Customs rules for telecommunications

Foreign trade and customs regulation has been completely reformed following the creation of the Customs Union (the “CU”) of Russia, Belarus and Kazakhstan. The fundamentals of the CU are defined in the Agreement on Creating a Single Customs Area and Forming the Customs Union (Dushanbe, 6 October 2007). The CU represents a form of trade and economic integration of the parties. It creates a single customs area on which:

1. reciprocal trade in goods of the Customs Union (i.e. goods originating fr om the single customs area or fr om third countries and released into free circulation in it) is not subject to customs duties, quotas and equivalent measures. The same is true of restrictions of an economic nature, save for those which are specially protected, antidumping and compensatory measures;
2. trade with third countries is subject to: a common customs tariff (with specific temporary exceptions); common measures for regulating external trade in goods and a trading regime; common rules of country of origin and customs value; uniform customs administration rules; and a rule whereby and goods which are banned or subject to non-economic restrictions are contained in common lists.

A single customs area presupposes that there are no borders between the CU member states and, as a result, no requirements to perform customs formalities and to receive import licences (if needed) in respect of goods moved under trade transactions fr om one CU member state to another. However, requirements for export control, technical regulation, veterinary, sanitary and phytosanitary control need to be observed in each country in the same way as before, notwithstanding steps being taken to unify them. Moreover, special rules on the payment of indirect taxes (VAT and excise duties) need to be applied in internal trade between the CU member states.

Legislation governing customs formalities and procedures is now structured into six levels, the highest level being the Customs Code of the Customs Union, followed by international agreements entered into by the CU member states and the decisions of the CU commission (which have the status of international agreements which do not need to be ratified and have direct effect).

The next level is national legislation, which may regulate the specifics of applying CU legislation, which may be vary depending on the member state of the CU. In Russia, this is done be Federal Law No. 311-FZ On customs regulation in the Russian Federation dated 27 November 2010. In its turn, it empowers the Russian Government and federal executive authorities to issue regulations governing specific issues.

The CU Customs Code establishes exceptions fr om the single customs area. For instance, goods imported into the single customs area may only be declared in the same CU member state as that in which the legal entity declaring the goods in question is registered. Accordingly, if goods are supplied under a foreign trade contract concluded by a Russian company then it may not file a customs declaration in respect of such goods with the customs authorities in Belarus or Kazakhstan. This restriction has been established to avoid the flows of trade and finance being changed and manufacturing being relocated from Russia to Kazakhstan or Belarus in view of the differences, in particular, in their customs administration and level of corruption. However, we believe that this barrier can easily be circumvented by creating a subsidiary in the relevant country which will conclude a supply contract with a foreign manufacturer. The subsidiary can then deliver goods to the other Customs Union countries and also throughout the CIS.

Conditionally released goods which have been placed under the customs procedure of release for internal consumption and in respect of which a CU member state applies rates of import duties which are lower than those established by the Single Customs Tariff may be used only within the CU member state whose customs authority released them.

Customs representatives may carry out their activity only within the state in which they have been registered. The status of an authorised economic operator is also recognised only within the state whose customs authority granted that status. Preliminary decisions have force exclusively within the CU member state whose customs authorities took those decisions. An example of exclusions from the single customs area is a prohibition on moving temporarily imported goods with a full conditional exemption from paying customs duties and taxes into different CU member states from the one wh ere the goods were placed by the customs authority under the customs procedure of temporary import (release).

Importing encryption and radio-electronic devices

The main amendments which affect goods imported by telecommunications companies are the rules for complying with restrictions on the import of encryption devices, radio-electronic devices (“REDs”) and high-frequency devices (“HFDs”).

From 1 January 2010, there has been a significant extension of the customs classification of equipment which is subject to import control in the area of encryption devices. For example, the list includes:

1. printers, photocopiers and fax machines with an encryption function which fall within subparagraphs 8443 32 100 9, 8443 32 200 0 and 8443 99 100 9 of subheading 8443 31 of the Harmonised System (the “HS”);
2. subscriber communications devices with an encryption function which fall within subparagraphs 8517 11 000 0, 8517 12 000 0, and 8517 18 000 0 of the HS;
3. televisions and equipment for accessing the Internet with an encryption function falling within subparagraphs 8528 71 300 0, 8529 90 650 0 and 8529 90 970 0 of subheading 8517 62 000 of the HS.

Now a compulsory notification procedure applies to devices and equipment which previously did not require an import licence (under clause 1 of the Regulations on Licensing Activity for Distributing Encryption and Cryptographic Devices approved by the Russian Government’s Resolution No. 957 dated 29 December 2007). Previously, a so-called “refusal letter” was only sometimes required from the Russian Federal Security Service’s Centre for Licensing, Certification and the Protection of State Secrets (the “FSS Licensing Centre”).

One positive point is, however, worth highlighting: as distinct from refusal letters issued by a specific organisation, a registered notification allows the relevant encryption devices to be moved across the CU customs border. There is no need to apply to the consenting authorities in CU member states for a second time or to put together any other permissive documents.

If equipment containing encryption devices is moved across the customs border for the purpose of being repaired or replaced under obligations under an agreement or contract, or if it is moved for an organisation’s own needs, the it is sufficient to receive an opinion from the FSS Licensing Centre (i.e. no licence is needed for the import in this instance).
In remaining instances, the import and export of equipment containing encryption devices requires a licence which is issued by the Russian Ministry of Industry and Trade on the basis of an opinion of the FSS Licensing Centre. That a registered importer must have a licence to carry out activity with encryption devices in Russia is a mandatory condition for an opinion to be issued stating that a shipment of encryption devices may be imported.

It should be noted that Decision No. 434 of the Commission of the Customs Union dated 20 September 2010 has simplified the procedure for obtaining an opinion. Firstly, when applying to the FSS Licensing Centre for it to be issued, a party involved in foreign trade is not obliged to state the number of encryption devices it intends to import or export. In addition, the opinion for a specific encryption device is issued only once, which means that it is possible to obtain from the Ministry of Industry and Trade single licences for a maximum duration of a year for the import and export of a specific model of encryption device on the basis of the same opinion. There is no need to make repeated applications every year to the FSS Licensing Centre.

Secondly, under the new rules, a party involved in foreign trade need not reveal to the FSS Licensing Centre the encryption source codes used in the equipment they propose to import or export. We understand that these amendments are extremely important for companies involved in foreign trade in encryption devices, since the encryption source codes (algorithms) may represent proprietary information the disclosure of which would entail the risk of business being lost.

Thirdly, under the new version of the Regulations, the overall timeframe for obtaining a licence from the Ministry of Industry and Trade should not exceed 90 days from the date of the application for the opinion. This takes account of the possible need to conduct a scientific and technical expert review of the encryption device. Thus, the Regulations establish the exact time when the party involved in foreign trade can count on receiving the licence.

The most negative change in the procedure for importing REDs and HFDs is the fact that an obligation has been introduced to obtain an import licence. Since no licence was required before 1 January 2010 to import REDs and HFDs, the Ministry of Industry and Trade’s local divisions had no experience of issuing them. This initially led to significant delays in customs clearance.

An exception from the requirement to obtain an import licence applies to the re-import REDs and HFDs that had been temporarily exported out of the Customs Union. In practice, the customs authorities also regard this as including the import of radio-electronic equipment which had been exported under a customs procedure and repaired, i.e. the goods were processed outside the customs area. However, the customs authorities and the Ministry of Industry and Trade consider that this exception cannot be applied if the servicing work included faulty equipment being replaced by working equipment with identical radio-electronic characteristics. This is because, in contrast with the rules for importing encryption devices, such replacement is not stipulated by either a decision of the Interstate Council of the Eurasian Economic Community or a decision of the Commission of the Customs Union.

We consider that this is a formal argument, and that this approach does not correspond to the intention behind the import restrictions established for REDs and HFDs.

Customs evaluation of equipment containing software

As before, determining the customs value of telecommunications equipment remains a topical issue. A company is often not interested in making full use of the equipment’s capabilities. Say, for example, that the technical characteristics of equipment mean that it can service 2,000 subscribers, but it is sufficient initially for it to be able to service 1,000 users. In the event that in-built software is adapted to restrict the equipment’s capacity to a certain number of users, many suppliers would be prepared to offer a price reduction. However, if it became necessary to increase the number of users, the company would have to pay a fixed amount (in practical terms, this is of the nature of a licence payment) to the supplier so that it supplied the code (either using a separate medium or via the Internet) enabling the software to be used more widely.

Moreover, suppliers often assume an obligation to service and provide technical support in respect of software built into the equipment; this includes an obligation to provide subsequent updates and upgrades. At the same time, in most cases, the cost of services such as updates is included in the price of the equipment supplied, while an additional payment is made for an upgrade to a later version of the software.

Do the above circumstances affect the customs value of the imported equipment?

Under article 4 of the Agreement between the Governments of the Russian Federation, Belarus and Kazakhstan dated 25 January 2008 On determining the customs value of goods moved across the customs border of the Customs Union, the main method for determining the customs value of goods is the cost of the transaction with the imported goods method (“Method 1”). To this end, the customs value of goods imported into the single customs area of the CU is the cost of the transaction involving such goods, i.e. it is the price actually paid or to be paid when they are sold for export, as increased by additional factors stipulated by legislation if those elements are not included in the price of the goods.

The application of Method 1 makes it possible to determine the exact amount of the customs value and, accordingly, the exact amount of the customs payments that have to be made. In practice, applying any of the following methods usually leads to both of them being increased.

The applicability of Method 1 to determining the customs value of goods is subject to the following conditions:
a lack of restrictions in respect of the purchaser’s rights to use and dispose of the goods (“Condition 1”);
the sale of the goods or their price must not depend on any terms or obligations which could have an influence on the price that could not be quantified (“Condition 2”);
no part of the income or proceeds of a subsequent sale or disposal by another method or use of the goods by the buyer (“subsequent income”) must be owed directly or indirectly to the buyer, save in instances wh ere additional charges may be incurred (“Condition 3”).
The customs authorities may regard as an indicator of non-compliance with Condition 1 a restriction on the buyer’s right to use in full all of the technical capabilities of software that has been installed. Thus, the customs authorities may adjust the declared customs value of such equipment, increasing it in proportion to the value of the part of the software not claimed.
The customs authorities may also decline to accept the declared customs value because it does not comply with Condition 2, which states that the price of goods is calculated taking account of the fact that the buyer is engaged in a process of operating the equipment and will update it from time to time. It will pay for such updates and for upgrades to later versions of the software. This could, in particular, lead the customs authorities to conclude that the foreign supplier discounted the price of the initial version because the buyer will later pay for it to be upgraded.
Payments for an extension of rights to use software and also for updates and upgrades may be treated as “subsequent income” or licence payments for using intellectual property. Such payments should be included in the customs value of imported goods when they meet the conditions stipulated by legislation.
Thus, wh ere it is possible to extend rights to use equipment, and wh ere the supplier undertakes to upgrade or update software and the buyer undertakes to pay for such services, there is a high chance that such additional payments will be included in the customs value of the equipment and the additional customs payments may reach significant levels. However, it is possible to assess this risk definitively only after examining the circumstances of the particular transaction.