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HQ 546229

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May 31, 1996

RR:IT:VA 546229 RSD

CATEGORY: VALUATION

Port Director
United States Customs Service
4735 Oakland Street
Denver, Colorado 80239

RE: Internal Advice on the dutiability of royalty payments for the use of a trademark

Dear Director:

This is in response to your letter dated December 27, 1995, forwarding the internal advice request submitted by counsel on behalf of Arena North America, Inc. (hereinafter "Arena") regarding the dutiability of royalties. Counsel made a supplemental submission by fax on March 15, 1996.

FACTS:

Arena is a company based in Englewood, Colorado and a subsidiary of a Japanese company, Descente, Ltd. (hereinafter "Descente"). It imports and distributes men's and women's bathing suits and accessories in the United States. These products bear the "ARENA" trademark, which is owned by Descente. Several factories unrelated either to Arena or Descente manufactured the imported swimwear in Hong Kong.

On February 1, 1993, Arena and Descente entered into a License Agreement for the period, February 1, 1993 through January 31, 1995. A copy of the License Agreement was submitted. Under the agreement, Descente, granted to Arena an exclusive license to use the "ARENA" trademark in connection with the manufacture, promotion, sale, distribution, or any other disposition of licensed products for the territory of the United States. The agreement further provides that Arena may source the licensed products outside the territory of the United States, with Descente's prior written consent. In exchange for the license, Arena agreed to pay Descente royalties equal to 2% of the net sales of the licenced products. The term "net sales" is defined by the agreement as gross sales of all licensed products sold by licensee to the independent dealers, less returns, trade discounts, and indirect sales taxes actually imposed by the United States Government.

At the end of each annual period covered by the agreement, Arena computed its net sales of the licensed products in the United States and paid the appropriate royalty to Descente. Under the Licensing Agreement, the licensee cannot commence the production without the licensor's prior consent, and the licensor reserves the right to disapprove any licensed product or its material which does not fully comply with the specifications or which are not in licensor's opinion compatible with the reputation of the products of the licensor. However, there is no indication that Descente had any control over what factories were chosen to make the merchandise, or that any portion of the royalties were given to the manufacturers.

Counsel submitted a series of documents labeled as "Sales Contracts" pertaining to the imported swimwear. These documents give a description of the goods being purchased, the price of the goods, the quantity purchased, and the terms of the sale. Included in the description of the goods is the instruction that the "ARENA" logo was to be embroidered on the garments, but there is no mention of royalties on these documents. Counsel has also indicated that there are no formal sales contracts between Arena and the manufacturers, and purchases are made through the use of purchase orders. Two sample purchase orders were submitted.

The only issue you raised in the internal advice request and the only issue decided here concerns the dutiability of the license fees Arena paid Descente. We note, however, that the submitted "Sales Contracts" relating to the import transactions do not originate from the factories, but from the company, Win Hanverky, Inc. According to counsel, Win Hanverky acted as Arena's agent in the purchase of the imported merchandise and Arena paid Win Hanverky a 5% commission for its services. However, these "Sales Contracts" state that "we hereby confirm having accepted your order as per terms and conditions printed below". This language suggests that Win Hanverky may have been acting in some capacity other than as Arena's buying agent. This evidence should be considered along with the other available evidence in determining Win Hanverky's role in the subject transactions. For purposes of this decision, we assume that the sellers to the import transactions are the factories, with Win Hanverky acting either as a buying or selling agent.

ISSUE:

Whether the license fees Arena paid to its related parent who is neither the seller of the imported merchandise nor related to the seller for use of a trademark, as described above, constitute additions to the price actually paid or payable for imported merchandise either as royalties or proceeds under sections 402(b)(1)(D) or (E) of the TAA?

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 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."

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 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, whereas royalties and license fees paid to third parties for use, in the United States, of copyrights and trademarks related 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.

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.

As quoted above, the Statement of Administrative Action explains that royalties and license fees paid to third parties for use in the United States, of copyrights and trademarks related to the imported merchandise are generally not dutiable, but the final determination depends on to whom and under what circumstances they were paid. An important consideration is whether the royalties are paid to the seller or to a party related to the seller to an unrelated third party. In this case, Arena pays the license fees to Descente, its parent company. Descente is neither the seller of the imported swimwear nor a party related to the seller.

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 Custom 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 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(b)(1)(D) of the TAA.

The first question posed by the notice is whether the imported merchandise was manufactured under patent. Although the information submitted with the internal advice request does not specifically indicate whether or not the imported merchandise was manufactured under patent, counsel claims that the imported products were not manufactured under patent, and therefore we assume the imported merchandise was not manufactured under patent.

The second question indicated in the notice is whether the royalty is involved in the production or sale of the imported merchandise. This question expands the analysis of question one. In this case, the royalty payment was made for the right to use the licensor's trademark in connection with the manufacture, promotion, sale, distribution or any other disposition of the various garments sold in the United States. The rights bear no relation to the actual production process by which the imported merchandise is manufactured. Thus, based on the information presented, it is our position that the royalty will not be paid for rights associated with processes to manufacture or produce the imported merchandise. See HRL 54536, July 20, 1995.

Similarly, the royalty is not involved in the sale of the imported merchandise. In the Hasbro II ruling, we held that a royalty was involved in the sale of imported merchandise where the sales agreements and purchase contracts were subject to the terms of the license agreement. In HRL 544991, September 13, 1995, we held that a royalty was involved in the sale of the imported merchandise where the payment of the royalty was closely tied to the purchase of the imported product. Here, there is no indication that the royalty payment was subject to the terms of the sale for exportation to the United States or closely tied to such sale. As indicated previously, the documents pertaining to the sale of the imported merchandise make no reference to the payment of royalties. Similarly, even though the agreement provides that Descente must approve of a sample before production commences, it does not specify the terms and conditions related to the purchase of the imported product. Based on a review of the submitted documents, the royalty payment to Descente was paid to use the trademark in the United States and appears to be unrelated to the sale for exportation of the imported merchandise to the United States. Accordingly, based on the information presented the second question also yields a negative response.

The third question asks whether the importer could buy the product without paying the fee. This question goes to the heart of whether a payment is considered to be a condition of sale. 27:6 Cust. B. & Dec. at ll. Here, all indications are that the importer can buy the merchandise from the seller and import it without having to pay royalties to the licensor. Under the license agreement, Arena is not obligated to pay any royalties for merely purchasing the licensed products abroad and importing them into the United States.

Furthermore, as noted above, based on a review of the submitted documents, there is no evidence to suggest that the royalty is linked to sales agreements or purchase contracts for the imported merchandise e.g., a requirement by the seller that Arena pay the royalty to the licensor. See HRL 545379, July 7, 1995. Based on counsel's representation that all the relevant documents were submitted and that there are no formal contracts covering the subject transactions, we conclude that the payment of the royalties is not a condition of sale of the imported merchandise for exportation to the United States, and is not an addition to the price actually paid or payable for the merchandise under section 402(b)(1)(D) of the TAA.

Although the royalty payments are not dutiable as royalties, we must also determine whether they would be considered proceeds of a subsequent, resale, disposal, or use of the imported merchandise under section 402(b)(1)(E). In HRL 544436 (C.S.D. 91-6; Vol 25 Cust. Bull. No. 18 dated February 4, 1991), commonly know as the "Hasbro ruling", the importer was required to pay a percentage of the "resale price" to the seller, for the imported merchandise, in addition to the price originally paid. The importer had been paying duties on these additional payments as "royalties' under section 402(b)(1)(D). Customs held that the payments were not dutiable under this royalty provision, but were dutiable under section 402(b)(1)(E) as "proceeds of subsequent resales" of the imported merchandise that accrued to the seller.

Customs subsequently reviewed the Hasbro ruling, by soliciting public comments thereon and published the General Notice on the Dutiability of "Royalty" Payment, referred to above and commonly known as the "Hasbro II" decision. Customs incorporated the analysis of the comments received. Hasbro II upheld the first Hasbro ruling and modified it to the extent the subject payment were found to be dutiable as either royalties under section 402(b)(1)(D) or as proceeds under section

Regarding proceeds, SAA provides the following:

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.

Statement of Administrative Action, H.R. Doc No. 153 96 Cong. 1st Sess., Pt. 2. reprinted in, Department of Treasury, Customs valuation under the Trade Agreement Act of 1979 (October 1981), at 49.

In this case, Arena pays the license fees to a party who is neither the seller of the imported merchandise nor a party related to the seller. Descente owns and licenses the trademark used by Arena, but does not produce or sell the imported merchandise. Accordingly, based on the facts presented, we find that the license fee payments that Arena made to Descente are not dutiable as proceeds under section 402(b)(1)(E) of the TAA because they do not accrue directly or indirectly to the seller of the imported merchandise.

HOLDING:

The royalty payments made by Arena to Descente are not includable in transaction value as royalties or proceeds under

The Office of Regulations and Rulings will take steps to make this decision available to Customs personnel 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
International Trade Compliance Division

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