HQ 0544381 - I.A. Request 34/89; payments for tooling to produce prototypes, research and development; license fees, royalties and technical aid; assists; apportionment of assists; indirect payments - United States International Trade Commision Rulings

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HQ 544381

November 25,1991

VAL CO:R:C:V 544381 DPS

CATEGORY: VALUATION

Area Director
Western Great Lakes Area
Minneapolis, Minnesota 55401

RE: I.A. Request 34/89; payments for tooling to produce prototypes, research and development; license fees, royalties and technical aid; assists; apportionment of assists; indirect payments

Dear Sir:

This is in response to your memorandum (App-7- 10:GL:AAD:CO:I JB) dated June 16, 1989, and a memorandum from NIS Division, Branch 1 (CLA-2-85:S:N1:101-118) dated August 7, 1989, requesting internal advice on transactions involving Lake Center Industries (LCI), and the dutiability of certain payments and fees in connection with the importation of prototype switches imported from England during the years 1984 through 1987. LCI, formerly represented by the law firm of Katten Muchin & Zavis, which initiated this internal advice request through the port of Minneapolis, Minnesota, now represents itself through its in-house counsel.

FACTS:

LCI manufactures and sells certain automobile switchgear in the United States. In connection with its manufacture of the switchgear, LCI imports prototype switches from Lucas Industries ("Lucas") in England. The switchgear are imported through the ports of Detroit and Minneapolis. In addition to the invoiced amounts that LCI pays Lucas for the prototypes, during the years 1984 through 1987, LCI also made payments to Lucas for tooling, research and development ("R&D") and testing.

LCI asserts that while the tooling, R&D, testing equipment and testing it pays for appears to be includable in transaction value, the dutiable portion of those expenditures is minimal. In its submission, LCI characterizes these payments as assists and contends that the payments should be allocated over the products benefited by them in accordance with section 152.103(e) Customs Regulations (19 C.F.R. 152.103(e)), in a manner consistent with generally accepted accounting principles. Minneapolis Customs and the National Import Specialist agree that the payments for tooling, R&D and testing do not fall within the statutory definition of assists. They believe that the payments are indirect payments which are part of the price actually paid or payable for the imported merchandise, which in this case are the prototypes.

In addition to payments for tooling, R&D, and testing, LCI pays Lucas a technical aid fee and part of royalty income. Pursuant to the license agreement between Lucas Industries and LCI, Lucas granted LCI the exclusive right to make, use and sell in the United States certain switchgear. Under the agreement, Lucas undertook to (1) allow LCI representatives to visit Lucas' facility in England and arrange for their instruction in Lucas' methods and techniques, (2) supply LCI with the technical information necessary to enable LCI to manufacture and sell the devices, (3) communicate to, and allow LCI to use, any improvements, (4) seek to obtain patents or registered designs in the United States for any improvements and (5) offer to sell devices or their components to LCI. In addition, Lucas and LCI agreed to share, in equal parts, certain costs associated with each individual device manufactured under the license agreement. These costs are:

(1) the cost of production and sample tooling performed in the United States by LCI, less reimbursement of these costs to LCI by the ultimate U.S. purchaser;

(2) the cost of sampling and sales promotion conducted by LCI;

(3) the cost of liaison visits of LCI personnel to Lucas' facilities;

(4) the cost of LCI's custom-designed plant and equipment;

(5) the cost of liaison visits of Lucas personnel to LCI's facilities; and

(6) the cost of prototypes, samples, testing and development incurred by Lucas, less amounts received by Lucas from the ultimate U.S. purchaser.

When manufacturing of a particular device in commercial quantities begins, the above costs are totalled and divided. If one party has incurred more than fifty percent of the costs, half of the excess amount becomes a debt of the other party. When Lucas incurs more than fifty percent of these costs, LCI pays Lucas what it characterizes as a license fee in the amount of fifty percent of the excess costs.

Counsel states that the technical aid fee is a one-time payment, representing in the words of the agreement, "the value of the right to use the Patents, Designs, Copyright and know-how supplied by Lucas in respect of all current and future Licensed Devices." The technical aid fee is paid in increments and is limited, in any one year, to the lower of (a) twenty percent of a total specified amount (b) ten percent of the gross Royalty Income or (c) one and one-half percent of the sales revenue from the licensed devices. Both the license fee and the technical aid fee are paid by LCI out of its fifty percent share of royalty income. Royalty income is the sales revenue from the devices, less LCI's manufacturing costs, selling and administrative expenses, warranty costs and interest expense.

LCI contends that none of the payments provided for in LCI's license agreement are royalties and license fees of the type contemplated by section 402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a(b); TAA) because LCI is not required to pay them as a condition of the sale for exportation of the importred merchandise.

ISSUES:

(1) Whether the payments made by the importer of prototypes for tooling, R&D and testing, are considered to be assists or part of the price actually paid or payable for the imported merchandise; and whether such payments can be allocated over the number of devices that can be demonstrated to benefit from the expenditures, which include the imported prototype samples and all subsequent devices based on the prototypes that have been, and will be produced by LCI in the United States.

(2) Whether the subject license fees, technical aid and royalty payments are dutiable as statutory additions to transaction value pursuant to 402(b)(1)(D).

LAW & ANALYSIS:

For the purpose of this response, we assume that transaction value is the proper basis of appraisement. Transaction value, the preferred method of appraisement is defined in section 402(b)(1) of the TAA as the "price actually paid or payable for the merchandise" plus five enumerated statutory additions. As stated in 402(b)(4)(A):

The term "price actually paid or payable" means the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.

The five enumerated statutory additions to transaction value set forth in 402(b)(1) of the TAA are as follows:

(A) the packing costs incurred by the buyer with respect to the imported merchandise;

(B) any selling commission incurred by the buyer with respect to the imported merchandise;

(C) the value, apportioned as appropriate, of any assist;

(D) any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States; and

(E) the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller.

Tooling, R&D and Testing

With regard to the first issue involving LCI's payments for tooling, R&D and testing, the importer asserts that such payments constitute assists, and should be apportioned over the anticipated production both abroad and in the U.S. Your office takes the position that such payments are not assists, but rather indirect payments for the imported merchandise. We agree. The term "assist" is defined in section 402(h)(1)(A) of the TAA as follows:
any of the following if supplied directly or indirectly, and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise:

(i) Materials, components, parts, and similar items incorporated in the imported merchandise.

(ii) Tools, dies, molds, and similar items used in the production of the imported merchandise.

(iii) Merchandise consumed in the production of the imported merchandise.

(iv) Engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise.

It has been Customs position that a payment of money from the buyer to the foreign manufacturer does not constitute an assist within the meaning of 402(h)(1)(A). In Headquarters Ruling Letter (HRL) 543376, dated November 13, 1984, Customs held that a payment by an importer to a foreign manufacturer for the design and development of a prototype industrial robot was not an assist, but rather was dutiable as part of the price actually paid or payable to the seller as a direct payment for the prototype. See also HRL 543983, dated December 2, 1987.

With regard to testing costs, Customs has held that testing costs are not assists, but are dutiable as part of the price actually paid or payable when paid by the buyer to the seller of the imported merchandise (See HRL 542187, dated November 7, 1980 (TAA No.11), and HRL 543645, dated February 17, 1987). With regard to payments for tooling, Customs has held that payments made by the buyer to the seller to produce or buy such items as tools and molds (which, if provided by the buyer, would constitute assists) necessary to produce the subject merchandise, constitute part of the price actually paid or payable for the imported merchandise. (See HRL 542812, dated July 19, 1982, and HRL 543983, dated December 2, 1987).

Here, the imported prototypes that are developed, tested and sold by Lucas to LCI are a necessary step in the subsequent manufacture of switchgear in the United States. Accordingly, we find that the payments for tooling, R&D and testing are part of the price actually paid or payable for the imported prototypes. We note that the Customs Regulations do not provide guidelines specifically for the apportionment of direct payments, as they do for assists. Consequently, under the circumstances no authority exists to apportion these expenditures over the anticipated number of units produced, as LCI's former counsel has requested. Furthermore, even if apportionment was proper under the circumstances, which it is clearly not, such apportionment pursuant to 152.103(e) of the Customs Regulations could only be applied to those units produced abroad and imported into the U.S., not to units manufactured in the U.S.

License Fees, Royalties and Technical Aid Fees

Based on the information provided in the I.A. request, the license fees, royalties and technical aid fees described by LCI relate to LCI's purchase from Lucas of the right to use, make and sell certain switchgear in the U.S. Consistent with their agreement, LCI acquires the designs, patents, copyrights and know-how utilized by Lucas in developing the prototypes, for production of switchgear in the United States by LCI. LCI has indicated that payments made pursuant to the license agreement are not related to the imported merchandise. LCI is not required to pay royalty and license fees as a condition of the sale for exportation of the merchandise. Rather, these payments are related to LCI's domestic production of switchgear. The technical aid payment, stated to be a one-time payment, likewise covers U.S. production units, and is not related to the sale of imported merchandise.

Consistent with the language set forth in 402(b)(1)(D) of the TAA, Customs held in HRL 543773, dated August 28, 1986, that where the royalty payment is not related to the imported merchandise, is not paid as a condition of the sale of the imported merchandise, is not connected to the ownership or importation of the merchandise, but rather, the payment is for the use of the trademarks and techniques with regard to the product, the royalty is not added to the price actually paid or payable. Likewise, in HRL 543617, dated June 8, 1987, the licensing fee in question did not relate to the imported merchandise. The rights granted to the importer related to the distribution and servicing of the affected merchandise as well as the worldwide use of the manufacturer's technical data and trademarks. Customs held that the fee was not dutiable as part of the transaction value of the imported merchandise.

Here, the license fees, technical aid fees and royalties are not required to be paid as a condition of the sale of the imported merchandise (the prototypes) for exportation to the U.S. Based on the information provided, these various fees paid pursuant to the Licensing Agreement between LCI and Lucas, pertain directly to the U.S. production of switchgear that utilizes the technology, methodology, and equipment developed by Lucas and incorporated in the imported prototypes. As long as these payments are separate from the importer's payments for tooling, R&D and testing discussed above, they are not to be added to the price actually paid or payable for the imported merchandise.

HOLDING:

The payments made by LCI to Lucas for tooling, R&D and testing are part of the price actually paid or payable for the imported merchandise, which are prototype samples. The additional payments which are characterized as license fees, technical aid fees and royalties, paid by LCI to Lucas, are not required to be paid as a condition of the sale of the merchandise to the U.S. These payments are related to units produced in the U.S. Accordingly, they are not dutiable under 402(b)(1)(D) of the TAA.

Sincerely,

John Durant, Director
Commercial Rulings Division

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