HQ 545784 - I.A. 39/94; royalties; proceeds; sufficient information; interest - United States International Trade Commision Rulings

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HQ 545784

June 6, 1995

VAL R:C:V 545784 LR

CATEGORY: VALUATION

District Director
U.S. Customs Service
Seattle, Washington

RE: I.A. 39/94; royalties; proceeds; sufficient information; interest

Dear Sir:

This is in response to your request for Internal Advice 39/94, dated June 2, 1994, regarding the dutiability of royalties paid by Nichimo USA ("importer") to Nichimo Co., Ltd. Of Japan ("seller") for manufacturing know-how associated with the purchase and use of an imported Net Making Machine. Your request was forwarded to us by the Chief, NIS Machinery Branch, New York Seaport on September 14, 1994. On September 22, 1994, your office notified the importer of your request for internal advice and indicated that any written comments submitted within 30 days would be considered. No written comments from the importer were received. We regret the delay in responding.

FACTS:

You state that the importer is a wholly owned subsidiary of the seller. By purchase agreement dated January 1992 ("Supply Agreement"), the importer agreed to purchase and the seller agreed to sell a used Ultra Net Making Machine ("Machine") and accessories. You state that the Machine, which manufactures knotless fish netting ("Product"), is unique. You further indicate that the Machine is internationally patented but that the importer stated that it was impossible to furnish a copy of this patent as it is located in Japan.

The Supply Agreement provides that the importer will pay the seller the purchase price in five yearly installments including ten percent interest. The amount of interest is separately identified. The Supply Agreement further provides that the seller retains ownership until all payments have been finalized and that the importer cannot resell the Machine even if ownership is transferred to the importer, because the Machine includes the production know-how which is owned by the seller. A copy of the Supply Agreement was submitted.

A separate Royalty Agreement dated May 1, 1992 ("Royalty Agreement"), between the importer and the seller provides that the parties shall agree on the royalty of manufacturing know-how owned by the seller concerning the Machine as follows: 1) the importer shall pay to the seller as royalty 5% of the domestic sales price in U.S.A. on all Products manufactured by the Partnership and 2) the payment of the royalty shall be continually made as long as the partnership for manufacturing the Product continued and existed. A copy of the Royalty Agreement was provided.

You indicate that the Machine was imported on May 1, 1992 and is leased to Superior Netting Products, Inc., a joint venture between the importer and another company ("the Partnership"). The entry has not been liquidated.

You ask us to address: 1) whether the royalty payments are dutiable and if so, for how long; and 2) whether the interest charges on the Machine paid after the date of importation are dutiable.

Your opinion is that the royalty payments are part of transaction value because they are a condition of sale of the imported machine. While the New York Seaport generally concurs with your analysis regarding this issue, that office is of the opinion that transaction value does not exist because the royalty is not quantifiable. Although the importer has not submitted any written comments, you advise that its position is that the royalty is for the value of a technician furnished to the importer to set up the machine and train personnel and that these expenses for the technician are paid as a separate cost by the importer.

ISSUES:

1. Whether the 5% royalties paid by the importer to the seller based on sales of Products manufactured using the imported Machine should be added to the price actually paid or payable and if so, for how long.

2. Whether the portion of the price representing interest is dutiable.

LAW AND ANALYSIS:

As you are aware, the preferred method of appraising merchandise imported into the United states is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. 1401a. Section 402(b)(1) of the TAA provides, in pertinent part, that the transaction value of imported merchandise is the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus enumerated statutory additions, including any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to the United States (section 402(b)(1)(D)) and the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue to the seller (section 402(b)(1)(E)).

The "price actually paid or payable" is defined in section 402(b)(4)(A) of the TAA as 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...) made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller." The price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the enumerated additions only to the extent that each such amount is not otherwise included within the price actually paid or payable; and is based on sufficient information. Section 402(b)(1) TAA.

The transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between such buyer and seller did not influence the price actually paid or payable or if the transaction value of the imported merchandise closely approximates certain "test values". For purposes of this ruling we assume that transaction value is acceptable.

ADDITIONS TO PRICE ACTUALLY PAID OR PAYABLE

Additions under 402(b)(1)(D)

Since the subject royalties are not included in the price actually paid or payable, we must analyze whether they should be added thereto under section 402(b)(1)(D) TAA. Under this provision, an addition is made for 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." Thus, in order to be dutiable under this provision, the royalty must be related to the imported merchandise and the payment of such royalty must be a condition of the sale of the imported merchandise. The following three questions are relevant in determining whether these conditions are satisfied: 1) was the imported merchandise manufactured under patent; 2) was the royalty involved in the production or sale of the imported merchandise and 3) could the importer buy the product without paying the fee. An affirmative answer to questions 1 and 2 and a negative answer to question 3 points to dutiability. See General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) ("Hasbro II ruling").

In this case, the answer to the first question is "yes"; the Machine was manufactured under patent. Royalties and license fees for patents covering processes to manufacture the imported merchandise will generally be dutiable. See Statement of Administrative Action (SAA), H.R. Doc. No 153, Pt. II, 96th Cong., 1st Sess. (1979), reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 at 48(1981) The answer to the second question is "yes"; the royalty was involved in the sale of the imported Machine. As indicated above, the Supply Agreement specifically states that the importer shall not resell the Machine because it includes the production know-how which is owned by the seller. Thus, in order to purchase and use this patented machine, the importer must pay the seller the royalties in question. The sale of the Machine to the importer is inextricably intertwined with the payment of the royalties. Finally, the answer to the third question is "no"; the importer could not buy the Machine without paying the royalty. Again, we refer to the language in the Supply Agreement that the Machine includes production know-how owned by the seller and that the importer is precluded from selling the Machine. Based on this language and the Royalty Agreement, we conclude that the importer could not buy the machine without paying the royalty.

Also, we note that as in Hasbro II, the royalties are paid by the buyer to the seller. In determining that the royalties could have been considered to be dutiable under section 402(b)(1)(D), Customs referred to the language in the SAA regarding royalties paid by the buyer to the seller:

. . . 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 for exportation to the United States (emphasis added).

Hasbro II at page 12.

In this case, the importer/buyer has not established that the royalty payment is distinct from the price actually paid or payable for the machine and that it was not a condition of importation. As discussed above, we believe that the facts indicate otherwise.

Finally, in Hasbro II, Customs determined that the method of calculating the royalty, e.g. on the resale price of the goods, is not relevant to determining the dutiability of the royalty payment. Thus, in this case, the fact that royalty is based on a percentage of the sales price of the Products manufactured with the Machine, is not relevant.

Based on the above considerations, we find that the royalty payments relate to the imported Machine and that such payments are a condition of sale of the imported merchandise. Therefore, provided the amount of the royalties is based on sufficient information, the royalties are to be added to the price actually paid or payable for the Machine under section 402(b)(1)(D).

Additions under 402(b)(1)(E)

Alternatively, as discussed below, the royalties in question are dutiable under section 402(a)(1)(E) TAA, as proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue to the seller are dutiable. (Emphasis added). With regard proceeds, the SAA, supra, reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 at 49, provides that:

[a]dditions for the value of any part of the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrues directly or indirectly to the seller, do not extend to the flow of dividends or other payments from the buyer to the seller that do not directly relate to the imported merchandise. Whether an addition will be made must be determined on a case-by-case basis depending on the facts of each individual transaction.

In Hasbro II, supra at 13, Customs referred to the definition of proceeds in analyzing whether certain payments were proceeds within the meaning of section 402(b)(1)(E). The decision states:

Proceeds are defined as "issues or income; yield; receipts; produce; money or articles of other thing of value arising or obtained by the sale of property; the sum, amount, or value of property sold or converted into money or into other property. Notice, p. 13 cited Black's Law dictionary, 6th ed., 1990 at p. 1204. Another definition of proceeds is "what is produced by or derived from something (as a sale investment, levy, business) by way of total revenue: the total amount brought in ***." Webster's Third New International Dictionary 1986.

In applying this definition in the context of 402(b)(1)(E) the income produced from the subsequent resale, disposal, or use of the imported merchandise that accrues directly, or indirectly, to the seller is added to the price actually paid or payable for the imported goods.

In Hasbro II, the payments at issue accrued to the seller upon the resale of the imported merchandise. Specifically, the seller received 7% of income from the subsequent resale of the imported merchandise. Customs ruled that such payments constituted proceeds of the subsequent resale of the imported merchandise and were to be added to the price actually paid or payable for the imported merchandise. See also HRL 544800, May 17, 1994 (regarding proceeds of a subsequent resale). In other rulings, Customs considered whether royalty payments accrued to the seller upon the resale of the imported merchandise where the royalty was based on the sale of a finished product which incorporated the imported product. See HRL 545307, February 3, 1995; C.S.D. 93-26 (HRL 545114, September 30, 1993); C.S.D. 92-12 (HRL 544656, June 19, 1991).

The present case is different from the above rulings because the Machine is not the subject of a subsequent resale. The issue here is whether proceeds accruing to the seller from the use of the imported merchandise are dutiable. Although we have not previously considered this question we believe that under appropriate circumstances they are. As the statutory language makes clear, it is not necessary for the proceeds to accrue from the resale of the imported product; the proceeds may also accrue from the use of the imported product. We believe that the present case falls squarely within the language of 402(b)(1)(E). As indicated above, the imported Machine contains the production know-how for which the royalties are paid. The importer pays the seller royalties for the right to purchase and use the imported Machine. The royalties are paid to the seller each time the Machine is used to produce the Product and such Product is sold. We conclude that the royalty is income which accrues to the seller upon the subsequent use of the imported Machine. The royalty may be added to the price actually paid or payable under 402(b)(1)(E) provided there is sufficient information to determine the amount.

Thus, the instant case involves the type of situation described by Congress where "certain elements called royalties' may fall within the scope of the language under either new section 402(b)(1)(D) or 402(b)(1)(E) or both. See, Hasbro II at 13, quoting from H.R. Rep. No 317, 96th Cong., 1st Sess. (1979) at 80 and S. Rep. No. 249, 96th Cong., 1st Sess., at 120 (1979).

Sufficiency of Information

The next issue to be addressed is whether there is sufficient information to determine the amount of the royalties/proceeds. This issue arises because the royalties are not due until the Products manufactured using the imported Machine are sold in the U.S.

Section 402(b) TAA provides that the price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the enumerated items only to the extent that such amount is based on sufficient information. If sufficient information is not available, for any reason, ... the transaction value of the imported merchandise concerned shall be treated, for purposes of this section, as one that cannot be determined. The term "sufficient information" is defined as "information that establishes the accuracy of such amount, difference, or adjustment."

In HRL 545504, May 4, 1995, involving proceeds under section 402(b)(1)(E), counsel argued that there was a lack of sufficient information to establish transaction value because the proceeds cannot be quantified in a reasonable period of time. In that case, the buyer was required to account for sales on a quarterly basis, with an accounting and payment due 30 days after the end of a quarter. Customs rejected counsel's argument noting the following:

The TAA is designed to accommodate situations in which a purchase price is established, but not paid, at the time merchandise is imported into the United States. For purposes of the transaction value provision, a bona fide sale may be found to exist even though actual payment has not been made for goods at the time of importation, provided that the purchase agreement includes fixed terms which make the purchase price either determined or determinable at that time.

Two situations in which a buyer and a seller have potentially agreed to a price without full payment being made prior to or at the time of importation involve royalties and proceeds of subsequent resale, disposal or use of the imported merchandise. In both of these instances, Customs must determine whether payments - which inure to the benefit of a foreign seller after importation has occurred -- should be added to the "price actually paid or payable" for purposes of calculating the duty owed. Such amounts should be added provided there is sufficient information upon which to determine the amounts therefor.

. . . we do not find that such a payment arrangement indicates, prima facie, that the proceeds cannot be quantified in a reasonable period of time and, hence, that there is a lack of sufficient information. It is our position that the term "subsequent resale," by its very nature, implies that proceeds may not be paid, or even quantifiable, for some time after importation of the merchandise. Furthermore, we do not believe the payment structure agreed to by the parties is uncommon in such transaction. To hold otherwise could render transaction value unacceptable in numerous cases in which proceeds subsequently accrue to the seller. Cf. HRL 542701, TAA No. 47, issued April 28, 1982, and HRL 542746, issued March 30, 1982.

In this case, even though the amount of the royalty/proceeds addition is not known at the time of importation, we believe that there is sufficient information to determine the amount of the addition. The royalty agreement clearly specifies how the royalties are to be calculated. As such, there is information that establishes the accuracy of such amount. Additions should be made for the royalties/proceeds paid by the importer to the seller up to the time the entry is liquidated. You should request an accounting from the importer regarding royalties paid to the seller in order to determine the proper amount of the addition. If such an accounting is not provided and you cannot otherwise determine the amount of the royalties/proceeds, the Machine cannot be appraised based on transaction value.

DUTIABILITY OF INTEREST PAYMENTS

The Supply Agreement provides that the importer will pay the seller the purchase price in five yearly installments including ten percent interest. The interest charges are identified separately in the Supply Agreement. In T.D. 85-111, July 17, 1985, Customs indicated that interest payments, whether or not included in the price actually paid or payable for imported merchandise, should be not considered part of dutiable value provided the following criteria are satisfied:

1. the interest charges are identified separately from the price actually paid or payable;
2. the financing arrangement in question is made in writing; 3. when required by Customs, the buyer can demonstrate that the goods undergoing appraisement are actually sold at the price declared as the price actually paid or payable, and the claimed rate of interest does not exceed the level for such transaction prevailing in the country where, and at the time, when the financing was provided.

On July 17, 1989, Customs published a Statement of Clarification regarding T.D. 85-111 (54 FR 29973) in which we stated that for the purposes of T.D. 85-111, the term "interest encompasses only bona fide interest charges, not simply the notion of interest arising out of delayed payment." Customs added that "bona fide interest charges are those payments that are carried on the importer's books as interest expenses in conformance with generally accepted accounting principles." This clarification became effective October 16, 1989. See also, C.S.D. 91-10 which applied the statement of Clarification for T.D. 85-111.

In this case, the interest charges on the imported machine are excluded from the price actually paid or payable provided the conditions set forth above are met.

HOLDING:

The royalty payments made by the importer to the seller should be added to the price actually paid or payable for the imported machines either as royalties under section 402(b)(1)(D) or proceeds of a subsequent use under section 402(b)(1)(E). Additions should be made for royalty payments made by the importer to the seller up to the time of liquidation. Interest charges are excluded from the price actually paid or payable if the conditions set forth in T.D. 85-111 and the Statement of Clarification are met.

Sincerely,

John Durant, Director

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