HQ 546146 - Dutiability of royalty and premium payments for use of trademarks and copyrights; royalty; proceeds of any subsequent resale; ?402(b)(1(D) and (E); SAA; General Notice, Dutiability of Royalty Payments; Imperial Products; HRL 544436; BBR Prestressed Tanks; Distribution, License and Supply Agreement - United States International Trade Commision Rulings

United States International Trade Commision Rulings And Harmonized Tariff Schedule

faqs.org Rulings By Number Rulings By Category Tariff Numbers

faqs.org > Rulings and Tariffs Home > Rulings By Number > 1996 HQ Rulings > HQ 546132 - HQ 559010 > HQ 546146

Previous Ruling Next Ruling
HQ 546146

May 10, 1996

RR:IT:VA 546146 KCC

CATEGORY: VALUATION

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

RE: Dutiability of royalty and premium payments for use of trademarks and copyrights; royalty; proceeds of any subsequent resale; ?402(b)(1(D) and (E); SAA; General Notice, Dutiability of Royalty Payments; Imperial Products; HRL 544436; BBR Prestressed Tanks; Distribution, License and Supply Agreement

Dear Ms. Friedman:

This is in response to your letter dated September 15, 1995, submitted on behalf of [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("Importer/Distributor"), requesting a ruling concerning the dutiability of royalty and premium payments made for trademarks and copyrights. Your request that, pursuant to ?177.2(b)(7), Customs Regulations (19 C.F.R. ?177.2(b)(7)), certain information provided in connection with this decision be treated as confidential is granted. Accordingly, the portions of this decision that appear in brackets will be deleted from any copies that are made available to the public. We regret the delay in responding. A copy of the Supply Agreement pertaining to the sale of the imported merchandise was submitted for our examination on April 26, 1996.

FACTS:

[xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("the Importer/Distributor") and [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("the Licensor") entered into a Distribution Agreement on February 8, 1995, wherein the Importer/Distributor acquired from the Licensor the right to utilize certain names, representations, logos, movements, personalities, artwork, photographs and other material ("names and characters") in connection with the distribution and sales in the
[xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] of a wide range of consumer electronic and household products ("the imported/licensed products"). See, ?1(a), (b) and (c) of the Distribution Agreement. The names and characters covered under this agreement are well-known [xxxxxxxxxxxxxx] characters: [xxxxxxxxxxxx], [xxxxxxxx], [xxxxxxxxxxxx], [xxxxxxxxxxx], [xxxxxxxxxxxxxxxxx], [xxxxxxxxxxxxx], [xxxxxxxxxxxxxxxx] and [xxxxxxxxxxxxxxxxxxxx], and will be used in conjunction with marketing the merchandise.

Pursuant to ?10(c) of the Distribution Agreement, the Importer/Distributor is to purchase the imported/licensed products from the Importer/Distributor's parent corporation, [xxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("the Parent") or from an authorized supplier. However, you state that the imported/licensed products will actually be manufactured by, and purchased from independent manufacturers. Thus, the authorized supplier will be the independent manufacturer. Although you state that the imported/licensed products will be manufactured by and produced from independent manufacturers, you only provided a Supply Agreement between [xxxxxxxxxxxxxxxxxxxxxxxxxx], the independent manufacturer, and the Importer/Distributor. A copy of a Supply Agreement between [xxxxxxxxxxxxx], an independent manufacturer, and the Importer/Distributor dated October 1, 1994, was submitted for our examination. You add that the Parent will not be manufacturing any of the imported/licensed products nor will it or any of its subsidiary companies be selling components to the independent manufacturers. However, you state that the independent manufacturers may acquire Parent components from independent parties, which will be incorporated into the imported/licensed products. This ruling is limited to the facts presented, i.e., the situation where the Importer/Distributor purchases the imported/licensed products from [xxxxxxxxxxxxx], the independent manufacturer unrelated to the Licensor.

In return for the right to use the names and characters, the Importer/Distributor agrees to pay the Licensor a royalty fee of [xxxx] percent of the net sales of the imported/licensed products, which will be set off against a pre-determined "Targeted Consideration". See, ?1(f), 1(g), 3(a) and 3(b) of the Distribution Agreement. The "Targeted Consideration" or, as you describe it, the minimum royalty is set at [xxxxxxxxxxx] dollars, payable over the term of the Distribution Agreement and is divided into yearly payments of varying amounts. Thus, you state that if [xxxx] percent of the net sales for a given year falls short of the "Targeted Consideration" required for that year, the difference is still owed by the Importer/Distributor.

Additionally, the Distribution Agreement requires that the Importer/Distributor pay the Licensor [xxx] percent of all "premium sales" of the imported/licensed products, even when those premium sales are made by the Importer/Distributor's customers. Premium sales are defined as "combination sales, free or self-liquidating items offered to the public in conjunction with the sale or promotion of a product or service, including traffic building or continuity visits by the consumer/customer, or any similar scheme or device, the prime intent of which is to use the Licensed Products in such a way as to promote, publicize and/or sell the products, services or business image of the user of such item." See, ?4(b) of the Distribution Agreement.

Finally, the Distribution Agreement states that the Parent is secondarily liable to the Licensor in the event that the Importer/Distributor fails to submit sales reports for the imported/licensed products, and/or fails to make royalty and premium payments and/or the "Targeted Consideration." See, 3(d), 5(d), 6(c) of the Distribution Agreement. However, ?8(h) and 9(k) of the Distribution Agreement holds the Parent primarily liable and the Importer/Distributor secondarily liable for proper use of artwork, proper notice of copyrights and trademarks and for approval of and quality control of the imported/licensed products.

The Parent and the Licensor entered into a License Agreement on February 8, 1995, wherein the Parent or Licensee acquired from the Licensor the right to utilize the names and characters in connection with the manufacture, distribution and sale in the [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx], of the imported/licensed products. See, ?1(a), (b) and (c) of the License Agreement. The names and characters covered under this agreement are the same as those defined in the Distribution Agreement.

In return for the right to use the names and characters, the Parent agrees that if the distributors, including the Importer/Distributor, fail to pay the Licensor the [xxxx] percent royalty fee on the net sales of the licensed products, as set off against the "Targeted Consideration", it will be liable. See, note that ?1(g) and 3(a) of the License Agreement provides for a "Guaranteed Consideration", which is similar to the Distribution Agreement's "Targeted Consideration", but is set at [xxxxxxxxx] dollars, payable over the term of the License Agreement and is divided into yearly payments of varying amounts. You state that the larger amount is due to the fact that the License Agreement covers additional distributors and territories than those set forth in the Distribution Agreement. Thus, you state that in the event one of the Parent's distributors fails to pay either its pro rata share of the "Guaranteed Consideration", or [xxxx] percent of the net sales of the licensed products, then the Parent is responsible for these payments.

?1(h) of the License Agreement states that the Parent or its approved suppliers may sell the licensed products only to the distributors, including the Importer/Distributor. Additionally, Licensor [xxx] percent of all "premium sales" of the licensed products, when those premium sales are made by the Parent. The definition of premium sales is the same as the definition of premium sales in the Distribution Agreement. The License Agreement states that the Parent is secondarily liable to the Licensor in the event that the distributors fail to submit sales reports for the licensed products See, ?5(d) and 6(c) of the License Agreement. Finally, like the Distribution Agreement, primarily liable and the distributors secondarily liable for proper use of artwork, proper notice of copyrights and trademarks and for approval of and quality control of the licensed products.

We note that the Supply Agreement does not contain any reference to the royalty and premium payments set forth in the Distribution and License Agreements. Moreover, there is nothing in the Supply Agreement which suggests that the purchase of the imported merchandise is subject to or conditioned upon payment of the royalty and premiums. We found no reference in the Supply Agreement and the Distribution or License Agreements which would link the agreements to one another.

You contend that the payments are not dutiable as royalties under ?402(b)(1)(D) of the TAA because they are not a condition of sale of the imported products, nor are they dutiable as proceeds of a subsequent resale under ?402(b)(1(E) of the TAA. You state that the Licensor is not related to the Importer/Distributor, the Parent or the independent manufacturer.

ISSUE:

Whether the royalty and premium payments, paid primarily by the Importer/Distributor and secondarily by the Parent to the Licensor for the right to distribute and sell the imported products which bears the Licensor's trademarks and copyrights, are included within the transaction value of the imported merchandise as royalties or proceeds of subsequent resale.

LAW AND ANALYSIS:

The preferred method of appraising merchandise imported into the United States is transaction value pursuant to ?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. ?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. ?402(b)(1) of the TAA provides 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.

For purposes of this decision, we assume that transaction value is the appropriate method of appraisement and that the royalty and premium 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, ?402(b)(4)(A) of the TAA. We note that the Distribution and License Agreements state that the distributors, including the Importer/Distributor, are to purchase the licensed products from the Parent or an authorized supplier. However, you state that the licensed products will actually be manufactured by, and purchased from [xxxxxxxxxxxxx], an independent manufacturer. You add that the Parent will not be manufacturing any of the licensed products nor will it or any of its subsidiary companies be selling components to the independent manufacturer. You do acknowledge that the independent manufacturer may acquire Parent components from independent parties which could be incorporated into the licensed products. Based on the facts submitted, the royalty and premium payments will be made to the Licensor, who is a third party, unrelated to the seller, i.e., the independent manufacturer, and are distinct from the price actually paid or payable. Thus, the issue to be resolved is whether the royalty and premium payments are
part of transaction value from the perspective of whether they constitute additions to the price actually paid or payable.

With regard to royalties, the Statement of Administrative Action (SAA), adopted by Congress with the passage of the TAA, provides 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. 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 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.

Statement of Administrative Action, 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 48-49 (1981).

In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 12, Cust. B. & Dec. at 1 (February 10, 1993), Customs articulated three factors, based on prior court decisions, for determining whether a royalty was dutiable. These factors were whether: 1) the imported merchandise was manufactured under patent; 2) the royalty was involved in the production or sale of the imported merchandise and; 3) the importer could buy the product without paying the fee. Affirmative responses to factors one and two and a negative response to factor three would indicate that the payments were related to the imported merchandise and a condition of sale and, therefore, dutiable as royalty payments.

The first question is whether the imported merchandise is manufactured under patent. You state that it is possible that the imported products are manufactured under patent, but that the patents are not the subject of either the Distribution or License Agreements. Thus, you contend that the imported/licensed products are not manufactured under patent. Both the Distribution and License Agreements involve the right to use the Licensor's trademarks and copyrights, which have nothing to do with the patents associated with the manufacture of the imported products. We agree that the imported products are produced by a foreign manufacturer independently from, and without regard to, the trademarks or copyrights.

The second question is whether the payments are involved in the production or sale of the imported merchandise. Under the terms of the Distribution and License Agreements, the royalty payments, including the Targeted and Guarantee Considerations, and the premium payments are paid to the Licensor in consideration for the right to sell merchandise which bears the Licensor's trademarks and copyrights. Thus, the royalty and premium payments are not paid for rights associated with the manufacture of the imported products.

Additionally, the royalty and premium payments are not subject to the terms of the sale for exportation to the United States. In Imperial Products, Inc. v. United States, 425 F. Supp. 852, 77 Cust. Ct. 66 (1976), aff'd 570 F.2d 337, 65 CCPA 38 (1978), the court held that a royalty paid on imported brush heads for the exclusive right to manufacture and sell a product using the imported brush heads in the United States was a right separate from the purchase price of the merchandise and therefore not dutiable. Additionally, in Headquarters Ruling Letter (HRL) 544436 dated February 4, 1991, we held that a royalty was involved in the sale of imported merchandise because the individual sale agreements and purchase contracts were subject to the terms of the royalty agreement. An examination of the Supply Agreement between the independent manufacturer, [xxxxxxxxxxxxx], and the Importer/Distributor reveals that the royalty and premium payments are not involved in the sale of the imported/licensed products. The Supply Agreement does not contain any reference to the royalty and premium payments set forth in the Distribution and License Agreements. Moreover, there is nothing in the Supply Agreement which suggests that the purchase of the imported merchandise is subject to or conditioned upon payment of the royalty and premiums. No reference in the Supply Agreement and the Distribution or License Agreements was found which would link the agreements to one another. Based on the facts submitted, the right to use the Licensor's trademarks and copyrights is not only separate from the production process, but is also separate from the sale for exportation to the United States given that the Licensor and independent manufacturer are unrelated.

The third question posed by the notice is whether the importer could buy the imported merchandise without paying the royalty and premium payments, i.e., whether the payments are a condition of sale. 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., Frank P. Dow Co., Inc., of L.A. v. United States, 60 Cust. Ct. 885, R.D. 11536 (1968), aff'd, 64 Cust. Ct. 787, A.R.D. 265 (1970), the buyer of imported merchandise 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 importation and are inextricably intertwined with the imported merchandise.

In this case, the royalty and premium payments are not optional, because they must be paid to the extent that the Importer/Distributor earns revenue by reselling the imported/licensed products. On the other hand, the royalty and premium payments are not paid to the seller. Additionally, pursuant to the submitted Supply Agreement, the royalty and premium payments are not linked to individual sales agreements or purchase contracts for the imported/licensed products, e.g., a requirement by the seller that the buyer pay the royalty to the licensor. However, if there were evidence, which established that it was the payment of the royalties by the Importer/Distributor that enabled the licensed products to be manufactured, we would regard this as an indication that the royalty and premium payments were a condition of sale. Nevertheless, this is not the case.

It is our position that the importer can buy the imported merchandise without paying the royalty and premium payments. The payments are payable only on merchandise sold which bears the Licensor's trademark or copyright. The imported products can and are manufactured and sold without the licensed names and characters. The payments at issue are only triggered when the Importer/Distributor decides to add a licensed image to the imported article. The Distribution and License Agreements do not restrict the Importer/Distributor or the Parent from distributing and selling the imported products, but are for the separate right to use the Licensor's trademarks and copyrights on the imported products. Accordingly, the royalty and premium payments at issue are not a condition of sale of the imported merchandise and, therefore, do not constitute an addition to the price actually paid or payable for the imported merchandise pursuant to

Nevertheless, we must also consider whether the payments may be added to the price actually paid or payable as proceeds of any subsequent resale pursuant to ?402(b)(1)(E). General Notice, supra, at 6-7. The SAA addresses the dutiability of proceeds of any subsequent resale as follows:

Additions for the value of any part of the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue 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.

Based on the facts presented, we do not find that the proceeds of any subsequent resale, disposal, or use of the merchandise accrues directly or indirectly to the seller. The royalty and premium payments are paid to the Licensor, who is not related to either the Importer/Distributor, the Parent, or the independent manufacturer. There is nothing which suggests that such payments will accrue directly or indirectly to the seller. Accordingly, in this instance, the royalty payments do not constitute proceeds of any subsequent resale, disposal or use of the merchandise pursuant to ?402(b)(1(E).

We note that our decision in this case is based on the specific facts submitted, in particular the Supply Agreement, Distribution and License Agreements and the fact that the Importer/Distributor purchases the imported/licensed products from [xxxxxxxxxxxxx], an independent manufacturer unrelated to the Licensor. If any of the facts should change in any material respect, a different conclusion may result.

HOLDING:

Based on the facts submitted, the payments made to the Licensor do not constitute dutiable royalties pursuant to disposal or use of the merchandise pursuant to ?402(b)(1)(E) of the TAA, to be included within the transaction value of the imported merchandise.

Sincerely,

Acting Director

Previous Ruling Next Ruling