Kim & Chang’s Customs Practice recently obtained a decision from the Supreme Court of Korea holding that the cost of defect warranty repairs (the “Warranty Costs”) paid by the plaintiff in the case (the “Plaintiff”) did not constitute an indirect payment for imported goods under the Customs Act because the Plaintiff was the principal providing the defect warranty pursuant to the legal relationship defined by the contracts executed among the relevant parties (Supreme Court Decision 2018Du56619, rendered on May 6, 2021).

The Plaintiff sold certain products through a domestic dealer (the “Dealer”) after importing the products from its overseas headquarters (“Headquarters”).  Product repairs under the defect warranty were managed by the Dealer, which had entered into a sales and service contract with the Plaintiff.  Once the Dealer carried out repairs and claimed payment of Warranty Costs through Headquarters’ reimbursement system, Headquarters first settled and reimbursed the Warranty Costs to the Dealer and then the Plaintiff repaid the corresponding amount to Headquarters.

However, when the Seoul Customs Office (the “SCO”) conducted a customs audit on the Plaintiff, the SCO determined that the Warranty Costs were a part of the payments made for imported products, rather than a payment by the Plaintiff’s for its own account.  The SCO held that the Warranty Costs constituted an indirect payment for imported goods under the Customs Act and assessed customs duties, etc. on the Warranty Costs.

Regarding the SCO’s assessment, the Seoul Administration Court stated that the principle responsible for the defect warranty liability must be determined based on the economic reality.  Therefore, while the contractual liability for the defect warranty lay with the Plaintiff, in reality, it was Headquarters that determined the details of the defect warranty and covered the relevant costs.  As such, the Plaintiff’s payment of the Warranty Costs to the Dealer through Headquarters ultimately amounted to a separate payment of the Warranty Costs with respect to the defect warranty that the seller (exporter) of the product was obligated to perform as a condition of the transactions relating to the products imported by the Plaintiff.  Accordingly, the Seoul Administration Court held that the Plaintiff’s payment of the Warranty Costs constituted an indirect payment for imported goods under the Customs Act.

On appeal, however, the Seoul High Court and the Supreme Court held that (i) the legal relationship under the relevant contract which provides that the defect warranty liability lies with the Plaintiff must not be overlooked; (ii) Headquarters’ payment of the Warranty Costs to the Dealer was no more than Headquarters’ performing the Plaintiff’s obligation as a proxy or agent, and as the economic reality is that the Plaintiff’s payment of the Warranty Costs to the Dealer through Headquarters is no different than the Plaintiff’s direct payment to the Dealer, the Plaintiff must be deemed as the principal responsible for the defect warranty; and (iii) it cannot be deemed that the Plaintiff paid the Warranty Costs to Headquarters as a condition for the transaction relating to the imported goods.  

Implications

The number of cases where the Korean customs authorities have tried to assess customs duties on payments—including repair costs, royalties (e.g., for the use of trademarks), marketing costs and other relevant fees—made by Korean affiliates of multinational companies to their overseas headquarters or other overseas affiliates have been increasing.  In the above-mentioned case, the Supreme Court notably held that, to treat warranty repair costs as dutiable indirect payments under the Customs Act, the fact that the liability for the defect warranty lies with the seller (exporter) must be clearly substantiated, and that, in doing so, the applicable legal relationship under the relevant contract must be respected.