HQ 547710 - Request for Internal Advice – Dutiability of Royalty Payments - 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 > 2002 HQ Rulings > HQ 547487 - HQ 561808 > HQ 547710

Previous Ruling Next Ruling
HQ 547710

December 16, 2001

VAL:RR:IT:VA 547710 NL

CATEGORY: VALUATION

Port Director
U.S. Customs Service
200 East Bay Street
Charleston, SC 29401

RE: Request for Internal Advice – Dutiability of Royalty Payments

Dear Sir:

This is in reply to your memorandum dated March 2, 2000 (your reference APP-6 PD:C CAT) requesting Internal Advice concerning the dutiability of certain royalty payments made by Fuji Photo Film, Inc, Greenwood, SC (Fuji Greenwood) to Fuji Photo Film Ltd. (Fuji Japan). Fuji Greenwood made a submission in support of its position dated August 29, 2000. We regret the delay in responding.

Fuji Greenwood has stated, and this office accepts, that certain materials included in its submissions to Customs constitute confidential business information pursuant to 19 CFR 103.12(d). The confidential materials were identified in an attachment to Fuji Greenwood’s letter dated November 20, 2001. Accordingly, our reply is prepared so as to omit mention of such confidential business information.

FACTS:

Fuji Greenwood is an indirectly owned subsidiary of Fuji Japan engaged in the manufacture of photographic and related products in the United States. You have asked this office to review the circumstances surrounding six royalty agreements under which Fuji Greenwood is licensed to produce articles developed by Fuji Japan. The subject-matter of the royalty agreements is the delivery to Fuji Greenwood of technical information necessary to produce the licensed products. This technical information includes technical data, information and formulae in documents, reports, manuals, recipes and media relating to or useful in manufacture of the licensed products. The products licensed under the agreements are: pressure sensitive plates, magnetic recording materials, single-use cameras, color photographic paper, graphic art film and 35mm color negative film. The agreements are substantially similar in their provisions.

Under these agreements Fuji Greenwood has agreed, in exchange for the right to manufacture and sell the licensed products worldwide, to pay Fuji Japan percentages of its worldwide sales of the licensed products.

Your office has suggested that these royalty payments appear to be related to payment for imported goods used in production of the licensed products that Fuji Greenwood buys from Fuji Japan, such that payment of the royalties is either a condition of the sale for exportation of these raw materials, or proceeds of subsequent resale. It was suggested that dutiability was indicated under Headquarters Ruling Letters (HRLs) 546034 (May 6, 1997) and 544800 (May 17, 1994).

Fuji Greenwood acknowledges that it purchases imported raw materials and components from Fuji Japan, but indicates that it does so on a non-exclusive basis and not as an obligation created under the royalty agreements. Fuji Greenwood asserts that it is free to source inputs from any supplier, and that most of its imported inputs are purchased from unrelated third parties. It states that there are no supply arrangements between itself and Fuji Japan or other related parties for raw materials. To the extent that materials are obtained from such sources, it is by means of purchase orders and not long-term agreements.

Finally, Fuji Greenwood advises that when buying raw materials from related parties all prices and terms are negotiated at arms length such that the relationship between the parties does not influence the price actually paid or payable. It therefore believes that transaction value is the appropriate method of appraisement for these imported raw materials.

Fuji Greenwood urges that the two Headquarters Ruling Letters cited above are inapposite, and that others, closer to the facts at issue, indicate nondutiability.

Scope of this Ruling

The articles imported by Fuji Greenwood and purchased from Fuji Japan are understood to include components and raw materials. Fuji Greenwood states in its August 29, 2000 submission that the majority of the components imported are raw materials and they are not produced under any patent. It further states that it does import a few specialty components which may be covered by unexpired patents in the U.S. or abroad. Finally, it is stated that “All royalties are paid based on the sale of finished products and are unrelated to any possible patents on the imported components.”

With respect to the imported components manufactured under patent, it is noted that the agreements grant the right, among other things, to manufacture licensed products using Fuji patents. In this regard, there remains a question whether royalty payments under the instant agreements are, at least in part, payment for the imported patented components. Our doubts on this point relate also to the definitions of licensed products as including both finished and unfinished goods.

Based on these unresolved matters, our decision here is limited to payments for imported components and raw materials bought from Fuji Japan and not manufactured under patent. For ease of reference, this decision refers to all such goods as “raw materials”.

As a further clarification, this decision is only with respect to royalty payments made in connection with the manufacture in the U.S. of products that are the subject of substantial manufacturing operations and do not, after such operations, retain their identity as imported components or raw materials.

In the event that your office or Fuji Greenwood seeks a definitive ruling on payments for imported specialty components manufactured under patent, the Office of Regulations and Rulings would require clarification as to the relevant patents and the circumstances of all payments made in connection with such purchases, including any royalty payments not covered by the instant agreements. Upon submission of such information the Office of Regulations and Rulings will issue a ruling on an expedited basis.

ISSUE:

Are the royalty payments to be treated a part of, or additions to, the price actually paid or payable for the imported raw materials purchased by Fuji Greenwood from its related companies?

LAW & 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 primary 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. Section 402(b)(1)(D)-(E) of the TAA. Such additions will be made only if amounts in respect of royalties, proceeds, etc. are not otherwise included in the price actually paid or payable.

However, as you know, 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," e.g., the deductive or computed value of identical or similar merchandise determined pursuant to actual appraisements of imported merchandise. Section 402(b)(2)(B) of the TAA. In the instant case, the buyer/licensee and the licensor/seller are related but no evidence has been presented as to whether the relationship influences the price actually paid or payable. Consequently, we are unable to determine whether transaction value is an appropriate basis of appraisement. Nevertheless, assuming that transaction value is the appropriate basis, the following constitutes our position in regard to the dutiability of the royalty payments at issue. In regard to the dutiability of royalties, 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. . . . An 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.

Price actually paid or payable

As the language of the SAA makes clear, an 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. The term "price actually paid or payable" is defined as, "the total payment (whether direct or indirect. . .) made, or to be made, by the buyer to, of for the benefit of, the seller." Section 402(b)(4)(A) of the TAA. Thus, the first inquiry is whether the payments at issue are part of the price actually paid or payable for the imported merchandise.

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).

However, the presumption that all payments made by the buyer to the seller are part of the price actually paid or payable may be rebutted. 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 made by Fuji Greenwood will not be considered part of the price actually paid or payable for raw materials bought from Fuji Japan 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 agree with Fuji Greenwood that pursuant to the agreements the rights for which the royalties are paid relate solely to the manufacture and sale in the U.S. of finished products made in part from the imported merchandise. We accept Fuji Greenwood’s representation that the sales documentation for the raw materials purchased from Fuji Japan makes no reference to the payment of royalties. Taking the information and representations as a whole, we find that the payment of the license fees by Fuji Greenwood to Fuji Japan was unrelated to the payments for the raw materials. They are not part of the price actually paid or payable for those raw materials, whether Fuji Greenwood purchases them from Fuji Japan or another supplier.

Royalties and License Fees

Having reviewed the two Headquarters Ruling Letters cited by your office, HRLs 546034 and 544800, we believe that they provide only limited guidance concerning the facts under consideration. For example, in HRL 546034, even though the imported product was further processed in the U.S., the license agreement specifically covered both the imported product and the finished product. In 544800 the imported product was the licensed product; moreover, the supply agreement said that the payment for the imported merchandise would be in the form of a royalty.

The instant situation is different in that it concerns royalties paid for the right to manufacture and sell licensed merchandise. The issue here is the relationship between these royalty payments and payments for imported raw materials used to produce the licensed products, both of which are made to the seller of the raw materials. If it is determined that the royalties are paid as a condition of sale of the raw materials, or if royalty payments amount to the proceeds of further sale, then the TAA provides that the amounts of the payments, appropriately allocated, are additions to the price actually paid or payable for the imported merchandise. Section 402(b)(1)(D)-(E), TAA.

Payment of Royalties as a Condition of Sale

Customs’ current approach based upon an examination of the issue undertaken in 1993. See, General Notice, "Dutiability of Royalty Payments," 27.6 Cust. B. & Dec. 1 (February 10, 1993) (the "General Notice"). After reviewing the legislative history of the TAA, Customs identified three questions that are relevant in determining whether royalty payments are dutiable under section 402(b)(1)(D) of the TAA. The questions are: (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? Id. at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability. The notice states that royalties may be dutiable either as part of the price actually paid or payable, or as additions thereto under section 402(b)(1)(D)-(E) of the TAA. Id. at 11. 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 (February 11, 1998); HRL 546433 (January 9, 1998); and HRL 544991 (September 13, 1995) (and cases cited therein).

According to Fuji Greenwood the answer to the first question posed by the General Notice is that the majority of the imported materials bought from Fuji Japan are not manufactured under patent. As recited above, a few specialty components may be manufactured under patent. Concerning these components, for the reasons previously indicated, we are declining to rule concerning the dutiability of license fees paid in connection with the manufacture in the U.S. of articles made in part from the specialty components manufactured under patent and sold by Fuji Japan to Fuji Greenwood. Leaving aside those situations, we accept the representation that in respect of the imported raw materials, no royalties are paid by Fuji Greenwood in connection with their production under patent, because they are not manufactured under patent.

As to the second question, based on our review of the information submitted there is no linkage between the sale for exportation of the imported raw materials and the payment of the royalties by the buyer, notwithstanding the fact that in some cases the payments are made to the licensor/seller. The royalty is paid for the right to manufacture and sell the licensed products in the U.S. Payment for this right appears to be separate from payment of the purchase price of the imported merchandise. The Licensed Products for which royalties are paid differ from the imported raw materials that are subjected to substantial manufacture after importation. Without evidence of a linkage between the supply of the imported merchandise and the payment of royalties based on sales of the licensed products, we do not find that the royalty payment was involved in the production or sale of the imported merchandise.

The third question posed by the General Notice, i.e., whether the importer could buy the merchandise without paying the fee, is central to the question of whether a royalty payment is a condition of sale. Payments that must be made for each imported item are a condition of sale. In the instant case, there does not appear to be a linkage of the payment of the royalties to the purchase of the raw materials imported by the buyer. Thus, unless there are other, undisclosed undertakings between Fuji Greenwood and Fuji Japan, the payment of the royalties is not a condition of the sale for exportation to the U.S. of the imported raw materials. In appraising the imported raw materials under transaction value, the royalty payments are not additions to the price actually paid or payable pursuant to section 402(b)(1)(D), TAA.

Proceeds of any subsequent resale, disposal or use

As noted previously, royalty payments may also be dutiable under section 402(b)(1)(E) of the TAA, which provides that the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller, are to be added to the price actually paid or payable. However, Customs has held that payments based on the resale of a finished product made in part from the imported merchandise are not dutiable as proceeds under 402(b)(1)(E). E.g., HRL 544656 (June 19, 1991); HRL 545770 (June 21, 1995). The royalty payments at issue are not based on the sale of the imported merchandise. Instead, the payments are based on the sale of licensed products, manufactured by Fuji Greenwood, that may or may not contain the imported merchandise. Accordingly, the payments at issue are not dutiable under the proceeds provision.

HOLDING:

In conformity with the foregoing, assuming transaction value is the appropriate basis of appraisement, royalties paid in respect of the licensed products are not part of the price actually paid or payable for the imported raw materials, nor do they constitute additions thereto under section 402(b)(1)(D)-(E) of the TAA. This holding is limited to the appraisement of imported raw materials as discussed above, and is further limited to raw materials which have substantially lost their identity when manufactured into licensed products under the agreements reviewed.

This decision should be mailed 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 this decision available to Customs personnel via the Customs Ruling 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

Previous Ruling Next Ruling