HQ 544982 - Request for Internal Advice; Dutiability of Royalty Payments; Dutiability of Proceeds. - United States International Trade Commision Rulings

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HQ 544982

August 23, 1995

VAL CO:R:C:V 544982 ER

CATEGORY: VALUATION

District Director
Los Angeles

RE: Request for Internal Advice; Dutiability of Royalty Payments; Dutiability of Proceeds.

Dear Sir:

This is in response to your memorandum [ ], dated April 22, 1992, forwarding counsel's letter of January 13, 1992, on behalf of ["A"] in which internal advice is sought in connection with prior disclosure no.[ ] regarding the dutiability of certain royalty payments made by [A] to ["B"]. Another submission dated April 9, 1993, was received from a different law firm in which a ruling was requested concerning the same issue. The two requests have been combined and [A] is now being represented solely by the law firm responsible for the 1993 submission. We regret the delay in responding.

FACTS:

[A] imports merchandise purchased from ["C"] of Japan and other third parties. Pursuant to an agreement with [B], [A] pays [B} a royalty on the products purchased from [C] and the other third parties which incorporate the [B] trademark. [A] and [B] are related parties within the meaning of section 402(g)(1) of the Tariff Act of 1930, as amended (19 U.S.C. 1401a(g)(1); TAA). [C] and the other third parties are not related to either [A] or [B].

Two licensing agreements are involved, one signed in 1987 and the other in 1989. Pursuant to the terms of the 1987 agreement between [A] and [B], a royalty is paid for the right to use the trademark in connection with the manufacture in Japan and sales in the United States of the products manufactured by [C]. The royalty amount is based upon the FOB Japan price of the product sold by [C] to [A].

In the 1989 agreement, the royalty is paid for the exclusive, non-transferable right to use the trademark in the United States and elsewhere in association with the licensed products. The royalty amount is a percentage of the resale price of the products purchased from third parties and resold in the United States. The agreement also provides that royalties are not due when the licensed products are purchased from [B], nor when the licensed products are purchased from third parties and are then sold to [B] or [to A's related party A] of Canada, Inc. [B] may also from time to time exempt in writing, in its sole discretion one or more of the licensed products from royalty payments.

ISSUE:

Whether the described royalty payments that [A] makes to [B] are dutiable.

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 listed in section 402(b)(1) of the TAA. Sections 402(b)(1)(D) and (E) provide for additions to the price actually paid or payable for:

(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.

The corresponding Customs Regulations are found at 19 CFR 152.103(f) and (g), respectively.

Concerning royalties described under section 402(b)(1)(D), 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.

This decision necessitates a bifurcated analysis. As you are aware, Customs published a general notice concerning the dutiability of royalty payments (Vol. 27 Cust. Bull. No. 6 (February 10, 1993)) ("General Notice"), which discussed royalty payments and set forth guidelines to determine their dutiability. The Headquarters Ruling Letter ("HRL") analyzed in the General Notice is commonly known as the "Hasbro decision" (HRL 544436, dated February 4, 1991). The position set forth in the General Notice became effective for merchandise entered on or after May 10, 1993. Entries made before that date must be decided under the earlier analysis used by Customs. Accordingly, we will discuss the separate outcomes for entries made before and after May 10, 1993, including prospective entries.

For purposes of this decision, we will assume that the royalty payments are not part of the price actually paid or payable for the imported merchandise because they are not part of the total payment, directly or indirectly, made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller. See 19 U.S.C. 1401a(b)(4)(a). Instead, the royalty payments are made to a third party, unrelated to the seller, and are distinct from the price actually paid or payable. Thus, the issue to be resolved is whether the royalties are part of transaction value from the perspective of whether they constitute additions to the price actually paid or payable.

Pre May 10, 1993 entries subject to 1987 and 1989 agreements

As set forth above in the quoted portion of the SAA, "royalties and license fees paid to third parties for use, in the United States, of copyrights and trademarks related to the merchandise, will generally be considered as selling expenses and therefore will not be dutiable". However, "if such payment was made by the buyer as a condition of the sale of the merchandise for exportation to the United States, an addition will be made."

According to counsel, there are no sales agreements between the buyer and the seller, nor have we been presented with any documentation which evidences an agreement between the buyer and the seller in which the seller requires the buyer to pay the royalty to the licensor. However, the language in the 1987 licensing agreement provides that the right to use the trademark is granted to [A](the buyer/licensee) by [B] (the licensor) "in connection with the manufacture in Japan and sales in the United States of the Products" manufactured by [C] (the seller). The 1987 agreement: (1) identifies the seller, [C], as the party with whom [A] will contract for the manufacture of merchandise incorporating the trademark and from whom [A] will purchase the merchandise incorporating the trademark and (2) restricts the seller's use of the trademarks to merchandise manufactured for and sold to [A]. Based on the evidence presented, Customs finds that the royalty is paid in consideration for the seller's right to manufacture and the buyer's right to purchase merchandise which bears the licensor's trademark. Under these circumstances, the payments are a condition of sale of the imported merchandise.

Although the royalty payments made pursuant to the 1987 licensing agreement are dutiable under section 402(b)(1)(D), they are not dutiable as proceeds under section 402(b)(1)(E) of the TAA because they are paid to a third party, [B], who is unrelated to the seller and, insofar as we can determine on the basis of the evidence submitted, the payments do not accrue, directly or indirectly, to the benefit of the seller.

It is our understanding that entries were also made prior to May 10, 1993, pursuant to a 1989 licensing agreement. Unlike the 1987 agreement, the 1989 agreement does not provide that the royalties will be paid in consideration for the right to "manufacture" the imported merchandise. Instead, the 1989 agreement provides that [B] grants to [A] "an exclusive, non-transferable right, license and privilege, to use the Mark in the United States of America and elsewhere in association with the Licensed Products".

As quoted above from the SAA, "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." Under the terms of the 1989 agreement, there is no mention that the royalty payments are linked to the right to produce the merchandise; therefore, the payment of the royalties is not a "condition of sale" of the imported merchandise. Accordingly, royalties paid pursuant to the terms of the 1989 licensing agreement for merchandise entered before May 10, 1993, are not dutiable as a statutory addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA. If there were evidence, however, which established that it was the payment of the royalties by the importer that enabled the licensed products to be manufactured, we would regard this as an indication that the payments were a condition of sale. See, HRL 545361, dated July 20, 1995.

Prior to the issuance of the General Notice, Customs, position was that a royalty payment that was deemed to be nondutiable under section 402(b)(1)(D) of the TAA could not be dutiable as a proceed of a subsequent resale under section 402(b)(1)(E) of the TAA. Thus, royalties paid for the merchandise imported prior to May 10, 1993, pursuant to the 1989 agreement, which are non-dutiable under section 402(b)(1)( D) are also non-dutiable under section 402(b)(1)(E) of the TAA, the proceeds of subsequent resale provision.

Post May 10, 1993 entries subject to 1989 agreement

Whether royalty payments for merchandise entered after May 10, 1993 are related to the merchandise and are a condition of sale is determined by applying the three-question analysis set forth in the General Notice, supra. The first question is whether the imported merchandise is manufactured under patent. Based on the information submitted, we are unable to determine whether the merchandise is manufactured under patent. However, whether the merchandise is manufactured under patent is not critical to the determination of dutiability of the royalty payments addressed in the 1989 licensing agreement because that agreement relates solely to the payment of royalties in connection with trademark licensing.

The second question is whether the royalty is involved in the production or sale of the imported merchandise. Under the terms of the 1989 licensing agreement, the royalty is paid in consideration for the use of the trademark in connection with the licensed products. The "use" of the trademark does not appear by the terms of the agreement to bear relation to the production of the imported merchandise. Thus, based on the information presented, the royalty is not paid for rights associated with the manufacture of the imported merchandise.

Nor is there any evidence that the royalty payments will be made subject to the sale for exportation to the United States. In HRL 544436, dated February 4, 1991, we held that a royalty was involved in the sale of imported merchandise because the individual sales agreements and purchase contracts were subject to the terms of the royalty agreement. In the instant case, no sales agreements exist between the buyer and the seller, nor does the licensing agreement tie the payment of royalties to the sale for exportation of the imported merchandise.

The third question is whether the importer could buy the imported merchandise without paying the royalty. As pointed out in the General Notice, supra, the answer to this question goes to the heart of whether a payment is considered to be a condition of sale." While royalties paid to third parties for the use, in the United States, of trademarks related to the imported merchandise are generally not dutiable, the SAA provides that such payments will nevertheless be treated as dutiable if they represent a condition of the sale for exportation. Payments that must be made for each imported item are a condition of sale. In a pre-TAA case, BBR Prestressed Tanks, Inc., v. United States, 60 Cust. Ct. 885, R.D. 11536 (1968), aff'd, 64 Cust. Ct. 787, A.R.D. 265 (1970), the buyer was required to pay a lump-sum royalty in addition to the price. The court held that such a mandatory payment was dutiable, based primarily on the fact that the payment went to the seller. Under the TAA, such payments may be dutiable as royalties, as part of the price actually paid or payable, or as proceeds. Royalty payments are also a condition of sale when they are paid on each and every item imported and are inextricably intertwined with the imported merchandise. However, where the payments are optional are not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell a product using the imported merchandise in the United States, they are not a condition of sale. Imperial Products, 425 F. Supp. at 854.

In the instant case, the royalty payment is not optional in that it must be paid any time goods purchased from a party other than the licensor are resold in the United States. However, the royalty is not paid to the seller, nor has any evidence been presented which ties the royalty to a sale agreement for the imported merchandise, e.g., a requirement by the seller that the buyer pay the royalty to the licensor. If there were evidence however, which established that it was the payment of the royalties by [A] that enabled the licensed products to be manufactured, we would regard this as an indication that the payments were a condition of sale. See, HRL 545361, dated July 20, 1995.

The royalty payments made pursuant to the 1989 licensing agreement for merchandise entered prior to May 10, 1993 are not dutiable proceeds of subsequent resale under section 402(b)(1)(E) of the TAA because they are paid to a third party, [B], who is unrelated to the seller and, insofar as we can determine on the basis of the evidence submitted, the payments do not accrue, directly or indirectly, to the benefit of the seller.

HOLDING:

Royalty payments made pursuant to the 1987 royalty agreement between [A] and [B], for merchandise sold by [C] to [A] and entered prior to May 10, 1993, are dutiable under section 402(b)(1)(D). Such payments are not dutiable as proceeds under section 402(b)(1)(E).

Royalty payments made pursuant to the 1989 royalty agreement between [A] and [B], for merchandise sold to [A] by a party unrelated to the licensor and entered prior to May 10, 1993, are not dutiable under section 402(b)(1)(D). Such payments are not dutiable as proceeds under section 402(b)(1)(E).

Royalty payments made pursuant to the 1989 royalty agreement between [A] and [B], for merchandise sold to [A] by a party unrelated to the licensor and entered on or after May 10, 1993, are not dutiable under section 402(b)(1)(D). Such payments are not dutiable as proceeds under section 402(b)(1)(E).

Sincerely,

John Durant, Director
Commercial Rulings Division

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