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HQ 547532

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November 2, 2001

RR:IT:VA 547532NL

CATEGORY: VALUATION

Port Director
U.S. Customs Service
610 S. Canal Street
Chicago, IL 60607

Re : Mitsubishi Motor Manufacturing of America, Inc. Request for Internal Advice; Royalty Payments for Technical Information and Patents

Dear Port Director :

This is in response to your memorandum (your file APP-4-TC-CH-CST307 LR), dated September 24, 1999, concerning the treatment of certain royalty payments made by Mitsubishi Motor Manufacturing of America, Inc. (MMMA) to its related party parent, Mitsubishi Motor Corporation (MMC). Your memorandum forwards for consideration by this office MMMA’s request for internal advice pursuant to section 177.11, Customs Regulations, together with supporting documentation. Subsequently, MMMA provided submissions to this office dated May 21, 2001, June 1, 2001 (including a videotape of MMMA plant operations), and August 14, 2001.

MMMA has requested, pursuant to 19 CFR 177.2(b)(7), confidential treatment for certain information included in the request. By a letter dated April 10, 2000, this office granted the request. Accordingly, information that constitutes trade secrets, or privileged or confidential commercial or financial information regarding the business transactions or the parties will be deleted from the public version of this document, and certain exhibits will be exempt from public disclosure.

FACTS:

Pursuant to a non-exclusive License Agreement with its parent, MMMA has acquired rights to certain technical information or patents for use in connection with the manufacture of ST series vehicles at its Foreign Trade Subzone at Normal, IL. In exchange for these rights, MMMA pays MMC a royalty of [xxxx] of the total sales amount of licensed products manufactured and sold by MMMA. We have examined the License Agreement together with other exhibits. We have examined also the Component Supply Agreement between the two companies.

The licensed products are manufactured using both foreign and domestic components. A varying portion of the components are purchased from MMC. Principally, MMMA purchases sets consisting of engines, transmissions and related parts from MMC that are referred to as KD Kits. The cost of an engine to MMMA is approximately $[xxxx]; the cost of a transmission is $[xxxx]; and the cost of the parts $[xxxx]. MMMA advises that the value of the KD Kits has varied between [xx] percent and [xx] percent of the total of parts purchased by MMMA during the last three years. For the year 2000, the cost to MMMA of KD Kit purchases represented [xxxxxxxxxxxxxxxxx] of its total costs to produce the vehicles. The production process entails, among other things, stamping, shaping, body production, metal finishing, painting, production and installation of plastic surfaces, assembly of components, trims, upholstery, electricals, and other parts. MMMA advises that [xxx xxxxxxxxxxxx xxxxxxxxxxxxx xxxxxxxxxxxxx xxxxxxx xxxxxxxxxxxxx xxxxxxxxxxxxxx xxxxx xx xxxxxxxxxxxxxx Xxxx xxxxxxx xx xxxxxxxxx xxxxxxxxxxxxx ]

The Component Supply Agreement between MMC and MMMA governs the sale of imported KD kits. Article 2 of that agreement provides that MMMA will purchase 100 percent of its requirements from MMC. MMMA has clarified that the reference to requirements is a reference only to KD Kits. MMMA is not obligated to purchase other products from MMC, and with respect to KD Kits, MMMA has rights to source some or all of the elements of the kits from other suppliers, and on occasion has done so for reasons of cost, quality, or availability.

MMMA points out that the Component Supply Agreement does not contain any reference to the Licensing Agreement or to any obligation to pay royalties. There are, for example, no mutual termination clauses. MMMA asserts that under these arrangements it is free to purchase components from MMC whether or not royalties are paid, and that correspondingly, it is free to operate under the licensing agreement without buying components from MMC.

According to MMMA, the licensed technical information and know-how (engineering parts lists; drawings of local parts; assembly drawings; installation drawings; engineering orders; and engineering specifications and parts drawings) relate only to the finished vehicles. We have reviewed MMMA’ supplemental submission of sample technical information, consisting of: exterior metal color specifications and samples; interior plastic specifications and samples; a set of specifications, part list, part drawings, and engineering drawings for an interior vehicle part; specifications for welding; and a set of assembly specifications and installation drawings showing implementation of an engineering change.

According to Annex A, point 2, 2 of the License Agreement, any research or development costs of the vendor are excluded from the Agreement. Thus, to the extent that MMC is the seller of, for example, KD Kits, its r&d costs for those goods are not being reimbursed by license fees paid by MMMA.

MMC provides certain personnel assistance and training in connection with the installation of new equipment or processes for production of the licensed products. The costs for this assistance and training are paid by MMMA separately from the License Agreement.

Taking these circumstances into account, MMMA submits that royalty payments under the License Agreement are entirely unrelated to any imported components that it purchases from MMC. In this regard the royalty payments are not payment for the imported KD Kits.

It is also MMMA’s position that royalty payments pursuant to the License Agreement with MMC are not includable in the appraised value of imported parts because payment of the royalty is not a condition of sale of imported parts, and because these royalty payments are not the proceeds of any subsequent resale, disposal or use of the imported parts. MMMA characterizes the royalty payments as made in consideration only of intangible rights to sell products produced in the United States, and in consideration of substantial technical advice and research from which it benefits.

Pending a decision by Customs concerning the dutiability of these payments, MMMA has been “flagging” under the Reconciliation Program consumption entries that contain imported components for the production of ST vehicles to indicate that royalty payments are being made.

Your office agrees that the royalty payments are not to be included in the appraised value of imported parts.

ISSUE :

Are royalty payments made by MMMA to MMC under their License Agreement covering ST model vehicles manufactured by MMMA includable in, or additions to, the price actually paid or payable for imported parts bought by MMMA from MMC?

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 (19 USC 1401a (“TAA”)). The preferred method of appraisement under the TAA is transaction value, defined as, “the price actually paid or payable for the merchandise when sold for exportation to the United States”, plus enumerated additions, including: 1) any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to the United States (19 USC 1401a(b)(1)(d)); and 2) the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the buyer (19 USC 1401a(b)(1)(D)).

Are the royalty payments an element of the price actually paid or payable?

Based on Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990), Customs presumes that all payments made by the buyer to the seller are part of the price actually paid or payable for imported merchandise. In Generra, the Court of Appeals held that the term "total payment" is all-inclusive and that "as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods." The court also stated:

Congress did not intend for the Customs Service to engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, are for the merchandise or for something else. As we said in Moss Mfg. Co. v. United States, 896 F.2d 535, 539 (Fed. Cir.1990), the "straightforward approach [of section 1401a(b)] is no doubt intended to enhance the efficiency of Customs' appraisal procedure; it would be frustrated were we to parse the statutory language in the manner, and require Customs to engage in the formidable fact-finding task, envisioned by [appellant].

Generra, 905 F.2d at 380 (brackets in original).

The presumption that all payments made by the buyer to the seller are part of the price actually paid or payable may be rebutted, however. In Chrysler Corporation v. United States, 17 CIT 1049 (1993), the Court of International Trade applied the standard in Generra 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. The court found that the evidence established that these fees were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller and not a component of the price of the imported engines. Accordingly, the royalty payments at issue will not be considered part of the price actually paid or payable if the evidence clearly establishes that, like those in Chrysler, they are totally unrelated to the imported merchandise. The burden of establishing that the payments are totally unrelated to the imported merchandise rests with the importer. Generra, 905 F.2d at 380.

Based on the information submitted, we find that MMMA has met its burden of establishing that the royalty payments made to MMC are completely unrelated to the purchase from MMC of imported merchandise. MMMA has demonstrated that the rights for which royalties are paid relate solely to use technical knowledge in the manufacture in the United States of licensed products made in part from the imported KD kits.

MMMA has established that its automobile manufacturing operation is more than mere assembly or finishing of components. The process begins with the shaping and stamping of steel, ends with the final assembly of finished automobiles, and takes in all the necessary operations in between. The Licensing Agreement relates to all of these processes in the context of the production of the Licensed products, and does not relate to the KD Kits. We can thus agree that the royalty payments cover operations of far broader scope than merely finishing the imported KD Kits.

As concerns the sale for exportation of the KD Kits by MMC to MMMA, we agree that the License Agreement has no bearing upon such sales. The Component Supply Agreement is independent undertaking between the entities that is not conditional upon the License Agreement or the royalties payable under it. Moreover, the value of the imported merchandise is not included in the calculating the royalty, which is tied to MMMA’s United States sales of manufactured vehicles. The independence of the sales from the royalty payments is demonstrated by the fact that the MMMA can purchase parts from MMC indefinitely without paying royalties; the obligation to pay these arises only upon the manufacture and sale of vehicles. Likewise, the purchase of replacement parts does not trigger any royalty payment obligation. Finally, if vehicles containing KD Kits are not sold, no royalty payment is due. These scenarios reinforce the conclusion that the royalty payments and sales of KD Kits are unrelated.

MMMA has clarified that the reference in the Component Supply Agreement in Article 2 to MMMA purchasing all its requirements from MMC relates only to the KD Kits, and not to all components used in production of the Licensed Products. Further, the obligation to purchase KD Kits from MMC is not absolute; MMMA is free under several circumstances to source from other suppliers.

In sum, we find that the royalty payments under the License Agreement do not form part of the price actually paid or payable for the KD Kits purchased by MMMA from MMC.

Are the royalty payments an addition to the price actually paid or payable?

To determine whether royalty or license payments are related to imported mechandise and paid as a condition of sale for export to the United States, the Customs Service generally applies the three-part test set forth in its General Notice of February 10, 1993 (“Hasbro II”), 27 Cust. B. & Dec. 6. With regard to each of the three parts of the Hasbro II test, MMMA has satisfactorily shown that its royalty payments to MMC are not includable in the appraised value of imported merchandise purchased from MMC.

First, when purchasing imported components from MMC, MMMA pays the purchase price for these components. There are no separate royalty payments regarding these components. The royalties paid under the ST License Agreement concern the assembly of ST vehicles in the United States, and not the imported components. Therefore, the question whether the imported components were manufactured under patent is not particularly relevant to the valuation treatment of royalty payments under the ST License Agreement.

Second, and similarly, royalty payments under the ST License Agreement are not involved in the production or sale of the imported components. There is no reference in the ST License Agreement to imported components, and MMMA’s supply orders are not subject to the Agreement. Pursuant to Article 2 of the Agreement, the license granted is for the right to use technical information and patents solely for the manufacture in the United States of ST series vehicles. This transaction is separate from sales of components from MMC to MMMA.

The Component Supply Agreement between MMC and MMMA, which governs the purchase of parts, and the associated commercial documentation, make no reference to royalties. Equally, MMMA’s accounting for import transactions does not reflect royalties as liabilities associated with the purchase of components from MMC. Finally, there are no adjustments to the royalty payment in the event that MMMA uses parts that are defective, lost or scrapped.

We conclude that the royalty payments under the ST License Agreement are not involved in the production or sale of the imported components, and therefore are not related to imported components. Previous decisions of the Customs Service have reached similar conclusions. See, e.g., HRL 544979 (April 27, 1995) (payments to overseas parent deemed part of a separate transaction conferring the right to use imported components and to manufacture motor vehicles in the United States); HRL 545307 (February 3, 1995) (payment was for the right to use technical knowledge to make, use and sell a finished pharmaceutical product in the United States).

The third inquiry under Hasbro II is whether the importer could buy the imported merchandise without paying the fee. In other words, is payment of the royalty a condition of sale for the imported merchandise? In this instance it is evident that the purchase of parts by MMMA from MMC is not conditioned upon the payment of the royalty for the U.S. manufacture of ST vehicles. MMMA is not obligated to purchase components from MMC for use in the ST series vehicles; the royalty obligation would exist whether or not components from MMC were used. Under similar circumstances, Customs has concluded that royalty payments were not a condition of sale of imported merchandise used in the domestic manufacture of licensed products. See, e.g., HRL’s 544979 and 545307, supra.

In summary, MMMA has made satisfactory demonstration that the instant royalty payments are neither related to the imported components nor required as a condition of their sale. Accordingly, the payments are not dutiable pursuant to section 402(b)(1)(D) of the TAA (19 USC 1401a(b)(1)(D).

MMMA also urges that the royalty payments under the ST License Agreement do not constitute proceeds of any subsequent resale, disposal or use of the imported merchandise. Therefore the amounts paid are not dutiable pursuant to section 402(b)(1)(E) of the TAA (19 USC 1401a(b)(1)(E).

We agree with this position. The royalty payments are in fact based upon the proceeds of the sale of U.S.-manufactured ST vehicles that may or may not contain imported components purchased from MMC. The amounts paid are not directly based upon the resale, disposal or use of the imported components themselves. In such circumstances the Customs Service has concluded that royalty payments are not dutiable. See HRL’s 544656 (June 19, 1991); 545307 supra; and 545381 (May 4, 1998). The royalty payments made by MMMA to MMC under the ST License Agreement are not additions to the price paid or payable pursuant to section 402(b)(1)(E), TAA.

HOLDING :

The amounts paid by MMMA to MMC under the ST License Agreement are not includable in, or additions to, the price acually paid or payable for imported components purchased from MMC and used in the production of ST vehicles.

This decision should be mailed by your office to the internal advice requester no later than 60 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,

Virginia L. Brown
Chief, Value Branch


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