HQ 545841 - Internal Advice Request number 57/94 concerning the dutiability of certain royalty payments - United States International Trade Commision Rulings

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HQ 545841

June 13, 1996
VAL:RR:IT:VA 545841 RSD

CATEGORY: VALUATION

Port Director
United States Customs Service
John F. Kennedy Airport
Jamaica, New York 11430

RE: Internal Advice Request number 57/94 concerning the dutiability of certain royalty payments

Dear Director:

This is in response to your memorandum dated October 5, 1994, forwarding the internal advice request 57/94 submitted by the law firm of Bryan Cave on August 3, 1994, on behalf of their client [xxxxxxxxxxxxxxxxxxx] (hereinafter "importer") concerning the dutiability of royalty payments made to a related party. Your memorandum was in turn forwarded by Chief, Food and Chemical Branch, New York Seaport, who also prepared a memorandum dated November 15, 1995, regarding this internal advice request. On March 15, 1995, a meeting was held at our offices with counsel to discuss this matter. Subsequently, counsel made a supplemental submission dated April 14, 1995. Counsel has requested that certain information regarding the relationship of the parties, how merchandise is purchased, and payments are made be kept confidential. To comply with counsel's request, the names of parties and other information regarding the transactions are bracketed and will not be disclosed in copies of this decision made available to the public. In addition, documents from the transactions such as the licensing agreement and submissions describing the transactions will be kept confidential. We regret the delay in responding.

FACTS:

The importer is based in New York City and imports cosmetics, fragrances, skin care, and make-up products. It is a wholly owned subsidiary of a U.S. corporation, [xxxxxxxxx xxxxxxxxxxxxxxxxxxxxxx]. Both of these companies, as well as approximately [xxx] foreign and domestic corporations, are under the control of [xxxxxxxxxxxxxxxxxxxxxx], a [xxxxxx] limited liability company.

The importer purchases fragrances and cosmetics from several different foreign suppliers which are also under the control of [xxxxxxxxxxxxxxxxx, including xxxxxxxxxxxxxxxxxxx., xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] (hereinafter "product suppliers"). Counsel recognizes the importer and the product suppliers are affiliated, but claims they are not related because they are separate profit centers. Orders are placed with the product suppliers based on the suppliers' price lists. The purchase price of the goods allegedly includes all of the costs to produce the goods, plus a reasonable profit to the product suppliers. For purchases from the product suppliers, the importer develops its purchasing requirements and sends its requests to the product suppliers. The payment terms are quoted in the price lists and the importer is notified of production plans and shipment dates. In addition, the importer purchases certain production related components (e.g., blotters, compact cases, caps, and lipstick containers) from other non-affiliated foreign companies. Despite the relationship between the importer and the product suppliers, your office accepted transaction value as the appropriate method of appraisement for the imported merchandise.

In 1991, the importer entered into a licensing agreement with [xxxxxxxxxxxxxxxxxx] (hereinafter "licensor"), a company also controlled by [xxxxxxxxxxxxx], in which the importer received a license for the use of certain trademarks owned by the licensor and a sublicense to the use trademarks licensed to the licensor by unrelated third parties. Among the third party trademarks the importer received a sublicense for are [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx xxxxxx]. Pursuant to the license agreement between the importer and the licensor, the importer is obligated to pay on a quarterly basis to the licensor: 1) a license fee equal to [xxx] percent of the net sales on all product lines, whether of U.S. or foreign origination bearing the [xxxxxxxxx and xxxxxxxxxxx] trademarks, and (2) an amount equal to [xxx] percent of the net U.S. sales of the product line sold using trademarks owned by the third party licensors.

Apparently, in order to obtain the rights to sublicense trademarks owned by the above-mentioned unrelated third parties, the licensor entered into other licensing agreements on the disposition of royalties it receives for sublicensing the use of such trademarks. Counsel makes reference to master licensing agreements between the licensor and third party licensors, but does not elaborate on the content of such agreements. It does claim that up to [xxx] of the receipts from the collection of the royalties for use of the third party owned trademarks are forwarded to the third party licensors, while the licensor retains [xxx] of these receipts from the trademarks in question. The actual percentage supposedly varies with each trademark and is based on these master license agreements with the licensor. For 1993, sales in the U.S. comprised approximately [xxx] of the total net sales value used to determine the license fees.

Counsel claims that no products are sold directly to the importer by either the licensor or the third party licensors. In addition, counsel maintains that the product suppliers do not receive any portion of the royalties. However, an affidavit, dated July 24, 1994, from [xxxxx xxxxxxx] identified as the "Procurist" of the licensor, states that in a limited number of occasions in 1993, the licensor sold fragrances and cosmetic products from its inventory on hand to the importer. Additionally, in 1993 the licensor sold to the importer posters and banners for advertising in the United States.

Furthermore, section 12.1 of the licensing agreement between the importer and the licensor stipulates that the licensor is to supply the products to the licensee. In a letter to our office dated September 19, 1995, counsel claims in actual practice the licensor does not supply products to the importer. Counsel further contends that this clause was put in a draft version of the license agreement and should have been deleted, but was included in the final version of the agreement as an oversight. However, counsel did not present a different version of the license agreement with section 12.1 deleted or furnish any evidence to show that the clause was included as an oversight.

Your office has conducted research on the corporate relationships of importer. According to this research, some of the same individuals hold positions as officers with several of the related organizations under the control of [xxx xxxxxxxxx].

ISSUE:

Whether the royalty payments made to related parties are included in the transaction value of the imported merchandise as royalties under section 402(b)(1)(D) of the TAA?

Whether the royalty payments would be included in transaction value of the imported merchandise as proceeds under

LAW AND ANALYSIS:

As you know, 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 is transaction value, which is defined as the "price actually paid or payable for merchandise when sold for exportation to the United States," plus certain enumerated additions. In this instance the buyer of the merchandise, the importer and the product sellers are related. Section 402(b)(2)(B) of the TAA sets forth two conditions under which a transaction value between related parties will be deemed acceptable. The first is where an examination of the circumstances of sale indicates that the relationship between the parties did not influence the price actually paid or payable. The second is where the transaction value closely approximates certain "test" values. 19 U.S.C. 1401a(b)(2)(B). In your memorandum you state that you have accepted that transaction value as the means of appraisement based on the circumstances of the sales. Accordingly, we have assumed for purposes of this ruling that transaction value is the appropriate basis of appraisement.

Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable. Two of the statutory additions to the price actually paid or payable are found in sections 402(b)(1)(D) and (E) which 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.

In regard to the dutiability of royalties and license fees, the Statement of Administrative Action provides in relevant part:

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 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, where as 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 for export to the United States.

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 Agreements Act of 1979 (October 1981) at 48-49.

The question of whether the royalty payments are dutiable or not was analyzed in our notice on the dutiability of royalty payments, which was published in the Customs Bulletin on February 10, 1993 commonly referred to as "Hasbro II". In that notice we indicated that several questions must be answered in order to determine whether a royalty payment is related to imported merchandise and thus required as a condition of sale. As set forth in the notice the questions are: (1) was the imported merchandise manufactured under the 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? 27:6 Cust. B. & Dec. 1 at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, suggest that a royalty payment is non-dutiable under section 402 a(b)(1)(D) of the TAA.

The first question posed by the notice is whether the imported merchandise was manufactured under patent. It appears that the imported merchandise was not manufactured under patent. The second question indicated in the notice that of whether the royalty is involved in the production or sale of the imported merchandise can be determined on information contained in the licensing agreement furnished with the ruling request. As already noted, the royalty was paid for the right to use certain trademarks on the imported merchandise sold in a designated territory. The royalty was not involved in the production of the merchandise and was not paid for the production of the merchandise.

The third question posed by the notice is whether the importer could buy the imported merchandise without paying the royalty fee i.e., whether the payments are a condition of sale. While royalties paid to third parties for use in the U.S., of trademark related to the imported merchandise are generally not dutiable, the SAA provides that the such payment will nevertheless be treated as dutiable if they represent a condition of the sale for exportation. SAA reprinted in, Dept. of Treas., Customs Valuation under the TAA at 49. Royalty payments are a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise; but if the payments are optional and not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell in a designated area, they are not a condition of sale. See Imperial Products, Inc. v. United States, 425 F.Supp. 852, 77 Cust. Ct 66 (1976).

Counsel for the importer argues that the royalty payments in this case should not be held to be dutiable because the royalties are paid in a separate transaction to an entity that is separate from the seller. Counsel further claims that no royalties go to the seller. It further contends royalties do not relate to the imported merchandise, but are paid for separate rights to use trademarks.

Although the SAA provides that the determination about the dutiability of royalty payment are to be made on a case-by-case basis, it is more likely that the royalty will be dutiable when the seller is the licensor and the royalty is paid to the seller. Under these circumstances, payment of the royalty is more likely to be a condition of the sale for exportation of the imported merchandise than when the royalty is paid to an unrelated third party. The same analysis would also hold true if the seller and licensor are related to each other. In HRL 545361, dated July 14, 1995, we ruled that certain trademark royalties were dutiable when paid to the seller or a party related to seller, but not where they were paid to a third party unrelated to the seller. We noted that where the licensor and the seller are the same person, and the royalty payment is made to the licensor/seller, we consider the royalty to be a condition of the sale of the merchandise for exportation to the U.S. The payment is not optional, but must be made to the licensor in its capacity as seller of the merchandise.

In this instance, counsel argues that the payments were not made to the sellers; and therefore the payments are not dutiable. However, the sellers of the merchandise and licensor of the trademarks, are under the common control of [xxx xxxxxxxxx] and thus are treated as related persons by the TAA. See 19 U.S.C. 1401a(g)(G). Accordingly, we must conclude that the analysis used in HRL 545361 should apply in this case since the payment of the royalties to the party related to the sellers cannot be considered optional. Because the licensor and the sellers are under the control of the [xxxxxxxxxxxxx], it is doubtful that the buyer could obtain the trademarked goods from the sellers unless it also agreed to pay royalties on the sale of the products by entering into licensing agreement with the licensor.

We also note that section 12 of the licensing agreement states that "Licensor shall supply the Products to the Licensee at its prime cost, plus an appropriate charge for warehousing, distribution and profits on these costs." Based on this clause, it appears that the parties intended that the licensor also have some control over the supply of the imported merchandise, and that the licensor had an obligation to supply products to the importer. Although counsel believes that the inclusion of this clause was merely an oversight, no evidence has been presented to support this claim. Without evidence to the contrary, we assume that the licensor satisfied its obligation to supply the products to the importer by having its related product suppliers sell the articles to the importer. This determination is supported by the statement of was in the license agreement as an oversight [xxxxxx xxxxxxx] an official with the licensor, who concedes that on some occasions, the licensor did sell products directly to importer. Therefore, because the sellers and licensor are related, we must conclude that in order to obtain the products from the sellers, the importer had to also agree to pay the royalty and license fee to the related party. The fact that the licensor eventually pays some of the royalty payments to third parties, is not relevant as long as royalties must be paid to the licensor in order to purchase the merchandise.

Accordingly, we reject the importer's contention that the royalty payments are automatically not dutiable when they are paid to a party other than the seller. Instead, the test for determining whether royalties are dutiable depends upon whether payment of the royalties are a condition of sale for export to the United States. In this case, the licensor is related to the sellers, and consequently the royalty payments would be added to the price actually paid or payable under section 402(b)(1)(D) of the TAA. Because we have determined that the license fee payments are dutiable under 402(b)(1)(D), we do not need to address whether they would be dutiable as proceeds under 402(b)(1)(E) of the TAA.

HOLDING:

Based on the information provided, the royalty payments made by the importer to a related party, the licensor are to be added to the price actually paid or payable of the imported merchandise as royalties under section 402(b)(1)(D).
The Office of Regulations and Rulings will take steps to make a version of this decision, with the confidential information deleted, available to Customs personnel and via the Customs Ruling Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels 60 days from the date of this decision. Sincerely,

Acting Director

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