HQ 546072 - Internal Advice 22/95 concerning dutiability of payments for trademarks; Related party transactions and applicability of transaction value; Dividends as royalties or proceeds of subsequent resale; 19 U.S.C. 1401a(b)(1)(D) and (E); BBR Prestressed Tanks; Imperial Products; HRLs 545813, 544991, 545528 - United States International Trade Commision Rulings

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HQ 546072

May 21, 1998

VAL RR:IT:VA 546072 LPF

CATEGORY: VALUATION

Port Director
U.S. Customs Service
JFK Airport - Building #77
Jamaica, NY 11430

RE: Internal Advice 22/95 concerning dutiability of payments for trademarks; Related party transactions and applicability of transaction value; Dividends as royalties or proceeds of subsequent resale; 19 U.S.C. 1401a(b)(1)(D) and (E); BBR Prestressed Tanks; Imperial Products; HRLs 545813, 544991, 545528

Dear Director:

This is in response to a letter received from your office (Importer) regarding the dutiability of payments made for trademarks incorporated in their imported merchandise. This inquiry emanates from an audit conducted by the Regulatory Audit Division concerning the Importer's entries filed during its fiscal years ending December 1992 and 1993 as well as during the first four months of its fiscal year ending December 1994. A meeting was held with counsel and the Importer on October 2, 1996. As designated by the bracketed portions of this decision, confidentiality has been granted for any references to the Importer or related companies and to the country of exportation, consistent with counsel's June 24, 1997 letter. We regret the delay in reply.

FACTS:

As a result of corporate reorganization in 1990, was incorporated in Delaware. The U.S. Holding Company Company). The U.S. Holding Company retained the exclusive rights and copyrights as well as the responsibilities in issuing dividends to the Foreign Parent, which previously were held by the U.S. Holding Company's predecessor, also known as reorganization, the Predecessor Company, also a wholly-owned subsidiary of the Foreign Parent, comprised the entire U.S. operation. The Importer also is a wholesaler and retailer of various commodities including perfume, leather handbags and wallets, silk ties, handkerchiefs, and girls'/women's blouses, primarily imported from related foreign suppliers such as behalf of the Foreign Parent.

As part of its 1949 licensing agreement with the Foreign Supplier, the Predecessor Company promised to establish a market for Company merchandise and obtained exclusive rights to sell Company merchandise in the U.S. This agreement did not require the payment of any royalties. Rather, profits, if any, were repatriated as dividends based on the Predecessor Company's earnings and capital needs as determined by the Predecessor Company's board of directors.

In 1990, the Predecessor Company underwent corporate reorganization to enhance management of the Foreign Parent's U.S. operations, create a U.S. structure to facilitate future investments, protect the Foreign Parent's assets in possible joint ventures, and lawfully minimize state tax liability. The Importer provides unequivocally that the reorganization did not change the relationship between the U.S. operation and the Foreign Parent/Seller. Specifically, through a March, 1990 license agreement the U.S. Holding Company transferred to the Sister Company its trademark rights used in connection with the sale and distribution of the products manufactured by or for, or dealt in by, the U.S. Holding Company's affiliates. Upon obtaining the trademark rights, the Sister Company entered into a license agreement with the Importer on the same day to facilitate merchandise distribution. As consideration for the rights to use the trademarks in connection with the sale and distribution of Company products, the Importer agreed to pay the Sister Company a royalty based on its net sales.

As a result of the corporate restructuring, the Importer advises that the consolidated earnings and consolidated cash flow of the U.S. Holding Company and its subsidiaries did not change. Moreover, the income available for distribution to the overseas parent was unchanged by the license agreements, creating no additional benefit. The Importer adds that the royalty payments currently at issue do not change the prices the U.S. company pays the Foreign Parent for imported merchandise or, stated differently, that the gross margin earned prior to and after the restructuring are similar. In essence, the Importer submits that the royalty payments simply represent the splitting of what previously were the Predecessor Company's earnings between the Importer and the Sister Company.

Invoices and purchase orders between the Importer and the Foreign Parent as well as a payment statement were submitted for our review. It is our understanding that although the Importer receives its merchandise from the Foreign Supplier, it submits payment to the seller, the Foreign Parent. A portion of the money paid to the Sister Company as royalties is returned to the Importer as loans. Other amounts described as loans, submitted by the Importer to the U.S. Holding Company, are transferred by the latter to the Foreign Parent as dividends. The Importer explains that the U.S. Holding Company pays its parent a dividend only when authorized by its Board of Directors after considering the U.S. operation's consolidated earnings and projected cash needs. In fact, in the year of restructuring and the following year the U.S. Holding Company issued no dividends because funds were needed for continued investment in fixed assets. However, after completion of the new store expansion program, the Foreign Parent accrued surplus cash from its consolidated operations and the U.S. Holding Company declared dividends. Thus, the Importer provides that the dividend distributions are the result of cashflow management and needs and other investments, as opposed to the license agreements. Your office provided documentation illustrating the manner in which the money flows from one entity to another, as largely directed by the Importer.

The Importer provides that the payments made under the license agreement merely represent intercompany transactions, or a transfer of funds among the U.S. entities, and are eliminated in consolidation in accordance with generally accepted accounting principles (GAAP). Because such transactions have no effect on the U.S. Holding Company's consolidated earnings and cash flow nor on the dividend payments made to the Foreign Parent, the Importer submits that none of the royalty payments directly or indirectly benefit the Foreign Parent or are related to the imported merchandise. The Importer submits that the instant scenario is distinguishable from that addressed in the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), commonly known as "Hasbro II" because, among other reasons, the payments at issue merely separate money belonging to the seller's operation between two of its subsidiaries, rather than generating additional revenue for the seller from an unrelated company. The Importer adds that in any event the dividend payments themselves do not represent payments made under a profit sharing agreement nor directly relate to the imported merchandise. Your office disagrees with the Importer's position.

ISSUE:

If the relationship between the parties did not influence the price actually paid or payable such that transaction value is the appropriate method of appraisement, whether the submitted evidence demonstrates that the subject royalty payments are not 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 U.S. 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. However, imported merchandise is appraised under transaction value only if the buyer and seller are not related or, if related, the transaction value is deemed to be acceptable. In this case the Foreign Parent, the seller, and the Importer, the buyer, are related pursuant to ?402(g)(1)(G) of the TAA. Section 402(b)(2)(B) of the TAA provides that a transaction value between related parties will be deemed acceptable if an examination of the circumstances of sale indicates that the relationship between the parties did not influence the price actually paid or payable or where the transaction value closely approximated certain "test" values.

Initially, we note that no previously accepted values, which could serve as test values in the instant case, have been shown to exist. However, under the circumstances of sales approach, if the parties buy and sell from one another as if they are unrelated, transaction value will be considered acceptable. Thus, if the price is determined in a manner consistent with normal industry pricing practice, or with the way the seller deals with unrelated buyers, the price actually paid or payable will be deemed not to have been influenced by the relationship. Furthermore, the price will not be considered to have been influenced if it is shown that the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind. 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 54 (1981); section 152.103(j)(2), Customs Regulations (19 CFR 152.103(j)(2)).

In this regard, the Importer has asserted that the price paid for the imported merchandise reflects a list price, including a discount for wholesaler expenses, which is consistent with the Foreign Parent's sales to other related and unrelated purchasers in third countries. Further, the Importer has indicated that its gross profit margin has remained constant prior to and after restructuring. However, these statements in and of themselves do not establish the acceptability of the related party price as the appropriate basis for the transaction value. Specifically, the SAA provides that a price will not be considered to have been influenced if it is shown that the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind (emphasis added). No such comparison of profit has been provided for our review. In fact, some of the submitted evidence indicates that the subsidiary Importer did not enjoy any net profit.

Furthermore, if evidence was to be submitted confirming that the initial list prices actually reflect world-wide, universal prices, insofar as Customs would understand such prices merely to reflect a starting price for the imported merchandise, information concerning the deductions or discounts made from the list prices in ultimately arriving at the final price would remain essential. See HRL 545813, issued September 11, 1996. In sum, based on the evidence provided, we cannot verify the acceptability of the related party price. Although we have concerns regarding the related party pricing and, hence, with appraisement of the merchandise under transaction value, we nevertheless will address the questions posed to our office concerning the dutiablity of the subject royalty payments.

The "price actually paid or payable" is defined in 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." Customs presumes that all payments made by the buyer to the seller, or a party related to the seller, form part of the price actually paid or payable of the imported merchandise, in accordance with Generra Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990) and Chrysler Corporation v. United States, 17 CIT 1049 (1993). See also HRL 545194, issued September 13, 1995. This presumption may be rebutted by evidence which clearly establishes that the payments are completely unrelated to the imported merchandise.

In HRL 545194, supra, which also involved license fees paid by the importer to a party related to the seller, Customs analyzed whether the fees were dutiable as part of the price actually paid or payable. In that case, Customs determined that such fees were part of the total payment for the imported merchandise. Citing to HRL 545663, issued July 14, 1995, Customs concluded that the Generra standard applies regardless whether payments are made directly to the seller or to a party related to the seller. The decision explains that such "position is consistent with the definition of the price actually paid or payable' as the total payment made directly or indirectly by the buyer to, or for the benefit of, the seller. In our opinion, payments to a party related to the seller represent indirect payments made to, or, at the very least for the benefit of, the seller."

A price actually paid or payable analysis is relevant to the dutiability of royalties or licensing fees. Although payments are proper additions to the price actually paid or payable under the language of ?402(b)(1), this provision also specifically states that the price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the items described in subparagraph (A) through (E), including royalties and proceeds, only to the extent that each such amount is not otherwise included within the price actually paid or payable. . . . " (emphasis added). Based on the emphasized language, we conclude that it is appropriate to consider whether certain payments are included within the price actually paid or payable before determining whether they are to be added to the price actually paid or payable. However, we agree that a payment made by the buyer to the seller or a party related to the seller is not part of the price actually paid or payable if the importer can demonstrate that it does not represent payment for the imported merchandise and/or if the importer can demonstrate that the payments are not paid to or for the benefit of the seller.

Customs adheres to its position that payments made to a party related to the seller are presumed to be part of the price actually paid or payable and that the burden is on the importer to provide evidence to rebut this presumption. Absent such presumption, payments for the merchandise could easily be funneled through an affiliated company and Customs would be engaged in endless fact finding in order to ascertain the nature of such payments and whether they are to be included in transaction value. This is the type of fact-finding which the court in Generra determined was not required by Customs. Rather, the burden is on the importer to provide Customs with sufficient evidence to determine whether such payments are dutiable.

Upon review of the submitted information, we find that the subject royalties are not an element of the price actually paid or payable for the imported merchandise. As such amounts represent dividend distributions resulting from cashflow management and needs as well as other investments, we find that they do not relate to the sale for exportation of the imported merchandise. Moreover, nothing links the payment of the royalties to the sale for exportation of the imported merchandise. Thus, based on the evidence presented, we find that the payment of the royalties is not related to the sale for exportation of the imported merchandise.

With regard to royalties the 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. 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.

SAA, supra, at 48-49.

In the General Notice, Dutiability of Royalty Payments, "Hasbro II," supra, 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 a condition of sale and, therefore, dutiable as royalty payments.

When analyzing the Hasbro II factors, Customs, in its more recent ruling decisions, has taken several considerations into account which follow from the language set forth in the SAA. These include, but are not limited to: i) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture imported merchandise generally will be dutiable); ii) to whom the royalty is paid (e.g., payments to the seller or party related to the seller more likely are dutiable than payments to an unrelated third party); iii) whether the purchase of the merchandise and payment of royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the merchandise and payment of royalties; license agreement refers to, or provides for, the sale of the imported merchandise or requires the buyer's purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other or termination of the purchase agreement due to failure to pay royalties); and iv) payment of royalties on each and every importation. See Headquarters Ruling Letter (HRL) 544991, issued September 13, 1995, and cases cited therein.

Based on the information provided, we do not find the subject payments to constitute royalties comprising part of the transaction value of the merchandise. First, it is our understanding that the imported merchandise is not manufactured under patent. Rather, the subject licensing agreements address the payment of royalties in connection with trademark and licensing rights.

Second, we find the royalty not to be involved in the production or sale of the imported merchandise. To the contrary, a portion of the money paid to the Sister Company as royalties is returned to the Importer as loans while other amounts, described as loans which are paid to the U.S. Holding Company, is transferred to the Foreign Parent as dividends. Based on the facts presented and the manner in which the money flows to the companies, we agree that such dividend distributions appear to be the result of cashflow management and needs as well as other investments as opposed to the license agreements. Our examination of the licensing agreements further supports a finding that without the agreements and the attendant royalty payments the imported merchandise as such still would have been produced and sold by the foreign seller. Specifically, we note that the licensing agreements address the royalty payments separate and apart from the purchase and supply of the merchandise itself. Although counsel provides that no purchase or supply agreements exist for the merchandise in question, we do not find a nexus between the submitted transaction documents, that is, the invoices and purchase orders, and the licensing agreements. We assume that an examination of any other pertinent transaction documents would support such a conclusion. In particular, this finding is based on the assumption that corporate books, records and statements would reflect such amounts to constitute loans and dividends.

Finally, we concur that the Importer could buy the imported merchandise without paying the fee. While royalties paid to third parties for the use, in the United States, of trademarks related to the imported merchandise generally are not dutiable, the SAA provides that such payments nevertheless will be treated as dutiable if they represent a condition of the sale for exportation. Customs has considered payments that must be made for each imported item to constitute a condition of sale. This would not be the case, however, where the payments are optional, not inextricably intertwined with the imported merchandise, or paid solely for the exclusive right to manufacture and sell a product using the imported merchandise in the United States. See HRL 545528, issued August 3, 1995, citing 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) and Imperial Products, Inc. v. United States, 77 Cust. Ct. 66, 425 F. Supp. 852 (1976).

Once again, our review of the license agreements and transaction documents supports a finding that the Importer could buy the merchandise without paying the fee. The language included in the agreements does not suggest that the payment of the royalties is closely tied to the purchase of the goods. Moreover, in some instances it is our understanding that the U.S. Holding Company issued no dividends to the Foreign Parent because funds were needed for continued investment in fixed assets. Finally, the fact that the payments are made to parties related to the foreign seller, while an indication that the royalties are tied to the purchase of the goods and, therefore, a condition of sale does not necessarily mandate such a finding in this case. Insofar as counsel's evidence demonstrates that the royalty payments actually are made manifest as intercompany loans and dividends, which in some cases never find its way, in any form, to the Foreign Supplier or the Foreign Parent, the subject royalty payments do not constitute a condition of sale.

Furthermore, we do not find the payments, alternatively, to constitute proceeds to be added to the price actually paid or payable as proceeds pursuant to ?402(b)(1)(E).

With regard to proceeds, the SAA 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.

SAA, supra, at 49; section 152.103(g), Customs Regulations (19 CFR 152.103(g)).

We are in accord with the Importer's assertion that the payments at issue represent dividends or other payments which do not directly relate to the imported merchandise. In particular, we concur that the subject payments constitute intercompany loans and dividends the distribution of which do not relate to the imported merchandise and which, in many cases, do not appear to yield any financial benefit to the foreign seller. Counsel has shown that the payments made under the license agreement represent, in effect, a transfer of funds among the U.S. entities which are eliminated in consolidation in accordance with GAAP. For these reasons, regardless of the fact that the subject payments are made to parties related to the seller, such amounts are not dutiable as proceeds. This finding likewise is based on the assumption that corporate books, records and statements would reflect such amounts to constitute loans and dividends.

We do note, however, that sufficient information has not been provided which currently would enable us to determine the effect, if any, that the manner in which the subject royalty payments are made and accounted for by the parties has on the acceptability of the related party pricing as a basis for transaction value.

HOLDING:

Based on the evidence presented, we cannot find that the relationship between the parties did not influence the price actually paid or payable such that transaction value is the appropriate method of appraisement. However, if transaction value is the appropriate method of appraisement, the subject royalty payments would not be included within the transaction value of the imported merchandise as royalties or proceeds of subsequent resale.

This decision should be mailed by your office to the internal advice requester no later than sixty days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels.

Sincerely,

Acting Director
International Trade Compliance

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