How a European Court case could impact businesses operating in the Middle East?

The European Court of Justice has confirmed that the value of software (designed in the European Union (EU)) and made available free of charge by the buyer to the third-country seller, could be added to the price of imported goods for Customs valuation purposes. This will have a global impact, which may affect businesses operating in the Middle East (ME). This note provides insight on the topics listed below.

Transaction value and additional elements

According to a basic principle of Customs law, the value of imported goods for Customs purposes is determined by the price the buyer pays for such goods to the seller when sold for export. Generally speaking, the higher this amount (transaction value), the higher the Customs duty. As is the case with most principles, however, the transaction value principle is not absolute. In order to prevent misuse and to ensure that Customs duties are calculated on the basis of the real economic value of imported goods, Article 71 of the
European Union Customs Code (UCC) allows adjusting the price paid or payable by adding certain elements, to the extent they are not already reflected in the price paid or payable.  

Case C-509/19

On 10 September 2020, the Court of Justice of the European Union (CJEU) issued a judgment in case C-509/19. The issue in that case was the disputed addition to the price paid by an EU buyer for imported vehicle control units of the value of software related to such units. The software in question was developed by the buyer in the EU and provided free of charge to the third-country manufacturer of those units. The control units were then imported into the EU with the software installed on them.

The price the buyer paid for the imported control units did not include the software development costs. The question before the CJEU was whether Article 71 of the UCC allowed, nevertheless, the Customs authorities to supplement that price with the value of the software development costs, which would result in a higher Customs duty. The question was thus whether software development could be considered as a dutiable assist under Article 71(1)(b) of the UCC.

The buyer objected to the addition of the software development costs to the price it paid for the imported control units, arguing that Article 71(1)(b) of the UCC, which does not explicitly mention software, lacked legal basis for such an adjustment. 

Assists under Article 71(1)(b) of the UCC

Even though article 71(1)(b) of the UCC does not explicitly mention software, the CJEU stated that it had already had occasion to reject a similar argument in the Compaq case (C-306/04). The CJEU further confirmed Conclusion No 26, included in the Compendium of Customs Valuation Texts issued by the Customs Code Committee, that intangible assets, such as software, could, in principle, fall under two subparagraphs of Article 71:

• As “materials, components, parts and similar items incorporated into the imported goods” under subparagraph 1(b)(i);
• As “engineering, development, artwork, design work, and plans and sketches undertaken elsewhere than in the Union and necessary for the production of the imported goods” under subparagraph 1(b)(iv).

The key difference is that software developed in the EU would be dutiable when classified under subparagraph 1(b)(i) and non-dutiable when classified under subparagraph 1(b)(iv). 

Decision but no resolution

Based on the information before the CJEU, the software in question provides smooth communication of applications and systems in a vehicle and is required to execute various technical processes to be carried out by the vehicle’s control unit. The manufacturers of the control units use the software to perform a functionality test prior to the delivery of the control units. The test protocol documents the fact that the interaction between the control unit and the software functions smoothly. The software further makes it possible to ascertain whether any errors that have arisen upon delivery were caused during transport or in the course of implementation of the software.

The reason this case is complicated therefore is that this specific software potentially qualifies for both subparagraph 1(b)(i) and subparagraph 1(b)(iv) of Article 71 of the UCC:

• Incorporation: software for smooth communication of applications and systems in a vehicle and required to execute various technical processes to be carried out by the vehicle’s control unit

versus

• Production: the software to perform a functionality test prior to the delivery of the control units and to make it possible to ascertain whether any errors that have arisen upon delivery were caused during transport or in the course of implementation of the software. 

In resolving the case at hand, the CJEU, however, did not see the need to clearly determine under which subparagraph of Article 71 the software in question fell. The Court limited its judgement to the fact that this software could be a dutiable assist based in article 71(1)(b) of the UCC. The fact that the software could qualify for subparagraph 1(b)(i) and 1(b)(iv) is relevant for the importer, yet this was not part of the request issued by the German Court and therefore not part of this judgement.

An important consideration highlighted by the CJEU is whether the software’s functionality is such as to confer on the control units a real value higher than their transaction value. This is significant, as only when this is the case, could the addition of such value to the price actually paid for the imported goods be justified. Eventually, the resolution of this question, as well as the question how this combined piece of software should be classified under subparagraphs 1(b)(i) and 1(b)(iv) of Article 71 of the UCC, would be for the national court to assess.

Impact on business

The discussion about the role of intangible assets in determining the value of goods for Customs purposes is likely to continue. Arguably, it was less important for the CJEU to neatly fit the software into one of the subparagraphs of Article 71 of the UCC than to confirm a broader principle –  intangible elements could be added to the price actually paid, as long as they increase the economic value of imported goods. Customs authorities may, however, need to grapple with the task of allocating these elements an appropriate place in the text of Article 71(b), when applying the Court’s guidance in practice. For instance, in a situation where EU-developed software could potentially qualify under both subparagraph 1(b)(i) and 1(b)(iv) of Article 71 of the UCC due to its specific functions in the pre- and post-production process: would apportioning be appropriate or is there a specific order in the application of the subparagraphs of Article 71(1)(b) that should be considered? A resolution of these questions could have a substantial impact on the amount of Customs duty, given that EU-developed software falling under subparagraph 1(b)(iv) is not dutiable. 

Simply, any businesses involved in importing goods into the ME or any other market are therefore strongly advised to carefully review the European CJEU Judgement in case C-509/19 and assess its impact on their supply chains and contractual arrangements. It is clear that Customs valuation has become a high priority and is increasingly scrutinized throughout the ME region and other markets as now in the EU. Even former cases on e.g. Transfer pricing adjustments (Hamamatsu), Royalties (Curtis Balkan) and now this one of software assists are leading to difficult discussions with the Customs authorities.

We therefore recommend companies to review and update their Customs valuation procedures frequently and, where required, obtain official confirmation of their correctness from the Customs authorities.