HQ 545370 - Dutiability of Certain Royalty Payments. - United States International Trade Commision Rulings

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HQ 545370

March 4, 1994

VAL CO:R:C:V 545370 ER

CATEGORY: VALUATION

Sandra Liss Friedman, Esq.
Barnes, Richardson & Colburn
475 Park Avenue South
New York, New York 10016

RE: Dutiability of Certain Royalty Payments.

Dear Ms. Friedman:

This is in response to your letter of June 25, 1993, on behalf of your client, Junior Gallery Ltd., (hereinafter referred to as "Gallery", "importer" or "buyer"), requesting a ruling on whether certain royalty payments are dutiable. We regret the delay in responding.

FACTS:

According to your submission, Gallery is an importer of ladies' wearing apparel. Pursuant to written agreement, dated May 17, 1992, between your client and Echo Design Group, Inc., (hereinafter referred to as "Echo"), located in New York, Echo periodically submits proprietary copyrighted fabric designs to Gallery for possible use in garments produced by Gallery.

In consideration for the right to use the fabric designs Gallery will pay Echo a non-refundable sum of $xxx, which amount will be credited towards a royalty of y percent of Gallery's net revenues on its sales in the U.S. of ladies' wearing apparel that incorporate an Echo design. No royalties beyond the non- refundable initial sum are due unless the imported merchandise is sold. A copy of that agreement was submitted with your request.

You additionally state that Echo is unrelated to Gallery and that the design work produced by Echo is undertaken in the United States. For purposes of this ruling, we will assume that Echo bears no relationship to the foreign manufacturers (or "sellers") producing the apparel for Gallery.

ISSUE:

Whether the described royalty payments that Gallery makes to Echo are dutiable as part of the transaction value of the imported merchandise.

LAW AND ANALYSIS:

The preferred method of appraising imported merchandise is transaction value which is defined in section 402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. 1401a(b)). This section provides, in pertinent part, that the transaction value of the imported merchandise is the price actually paid or payable for the merchandise when sold for exportation to the United States plus amounts for certain items enumerated in section 403(b)(1) of the TAA.

19 U.S.C. 1401a(b)(1) provides that the transaction value of imported merchandise includes ... "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." The corresponding regulation is found in section 152.103(f), Customs Regulations.

Both statute and regulation parallel the Statement of Administrative Action ("SAA"), which was adopted by Congress and has the force of law. Although there is an absence of precedent directly addressing dutiability of royalty payments made to third parties in connection with copyrights and trademarks, the law states that such payments are generally not dutiable unless they are a condition of the sale. The relevant portion of the SAA provides:

Additions for royalties and license fees will be limited to those 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. In this regard, royalties and license fees for patents covering processes to manufacture the imported merchandise will generally be dutiable, whereas royalties and license fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise, will generally be considered as selling expenses of the buyer and therefore will not be dutiable. However, the dutiable status of royalties and license fees paid by the buyer must be determined on [a] case-by-case basis and will ultimately depend on: (i) whether the buyer was required to pay them as a condition of sale of the imported merchandise for exportation to the United States; and (ii) to whom and under what circumstances they were paid. For example, if the buyer pays a third party for the right to use, in the United States, a trademark or copyright relating to the imported merchandise, and such payment was not a condition of the sale of the merchandise for exportation to the United States, such payment will not be added to the price actually paid or payable. However, if such payment was made by the buyer as a condition of sale of the merchandise for exportation to the United States, an addition will be made.

SAA, H.R. Doc No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of Treasury, Customs Valuation under the TAA of 1979 (October 1981), at 48-49. The royalty in question is paid to a third party, Echo, for the right to use the copyrighted designs in the U.S.

In the General Notice concerning the dutiability of royalty payments, Vol 27 Cust. Bull. No. 6 (February 10, 1993) (hereinafter referred to as "General Notice"), Customs set forth a three-question test to identify whether a royalty payment is dutiable: (1) Was the imported merchandise manufactured under patent?; (2) Was the royalty involved in the production or sale of the imported merchandise?; (3) Could the importer buy the product without paying the fee? General Notice at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, point toward non-dutiability.

In the instant case, although the imported garments are not manufactured under patent, they do incorporate fabric bearing patterns identical or substantially similar to the proprietary copyrighted patterns of Echo. However, the royalty paid to Echo is not involved in the production or sale of the imported garments. The royalty is paid for the exclusive right of the importer to utilize the copyrighted patterns. This right is separate from the purchase price of the garments. Gallery may import the garments without paying the royalty because the royalty becomes due only upon the sale in the U.S. of the imported merchandise.

You additionally inquire whether the payments would be dutiable as either an "assist" or as "proceeds to the seller" within the meaning of 19 U.S.C. 1401a(b)(1)(C) and (E). Engineering, development, artwork, design work, and plans undertaken elsewhere than in the United States and necessary for the production of the imported merchandise may constitute an assist 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. (See, 19 U.S.C 1401a(h)(1)(A)(iv)). Inasmuch as the copyrighted design work to be provided by Echo to Gallery will be undertaken in the United States, such work is outside the statutory definition of an "assist" and is not dutiable. Nor does the fabric on which the copyrighted designs are printed constitute an assist so long as Gallery does not provide it to the manufacturer, directly or indirectly, and free of charge or at reduced cost.

Section 1401a(b)(1)(E) provides that the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller are dutiable as part of the price actually paid or payable. Under this section, the "seller" of the merchandise is the foreign manufacturer. The royalty payments are made by the buyer, Gallery, to an unrelated third party in the United States, Echo. Assuming Echo is also unrelated to the foreign manufacturers, the royalty payments do not constitute "proceeds to the seller" since these payments in no way accrue to the benefit of the foreign manufacturer. Accordingly, the royalty payments are not dutiable as proceeds.

HOLDING:

For the reasons discussed above and on the basis of the written agreement between Gallery and Echo and the additional information submitted in connection with this ruling request, we find that the subject payments made by Gallery to Echo are not dutiable royalties, nor are they dutiable as proceeds of a subsequent resale. Moreover, because the copyrighted design work to be provided by Echo to Gallery will be undertaken in the United States, such work is outside the statutory definition of an "assist" and is not dutiable. We additionally find that the fabric on which the copyrighted designs are printed does not constitute an assist so long as Gallery does not provide it to the manufacturer, directly or indirectly, and free of charge or at reduced cost.

Sincerely,

John Durant, Director
Commercial Rulings Division

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