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HQ 545528

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August 3, 1995

VAL CO:R:C:V 545528 er

CATEGORY: VALUATION

District Director
Chicago, Illinois 60607

RE: Request for Internal Advice (I/A 107/93); Payments for use of trademark; royalties; proceeds.

Dear Sir:

This is in response to your request for internal advice dated December 16, 1993, regarding the dutiability of certain royalty payments made by the importer/licensee, , pursuant to trademark licensing agreements with , , and . A copy of each agreement was received with your memorandum. We regret the delay in responding.

FACTS:

The imported merchandise consists of a variety of models of trucks and passenger cars. Although the entries are made with invoices from , located in Hong Kong, the manufacturers are identified as , , and , all of which are located in Canton, China. The importer states that the manufacturers are owned by Chinese entrepreneurs and may be partially owned by the Chinese government. There is no evidence to indicate that the manufacturers in Canton and the sellers in Hong Kong are related to either the importer or the licensors of the trademarks.

The trademark licensing agreement between the importer/licensee and provides that the licensor grants to the licensee a "nonexclusive License to use the trademarks solely and only upon and in connection with the manufacture, sale, and distribution of the licensed products." In consideration of the license, a basic royalty of three percent (3%) of the licensee's nets sales is paid in addition to an advance annual royalty amount of three thousand dollars ($3,000). The advance royalty is credited against the royalty calculated on the net sales during the initial one year period of the term but not thereafter.

The trademark licensing agreement between the importer/licensee and provides that the licensor grants to the licensee a "non-exclusive License to use the Trademarks solely and only upon and in connection with the manufacture, sale, and distribution of the Licensed Products in the Licensed Territory in the Distribution Channel provided [in the agreement]." In consideration for the license, a basic royalty is paid to the licensor increasing from four percent (4%) of the licensee's net sales in the first year, to four and one half percent (4.5%) in the second year and to five percent (5%) in the third year. Also paid is an advance royalty of seven thousand five hundred dollars ($7,500) against a minimum royalty of fifteen thousand dollars ($15,000) for the first year. Minimums royalties of twenty thousand dollars ($20,000) and twenty-five thousand dollars ($25,000) are paid for the second and third years, respectively.

The trademark licensing agreement between the importer/licensee and provides that the licensor grants to the licensee a "nonexclusive right and license to use the trademarks and truck designs on and in association with scale-model, die cast truck toys which are manufactured, sold and/or distributed by Licensee ... and that are scale-model facsimiles of past, present and future truck models designed and manufactured by for which has given Licensee its approval pursuant to ... [the] agreement." In consideration for the granting of the license, the licensee agrees to pay to a one percent (1%) royalty on all sales, worldwide, of truck toys. The 1% royalty is based on the licensee's average wholesale selling price of truck toys and is to be paid to on a semiannual basis.

ISSUE:

Whether royalty payments made to third parties in accordance with trademark licensing agreements are dutiable as part of transaction value?

LAW AND ANALYSIS:

The preferred method of appraising imported merchandise is transaction value which is defined in section 402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. 1401a(b)). This section provides, in pertinent part, that the transaction value of the imported merchandise is the price actually paid or payable for the merchandise when sold for exportation to the United States plus amounts for certain items enumerated in section 402(b)(1) of the TAA, including the amount of royalties and proceeds. However, imported merchandise will be appraised under transaction value only if the buyer and seller are not related, or if related, the circumstances of sale indicate that the relationship did not influence the price actually paid or payable, or the transaction value approximates certain test values. 19 U.S.C. 1401a(b)(2)(A)-(B). In the instant case, because the sellers of the merchandise are unrelated to the buyer, we have assumed that transaction value is the appropriate basis of appraisement.

We will additionally assume, based on the information submitted, that the royalty payments are not part of the price actually paid or payable for the imported merchandise as they do not appear to be a part of the total payment, directly or indirectly, made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller. See, section 402(b)(4)(a) TAA. In the absence of evidence to the contrary, where, as here, the payments are made by the buyer to a party unrelated to the seller, such amounts are considered as separate from the price. Therefore, in this decision, the issue to be addressed is whether the subject payments are included in transaction value solely from the perspective of whether they constitute additions to the price actually paid or payable.

Among the statutory additions described in section 402(b)(1) of the TAA are:

(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.

19 U.S.C. 1401a(b)(1). It is your belief and that of the Chief, National Import Specialist, special Merchandise Branch, New York Seaport, that the above-described royalty payments are not dutiable.

Regarding royalties and license fees, the Statement of Administrative Action ("SAA"), which was adopted by Congress and has the force of law, provides in pertinent part:

[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 [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.

SAA, H.R. Doc No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of Treasury, Customs Valuation under the TAA of 1979 (October 1981), at 48-49. The royalties in question are paid to third parties, Ford, Chevrolet and Paccar. Provided the royalty is not a condition of sale, the amount of the payment will not be added to the price actually paid or payable.

Whether royalty payments for the subject merchandise are a condition of sale is determined by applying the three-question analysis set forth in the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) ("General Notice"). The first question is whether the imported merchandise is manufactured under patent. Based on the information submitted, we are unable to determine whether the merchandise is manufactured under patent. However, whether the imported merchandise is manufactured under patent is not critical to the determination of dutiability of the royalty payments addressed in the subject licensing agreements because the agreements address payment of royalties in connection with trademark licensing.

The second question is whether the royalty is involved in the production or sale of the imported merchandise. Under the terms of the and licensing agreements the royalty is paid in consideration for the license to use the trademarks in connection with the manufacture, sale, and distribution of the licensed products in the licensed territory. The agreement provides that the a royalty is due in consideration for the right to use the trademarks and truck designs on and in association with the imported merchandise which is manufactured, sold and/or distributed by the importer/licensee. All three agreements also require payment of minimum royalties. In the past, Customs has held that where royalty payments, including minimum royalty payments, are paid to third parties for rights such as these and such payments are not associated with processes to manufacture the imported merchandise, the payments are not dutiable under the royalty provision. See, HRL 545930, dated June 28, 1995 and HRL 545379, dated July 7, 1995. Accordingly, in response to the second question, Customs finds that based on the evidence submitted, the royalties in question are not involved in the production of the imported merchandise.

The second question also requires a determination as to whether a royalty payment is involved in the sale of the imported merchandise. Based on the evidence submitted, we find that the royalty payments are not made subject to the sale for exportation to the United States. In HRL 544436, dated February 4, 1991, we held that a royalty was involved in the sale of imported merchandise because the individual sales agreements and purchase contracts were subject to the terms of the royalty agreement. In the instant case, there are no sales agreements of which we are aware that exist between the buyer and the seller, nor does the licensing agreement tie the payment of royalties to the sale for exportation of the imported merchandise.

The third question is whether the importer could buy the imported merchandise without paying the royalty. As pointed out in the General Notice, supra, the answer to this question goes to the heart of whether a payment is considered to be a condition of sale." While royalties paid to third parties for the use, in the United States, of trademarks related to the imported merchandise are generally not dutiable, the SAA provides that such payments will nevertheless be treated as dutiable if they represent a condition of the sale for exportation. Payments that must be made for each imported item are a condition of sale. In a pre-TAA case, 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), the buyer was required to pay a lump-sum royalty in addition to the price. The court held that such a mandatory payment was dutiable, based primarily on the fact that the payment went to the seller. Under the TAA, such payments may be dutiable as royalties, as part of the price actually paid or payable, or as proceeds. Royalty payments are also a condition of sale when they are paid on each and every item imported and are inextricably intertwined with the imported merchandise. However, where the payments are optional are not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell a product using the imported merchandise in the United States, they are not a condition of sale. Imperial Products, Inc. v. United States, 425 F. Supp. 852, 77 Cust. Ct. 66 (1976).

In the instant case, neither the royalties or the minimum royalties are optional. However, the payments are not paid to the seller, nor has any evidence been presented which ties the royalty to a sale agreement for the imported merchandise, e.g., a requirement by the seller that the buyer pay the royalty to the licensor. If there were evidence, however, which established that it was the payment of the royalties by the licensee/importer that enabled the licensed products to be manufactured, we would regard this as an indication that the payments were a condition of sale. See, HRL 545361, dated July 20, 1995.

We also find that the royalty payments are not proceeds of a subsequent resale, disposal or use of the imported merchandise. The importer and the seller are unrelated; accordingly, provided that no portion of the royalty payments accrues, directly or indirectly, to the sellers, the royalty payments would not constitute an addition to the price actually paid or payable under 19 U.S.C. 1401a(b)(1)(E).

HOLDING:

The royalty payments paid by the licensee to third party licensors pursuant to the terms of trademark licensing agreements are not dutiable under section 402(b)(1)(D) or (E), as royalties or as proceeds of subsequent resale.

Sincerely,

John Durant, Director
Commercial Rulings Division

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