HQ 545035 - Dutiability of certain trademark licensing payments; royalties; proceeds; related parties; section 402(b)(1)(D); section 402(b)(1)(E). - United States International Trade Commision Rulings

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HQ 545035

August 23, 1995

VAL R:C:V 545035 LR

CATEGORY: VALUATION

John M. Peterson, Esq.
Neville, Peterson & Williams
39 Broadway
New York, New York 10006

RE: Dutiability of certain trademark licensing payments; royalties; proceeds; related parties; section 402(b)(1)(D); section 402(b)(1)(E).

Dear Mr. Peterson:

This is in response to your letter of July 1, 1992, on behalf of your client, ("the importer" ), requesting a ruling on whether certain royalty payments are dutiable. An additional submission was made on June 1, 1995, regarding your request for confidentiality for the identities of the importer and the licensor of the imported merchandise. For the reasons set forth in your submission, your request is granted. We met with you on July 11, 1995 to discuss the substantive issues presented in your ruling request. We regret the delay in responding.

FACTS:

The importer purchases alcoholic beverages from suppliers located throughout the world. In this instance, the importer intends to purchase from its parent company in the United Kingdom ("the seller") an alcoholic beverage which is marketed worldwide under a well-known trademarked brand name ("the licensed product"). You indicate that the importer and the seller are "related" parties within the meaning of section 402(g)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 ("TAA"), codified at 19 U.S.C. ?1401a(g)(1) and that the importer purchases the imported liquors from the seller at an "arms length" freely negotiated price. The United States trademark rights for this product are owned by a Netherlands company ("the licensor") which is related to both the importer and the seller. (You do not indicate the nature of this relationship). The licensor proposes to license the importer as the sole company authorized to import and sell alcoholic beverages bearing the licensed trademark in the United States. The licensor and the importer propose to enter into an agreement ("the agreement") under which the licensor will grant to the importer the exclusive right limited to the United States, to use the licensed trademark solely in connection with the importation, distribution, promotion and sale of liquor products bearing and sold under the licensed mark. In exchange for this right, the importer will pay the licensor a trademark royalty. An unsigned draft copy of the agreement was submitted.

Under the agreement royalty payments are calculated on the basis of the "gross margin" realized by importer on the sale in the United States of the licensed product. The gross margin excludes the cost or value of the imported liquors. Minimum quarterly and monthly royalty payments are specified in the agreement, and these payments must be made without respect to whether any liquors are imported during the period in question. The royalty is calculated as a percentage of the importer's net sales. You indicate that trademark royalties paid to the licensor will remain with the licensor in the Netherlands, and will not be remitted, directly or indirectly, to the seller.

ISSUE:

Whether the described royalty payments from the importer to the licensor, a party related to the importer and the seller, are dutiable as part of the transaction value of the imported licensed products.

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. ?1401a). The preferred method of appraisement under the TAA is transaction value, defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus five enumerated additions.

For purposes of this ruling, we assume that transaction value is the proper basis of appraisement and that the "related" party status of the importer and the seller does not influence the price actually paid or payable, as set forth in section 402(b)(2)(B). Under this assumption, the transfer price between the importer and the seller is acceptable for transaction value provided it meets one of the tests set out in section 402(b)(2)(B). (Counsel's statement that the importer purchases the imported liquors from the seller at an "arms length" freely negotiated price, by itself, is not sufficient to establish the acceptability of the transfer price).

The term "price actually paid or payable" is defined in section 402(b)(4)(A) of the TAA as "the total payment (whether direct or indirect, ....) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller." 19 U.S.C. ?1401a(b)(4)(A). Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable. Among these are:

(D) any royalty or license fees related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of 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.

19 U.S.C. ?1401a(b)(1). You contend that the royalty paid by the importer to the licensor is neither a royalty pursuant to section 402(b)(1)(D) nor proceeds under section 402(b)(1)(E).

For purposes of this ruling, we have assumed that the payment of the royalty at issue is distinct from the price actually paid or payable for the imported merchandise. Consequently, we have addressed the issue of whether the subject payments are included in transaction value solely from the perspective of whether they constitute additions to the price actually paid or payable under section 402(b)(1)(D) or (E).

Royalty or License Fees

The Statement of Administration Action (SAA), adopted by Congress with the passage of the TAA, explains that "[a}dditions 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." (emphasis added). The SAA further provides:

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. As a further example, an addition will be made for any royalty or license fee paid by the buyer to the seller, unless the buyer can establish that such payment is distinct from the price actually paid or payable for the imported merchandise, and was not a condition of the sale of the imported merchandise to the United States. (emphasis added)

Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreement Act of 1979 (October 1981) at 48-49.

On February 10, 1993, the Customs Service issued a notice regarding the dutiability of royalty payments. Vol 27 Cust. B. & Dec. No.6 ("the General Notice"). After considering the legislative history of the provisions in question, prior case law and the SAA, the notice sets 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?

Vol. 27 Cust. B. & Dec. No.6, at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, point toward non-dutiability.

The SAA indicates that the dutiable status of royalties ultimately depends on whether the buyer was required to pay them as a condition of sale of the imported merchandise for exportation to the United States and to whom and under what circumstances they are paid. As pointed out in the General Notice, supra, the answer to question three goes to the heart of whether a payment is considered to be a condition of sale.

Counsel contends that the royalties at issue are not a condition of the sale for exportation of the imported licensed products because liability for payment of the royalties is not triggered by the sale of the licensed products "for exportation to the United States", but rather by the resale of the products in the country of importation. It maintains that the sale of the liquor for exportation to the United States is an entirely separate transaction from the payment of the royalty. Counsel also points to the fact that the minimum royalty payments are due and payable regardless of whether merchandise is imported (or how much).

Our position, as articulated in the General Notice, supra, at 12, is that the method of calculating the royalty, i.e, based on the resale price, is not relevant in determining its dutiable status. Thus, in HRL 545361, July 20, 1995, the fact that liability for the payment of a trademark royalty was triggered by the resale of the products after importation did not preclude a finding that the payments are dutiable under section 402(b)(1(D). See also, HRL 545784, June 6, 1995. In view of the fact that the royalties are to be paid to a party related to the seller of the imported liquor, we disagree with counsel's statement that the sale of the liquor for exportation to the U.S. is entirely separate from the payment of the royalty. In HRL 545361, supra, the dutiable status of the trademark royalties depended largely on to whom they were paid.

In that case, we considered whether royalties paid by the licensee/buyer to the trademark owner for the right to use the latter's trademark were dutiable under section 402(b)(1)(D) or (E) as an addition to the price actually paid or payable of the imported licensed products. Three scenarios were presented. The underlying facts in each scenario were the same except with regard to whom the royalties were paid. In each case, the royalties were based on a percentage of the net sales price of all products manufactured and sold by the licensee using the licensed trademark. Liability for payment of the royalty was triggered by the resale of the trademarked product by the licensee/buyer.

In the first scenario, the licensee/buyer purchases and imports trademarked merchandise manufactured and sold by a seller unrelated to either the licensor or the licensee. Customs determined that the royalty payments were not dutiable as royalties because there was no indication that such payment was a condition of sale of the imported merchandise. However, in the second scenario the licensor and the seller are the same person, and the royalty payment is made to the licensor/seller. Under these circumstances Customs found that the royalty was a condition of the sale of the merchandise for exportation to the U.S. and dutiable under 402(b)(1)(D):

The payment is not optional, but must be made to the licensor in its capacity as seller of the merchandise. The agreement provides that the licensee/buyer must pay an amount equal to a percentage of the net sales price of all products that use the licensor/seller's trademarks and trade names, and an equal percentage amount on the net sales price of all products sold to trademarked retail shops. Draft License Agreement at 5. Therefore to the extent that the products described by the draft agreement are imported, the payment of the royalty is a condition of sale and as such, an addition should be made to the price actually paid or payable (emphasis in original).

In the third scenario, the licensee/buyer purchases the imported merchandise from a seller related to the licensor. Customs concluded that the royalty was a condition of sale and dutiable under section

Under section 402(b)(1)(D). . ., royalties payments are included in transaction value if the buyer is required to pay them directly or indirectly, as a condition of sale. 19 U.S.C. ?1401a(b)(1)(D); see also, SAA, reprinted in, Dept. Treas., Customs Valuation under the TAA at 49. In this scenario, it is our position that the royalty is paid indirectly as a condition of the sale for exportation to the U.S. CF., HRL 542984, dated April 8, 1983 (a payment by the buyer to a third party, required as a condition of sale, was included in transaction value as part of the price actually paid or payable). The instant payment is not optional. Under the terms of the agreement it must be made to the licensor. Although in this particular scenario the payment is made to the licensor in respect of merchandise purchased from a seller related to the licensor, we find that it is no less a condition of sale than in the second scenario since the agreement provides the licensee/buyer must pay the royalty on all products, to include the imported merchandise, that use the licensor's trademarks and trade names, or that are sold to the trademarked retail shops.

The instant case presents the same situation as in scenario three above. Here, the draft agreement provides that the "Licensor hereby grants to Licensee...an exclusive license limited to the United States...to use the Licensed Mark solely in connection with the importation, distribution, promotion and sale of liquor products bearing and sold under the Licensed Mark ." Section 1, Agreement. As in scenario three the royalty here will be due on all licensed trademarked goods imported and sold by the importer/buyer and such royalties will be paid to the licensor, a party related to the seller. Based on the analysis in HRL 545361, we find that to the extent that the licensed products are imported, the royalties are dutiable under section 402(b)(1)(D) as an addition to the price actually paid or payable of such imported products. Obviously, if there are no importations of licensed products, the payment of minimum royalties would have no duty consequences.

Proceeds

In order for proceeds of a subsequent resale to be dutiable under section 402(b)(1)(E), they must pertain to the resale of the imported merchandise and they must accrue directly or indirectly to the benefit of the seller. In HRL 545361, supra, the imported products were the licensed products and the trademark royalties in question resulted from the resale of such products. Thus, Customs concluded that the royalties could alternatively be considered dutiable under section 402(b)(1)(E) where the licensor and the seller are the same person or where the seller is related to the licensor (unless the importer could establish that no portion of the proceeds accrued directly or indirectly to the seller). The ruling held that the royalties were not dutiable under this section where the licensor was neither the seller nor a party related to the seller because in such case they would not accrue directly or indirectly to the benefit of the seller.

The same analysis applies here. The royalties pertain to the resale of the imported licensed products and are to be paid to the licensor, a party related to the seller. Based on HRL 545361, supra, we find that the royalty payments may alternatively be considered proceeds within the meaning of section 402(b)(1)(E) unless the importer can establish that no portion of the proceeds accrued directly or indirectly to the seller. No evidence was submitted in this regard.

HOLDING:

The payments by the importer to the licensor under the draft agreement are included in the transaction value of the imported licensed products either as royalties under section 402(b)(1)(D) or as proceeds under section 402(b)(1)(E).

Sincerely,

John Durant, Director
Commercial Rulings Division

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