upheld by the Commissioner (Appeals), leading to the present appeal before CESTAT. 

Before the Tribunal, the appellant contended that Rule 10(1)(c) requires satisfaction of two cumulative conditions before royalty can be added to the value of imported goods.

According to the appellant, the royalty payments related to manufacturing rights, technical know-how, patents, trademarks and engineering support granted by the foreign collaborator. The royalty, fixed at 2% of the turnover or net selling price of finished products, became payable only in relation to finished products manufactured and sold in India. 

The appellant submitted that none of the contractual agreements required it to pay royalty as a condition for purchasing or importing raw materials or components. Therefore, the royalty was consideration for post-import manufacturing rights and commercial exploitation of intellectual property rather than a payment connected with the import transaction itself. 

The Revenue, on the other hand, argued that the appellant and the foreign supplier were related entities and that the import of components, manufacture of CE+T-branded products and payment of royalty formed part of an integrated commercial arrangement.

According to the Department, the imported components constituted the essential basis for manufacturing the finished products on which royalty was calculated. It therefore argued that there was a sufficient nexus between the royalty payments and imported goods to justify their inclusion in the assessable value. 

The Tribunal examined Rule 10(1)(c) of the Customs Valuation Rules, 2007, which provides for inclusion of royalties and licence fees where such payments are related to imported goods and are required to be paid, directly or indirectly, as a condition of sale of the imported goods.

CESTAT observed that royalty payments do not automatically become includible merely because they are paid by an importer to its foreign collaborator.

The Tribunal held that two cumulative statutory conditions must be established the royalty payment must be related to the imported goods; and payment of the royalty must constitute a condition of sale of the imported goods.

According to the Tribunal, unless both requirements are affirmatively established by the Revenue, the assessable value cannot be enhanced by including royalty. The burden of establishing these statutory ingredients lies on the Department. 

The Revenue had also relied upon Rule 10(1)(e), which covers other payments made as a condition of sale of imported goods.

CESTAT held that neither Rule 10(1)(e) nor the Explanation to Rule 10 could assist the Department in the absence of the primary statutory requirements. The Explanation, according to the Tribunal, does not create an independent charging mechanism or enlarge the substantive scope of Rule 10(1)(c) and (e).

It merely clarifies that where the statutory conditions for inclusion are otherwise fulfilled, the fact that imported goods undergo processing after importation would not by itself prevent inclusion of the relevant charges. 

A key observation of the Tribunal was that the Department had proceeded on the assumption that because imported components were used to manufacture CE+T-branded finished products, the royalty automatically became connected with the imported goods.

CESTAT rejected this broad approach, distinguishing between payments connected with the importation of goods and payments arising from post-import manufacturing and commercial exploitation.

The Tribunal observed that royalty paid for technical know-how, intellectual property rights, trademarks, manufacturing rights and post-import commercial exploitation cannot automatically be loaded into the value of imported goods merely because imported components are subsequently used in manufacturing. 

The Tribunal examined the contractual framework between the parties, including the Term Sheet dated March 6, 2008, Royalty Agreement dated April 1, 2010 and Licence Agreement dated April 1, 2012.

Under the arrangements, the foreign collaborator provided manufacturing rights, technical assistance, engineering support, patents, trademarks, confidential technical know-how and manufacturing technology. Royalty at 2% was calculated on the net selling price of finished products manufactured and sold using CE+T technology. 

Importantly, none of the agreements stipulated that purchasing imported components was conditional upon payment of royalty. The Tribunal also noted that the royalty calculation was not linked to the assessable value, invoice value or quantity of imported components.

Instead, the royalty liability arose after manufacture of finished products and their subsequent commercial sale. CESTAT therefore concluded that the contractual structure demonstrated that the payment was for post-import manufacturing rights and exploitation of intellectual property, rather than consideration connected with importation. 

The Tribunal also considered the appellant’s year-wise procurement data.

The appellant relied upon the figures to contend that purchases from the related foreign suppliers constituted only a limited portion of its overall procurement requirements, while substantial raw materials were sourced domestically or from unrelated suppliers. 

CESTAT found considerable force in this submission. It observed that the procurement pattern weakened the Department’s contention that royalty payments were directly relatable to the imported goods or constituted a condition precedent for their importation. According to the Tribunal, the data reinforced the position that royalty was fundamentally linked to technology transfer, manufacturing rights and post-import commercial exploitation. 

The Tribunal also referred to the Supreme Court’s decisions in Ferodo India Pvt. Ltd. v. Commissioner of Customs, Mumbai and Toyota Kirloskar Motor Pvt. Ltd. v. Commissioner of Customs, Bangalore.

CESTAT noted that these decisions establish that royalty payments relating to technical know-how or licence agreements cannot automatically be added to the transaction value of imported goods unless the Revenue establishes a clear nexus between the royalty and imported goods and demonstrates that the royalty constituted a condition of sale. 

The Tribunal also relied upon its earlier decisions in Ajinomoto India Pvt. Ltd. and BBL Daido Pvt. Ltd., which dealt with similar questions concerning royalty and licence payments under Rule 10.

In Ajinomoto, the Tribunal had held that the Explanation to Rule 10 could not independently justify inclusion of royalty unless the primary requirement of establishing a condition of sale was satisfied. Similarly, in BBL Daido, the Tribunal held that even a direct or indirect nexus between imported raw materials and royalty was insufficient unless the Department independently established that royalty payment was a condition of sale of the imported goods. 

CESTAT ultimately held that the royalty payments made under the contractual arrangements did not satisfy the requirements of Rule 10(1)(c) or Rule 10(1)(e) of the Customs Valuation Rules, 2007.

The Tribunal further noted that although the original adjudicating authority had initially concluded that royalty was not includible, the subsequent de novo proceedings did not produce any fresh contractual clause, additional documentary evidence or independent material establishing that payment of royalty was a condition of sale of the imported goods. 

The Commissioner (Appeals), according to the Tribunal, had substantially adopted the same reasoning without independently examining whether the mandatory statutory requirements under Rule 10 were satisfied. CESTAT emphasized that customs valuation provisions constitute a statutory code and additions to transaction value cannot be sustained merely on generalized commercial assumptions. 

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