HQ 546203 - IA 61/95; dutiability of royalty payments; price actually paid or payable; condition of sale - United States International Trade Commision Rulings

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HQ 546203

May 21, 1998

VAL RR:IT:VA 546203 CRS

CATEGORY: VALUATION

Director, Trade Compliance
U.S. Customs Service
610 South Canal Street
Chicago, IL 60607

RE: IA 61/95; dutiability of royalty payments; price actually paid or payable; condition of sale

Dear Sir:

This is in reply to your memorandum of October 25, 1995, under cover of which you forwarded, through the National Commodity Specialist Division, a request for internal advice (I/A), dated June 6, 1995, submitted by counsel Arent Fox Kintner Plotkin & Kahn on behalf of Alpine Electronics Manufacturing of America (USA), Inc. ("AOMA"), concerning the dutiability of certain royalty payments made by AOMA to related parties. Additional submissions made by counsel regarding this matter were also forwarded with your memorandum. The request for internal advice arose in connection with a prior disclosure submitted by AOMA on February 10, 1995, and an audit of AOMA conducted by the Cincinnati office of the Regulatory Audit Division. Regulatory Audit contends that the royalty payments in question are dutiable, and your office concurs with this position. We regret the delay in responding.

Counsel has requested that certain specifically identified cost and financial information submitted in connection with this matter be treated as confidential. After reviewing the information in question, we have granted counsel's request for confidentiality pursuant to section 177.8(a)(3), Customs Regulations (19 C.F.R. ?

FACTS:

AOMA purchases and imports parts and components from Alpine Electronics, Inc. ("AOJ"), a related Japanese seller, and also, but to a lesser extent, from other related party sellers including Alps Electric Co., Ltd ("Alps"). AOMA uses the imported merchandise together with domestic components to manufacture in the United States certain switches and clock spring cables, and car audio products. The corporate structure of AOMA and its related parties is as follows. Alps owns 100 percent of the stock of AOJ. AOJ owns 100 percent of Alpine Electronics of America, Inc., which, in turn owns seventy percent of AOMA. The balance of AOMA's stock is owned by Alps.

The Alps Agreement

On March 16, 1994, AOMA and Alps executed a "Technology License and Technical Assistance Agreement" covering the following products produced by AOMA: mode control switches; cruise switches; and clock spring cable with flat assembly (the "Alps licensed products"). Under the terms of the agreement (hereinafter, the "Alps agreement"), Alps, the licensor, granted AOMA the right to use Alps' "technical data" in the manufacture and sale of the Alps licensed products. In exchange for these rights, AOMA agreed to pay Alps a royalty equal to a fixed percentage of the gross sales value of the Alps licensed products manufactured by AOMA. Based on the information submitted, specifically, the Alps agreement and counsel's letter of August 23, 1995, none of the imported merchandise used to manufacture the Alps licensed products was manufactured under patent. In addition, Regulatory Audit advises that imported Alps parts represent from [***] percent to [***] percent of the value of the Alps licensed products manufactured by AOMA in the U.S.

The term "technical data", as defined in Article 1.2 of the Alps agreement, refers to "manufacturing and engineering data, techniques, methods, information and know-how relating to the design, engineering, manufacture, assembly and testing" of the Alps licensed products. It includes: assembly drawing; piece part drawings; technical specifications for licensed products including but not limited to piece parts supplied by Alps to AOMA; test and inspection standards; drawings for manufacture of piece parts and assembly jigs; line layout for manufacturing and inspection; standard work time; manufacturing methods and processes; other pertinent information in written and photographic form or maintained in computer software programs; and equipment information (structure, size and other information). The term also covers cost calculation information in respect of: the price of piece parts supplied by Alps to AOMA for use in the manufacture of the licensed products; the price of piece parts that Alps buys from third parties; and the rate of material costs for the prices of the licensed products manufactured and sold by Alps.

The AOJ Agreement

On April 1, 1994, AOMA executed a separate "Technical Assistance Agreement" (hereinafter the "AOJ Agreement") with AOJ covering the following finished products produced in the U.S.: radio-cassette players; radio-CD players; CD changers; amplifiers; and CD and cassette mechanisms (hereinafter, the "AOJ licensed products"). Under the terms of the agreement, AOJ, the licensor, granted AOMA a license to use AOJ's technical information in the design, engineering, testing, assembly and manufacture of the products described above. Pursuant to Article 1.2 of the agreement (hereinafter, the "AOJ agreement"), the term "technical information" refers to any information, including certain patents and utility models described in Exhibit A, provided by AOJ in regard to the design, engineering, testing, assembly, and manufacturing of the AOJ licensed products. In return for the right to use the technical information, AOMA agreed to pay AOJ a royalty equal to a percentage of the selling price of the AOJ licensed products made from the imported merchandise. Based on the information submitted, AOJ parts represent approximately [***] percent to [***] percent of the AOJ licensed products manufactured by AOMA in the U.S.

Pursuant to article 5 of the AOJ agreement, AOMA agreed to purchase certain key parts from AOJ or its designated suppliers. The key parts consist of: printed circuit boards; tuners; cassette mechanisms; and central processing unit integrated circuit chips. The AOJ Agreement provides that AOMA may also purchase key parts from third parties if AOJ so consents. Since April 1, 1994, all key parts with the exception of the printed circuit boards have been procured from AOJ or AOJ affiliates. The printed circuit boards have been sourced either from AOJ or an unaffiliated U.S. supplier approved by AOJ. In a letter dated August 23, 1995, counsel for AOMA advised that AOMA does not have to obtain AOJ's approval to procure non-key parts from suppliers other than AOJ or Alps and that as to key parts, AOMA must comply with paragraph 5 of the Technical Assistance Agreement which requires AOMA to obtain AOJ's consent' before purchasing from other suppliers.

Exhibit A of the AOJ agreement lists some eighty-five patents that are covered by the definition of technical information. According to counsel's letter of August 31, 1995, the patents apply to a broad range of technology. Some of the patents are related to the AOJ licensed products; others are unrelated. In respect of the imported merchandise sold by AOJ to AOMA, counsel noted that AOMA is uncertain whether patent rights applied to every imported part. As a general matter, however, counsel stated that none of the parts manufactured or purchased by AOJ (and imported by AOMA for use in the production of the AOJ licensed products) are subject to a patent or patented process with the exception of certain cassette mechanisms which are subject to the so-called "Dolby Patent".

Parts Supply Agreement

As noted above, article 5 of the AOJ agreement requires AOMA to purchase certain key parts from AOJ or its designated suppliers. In contrast, there is no such requirement under the Alps agreement. The terms and conditions governing purchases of parts from AOJ are set forth in a "Basic Agreement Regarding Parts Supply" (hereinafter, the "parts supply agreement"), dated January 1, 1987. The parts supply agreement provides that individual sales contracts will be concluded in respect of orders placed by AOMA. The prices of parts and components purchased from AOJ are the prices in effect for those goods at the time individual sales contracts are concluded.

ISSUE:

The issue presented is whether the payments in question should be included in the transaction value of the imported merchandise.

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 basis of appraisement is transaction value, defined as the "price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain enumerated additions thereto including: any royalty or license fee 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 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)(D)-(E).

However, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain "test values." 19 U.S.C. to Alps and AOJ, the sellers of the imported merchandise. No information regarding the acceptability of transaction value has been submitted; accordingly, we do not address this issue. Nevertheless, assuming the appraising officer determines that transaction value is the applicable basis of appraisement, the following constitutes our position in respect of the royalty payments in question.

In regard to the dutiability of royalty payments, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in pertinent 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.... 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.... [A]n 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.

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. Thus, under the TAA, any royalty paid by the buyer to the seller will be included in transaction value unless the buyer can establish that the payment is distinct from the price actually paid or payable and not a condition of the sale for exportation to the U.S.

In reviewing the legislative history of the TAA Customs has identified three questions that are relevant in determining the dutiability of royalty payments under section 402(b)(1) of the TAA. General Notice, "Dutiability of Royalty Payments," 27:6 Cust. B. & Dec 1 (February 10, 1993). The questions are as follows: (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? Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability. 27:6 Cust. B. & Dec. at 9-11. The method of calculating the royalty, e.g., on the resale price of the goods, is not relevant in determining the issue of dutiability. Id. at 12. Furthermore, the notice reaffirmed that royalty payments may be dutiable as part of the price actually paid or payable, under the "royalties" provision pursuant to section 402(b)(1)(D) of the TAA, or as proceeds under 402(b)(1)(E) of the TAA.

In analyzing these factors, Customs in most recent rulings has taken into account certain considerations which flow 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 the imported merchandise will generally be dutiable);

(ii) to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated third party);

(iii) whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require 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 the failure to pay the royalties); and

(iv) payment of the royalties on each and every importation.

See HRL 546478, dated February 11, 1998; see also, HRL 546433 dated January 9, 1998, and HRL 544991 dated September 13, 1995 (and cases cited therein).

As both the Statement of Administrative Action and the General Notice make clear, royalty payments are dutiable as part of the price actually paid or payable, or as an addition thereto. The TAA defines the term "price actually paid or payable" as meaning "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). As a general matter, all payments made by the buyer to the seller are presumed to be part of the price actually paid or payable. Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990).

However, this presumption may be rebutted by evidence which clearly establishes that the payments are totally unrelated to the imported merchandise. In Chrysler Corporation v. United States, 17 CIT 1049, No. 93-186 (1993), the Court of International Trade applied the Generra standard and determined that certain shortfall and Special Application fees which the buyer paid to the seller were not a component of the price actually paid or payable for the imported merchandise. Instead, the court found that the evidence established that the fees were independent and unrelated costs which were assessed because the buyer failed to purchase other products from the seller and not a component of the price of the imported engines.

The Alps Agreement

Under the Alps agreement AOMA pays a royalty as consideration for the right to manufacture the Alps licensed products, and for the right to use Alps' research and development, or technical data, in the manufacture of the licensed products. Alps Agreement, art. 2.1, at 2. The term "technical data" as defined by the Alps agreement means manufacturing and engineering data, techniques, methods, information and know-how relating to the design, engineering, manufacture assembly and testing for the licensed products. Alps agreement, art. 1.2, at 1. None of the imported merchandise used to manufacture the Alps licensed products was manufactured under patent. Based on the information submitted, we find that the rights for which the royalties are paid relate to the manufacture of the Alps licensed products in the U.S. rather than for rights connected with the manufacture of the imported merchandise.

As to whether the royalty was involved in the sale of the imported merchandise we note that the royalty was paid to Alps, a seller of the imported merchandise. Royalties are involved in the sale of imported merchandise where the sales agreements or purchase contracts are subject to the terms of the royalty agreement. 27:6 Cust. B. & Dec. at 12. For example, in HRL 544991, dated September 13, 1995, royalties were paid in consideration of licensed technology and technical assistance provided by the licensor/seller to the importer/buyer. An agreement between the licensor/seller and the importer/buyer effectively linked the payment of the royalties to the purchase of the imported parts by providing that the licensor/seller would supply the importer/buyer with parts in accordance with such terms and conditions as were separately agreed.

Moreover, as noted above, there is a presumption under Generra that all payments made by the buyer to or for the benefit the seller, or a party related to the seller, are part of the price actually paid or payable for the imported merchandise. This may be rebutted, however, by evidence which shows that the payments are not a component of the price actually paid or payable. In the instant case, the royalty payments were made by the buyer to a related party seller of components used in the Alps licensed products. However, the evidence does not support a finding that the royalty payments are part of the price actually paid or payable for the imported parts and components. Instead, the evidence indicates that the payments relate to the design and manufacture of the Alps licensed products. There is no information, such as invoices, for example, which would link the payment of the royalty fees to the sale for exportation of the imported merchandise. Based on our review, we therefore find no linkage between the sale for exportation of the imported merchandise and the payment of the royalties to Alps.

Finally, we find that AOMA could buy imported merchandise purchased from Alps without paying the royalty. There is nothing in the Alps agreement which inextricably links the payment of the royalty to the purchase of the imported merchandise as there was in, e.g., HRL 544991 and HRL 546433. Accordingly, we find that the royalty payments made under the Alps agreement are neither part of, nor an addition to, the price actually paid or payable for the imported merchandise.

The AOJ Agreement

Under the AOJ agreement, AOMA pays a royalty as consideration for the right to use AOJ's technical information in the design, engineering, manufacturing and testing of the AOJ licensed products. The term "technical information" as defined by the AOJ agreement means "any information, including patents and utility models described in Exhibit A, which are provided by ALPINE from time to time, concerning the design, engineering, testing, assembly and manufacture of the Products." AOJ agreement, art. 1.2, at 1.

Counsel has advised that while it is generally the case that none of the imported parts and components used to manufacture AOJ licensed products is patented, AOMA and AOJ are uncertain that this is true in all instances. Indeed, counsel has advised that certain cassette mechanisms, used in the AOJ licensed products and subject to the so-called "Dolby patent", are in fact manufactured under patent. However, because the evidence on this point is inconclusive with respect to all the imported merchandise, we are unable to determine whether the royalties were involved with the production of imported merchandise purchased from AOJ.

The royalty is involved in the sale of the imported merchandise, however. Article 5 of the AOJ agreement provides for the purchase of certain key parts and components used in the manufacture of the licensed products. Specifically, article 5 provides:

To meet the standard quality of ALPINE's products and for the sake of preservation of the reputation and name value of ALPINE, LICENSEE [AOMA] agrees to purchase certain key parts from ALPINE or its designated suppliers at reasonable prices and terms. Considering price, quality, percentage of country origin, etc., in accordance with the mutual agreement between ALPINE and LICENSEE, LICENSEE may purchase key parts from third parties.

AOJ agreement, art. 5, at 4. This provision is similar to the provisions at issue in the agreements under review in HRL 544991. In that case, as discussed above, an agreement between the licensor/seller and the importer/buyer linked the payment of the royalties to the purchase of imported parts by providing that the licensor/seller would supply the importer/buyer with parts.

Similarly, section 5 of the AOJ agreement links the payment of the royalty to the purchase of the imported parts. We also note that the imported AOJ parts and components on which royalties are paid under the AOJ agreement comprise between [********] and [**********] percent of the total cost of the parts used by AOMA in the production of finished car audio products in the U.S. In addition, the payments are made by the AOMA to AOJ, the seller of the imported parts and components and the information presented supports the Generra presumption. Consequently, it is our position that AOMA could not purchase the imported merchandise without paying the royalty fee and that the royalties are included in the transaction value of the imported parts and components.

HOLDING:

In conformity with the foregoing, royalty payments made pursuant to the Alps agreement are not included in transaction value as part of, or an addition to, the price actually paid or payable for the imported merchandise.

In contrast, royalty payments made pursuant to the AOJ agreement are included in transaction value as either part of the price actually paid or payable, or as an addition thereto under section 402(b)(1)(D) of the TAA.

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 to the public via the Diskette Subscription Service, the Freedom of Information Act and other public access channels.

Sincerely,

Acting Director
International Trade Compliance Division

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