HQ 546675 - The Freestyle Group, Inc.; Licensing Agreement - United States International Trade Commision Rulings

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HQ 546675

June 23, 1999

RR:IT:VA 546675 EK

CATEGORY: VALUATION

Ms. Laura Denny
CBT International, Inc.
110 West Ocean Blvd., Suite 728
Long Beach, California 90802

RE: The Freestyle Group, Inc.; Licensing Agreement

Dear Ms. Denny:

This is in response to your letter of February 22, 1997, requesting a ruling regarding certain licensing fees paid by your client, The Freestyle Group (importer; licensee), to Ocean Pacific Apparel Corporation (licensor). In your letter of June 24, 1997, you forwarded relevant purchase orders relating to the transactions. We requested additional information regarding a specific clause in the royalty agreement which you provided to us by a submission dated May 12, 1998. We regret the delay in responding.

FACTS:

Freestyle will be importing watches, watchbands and watch-related accessories from Pan-Pace (H.K.) Co., Ltd. in Hong Kong (seller). Freestyle is not related to the seller, nor is the seller related to licensor. In addition, Freestyle has entered into a licensing agreement with OP (licensor), an unrelated party. The license agreement grants to the licensee the use of the licensor=s trademarks in the manufacture and wholesale distribution and sale in the United States of products specifically enumerated in the agreement, i.e., watches, watchbands and watch-related accessories for men, women, boys and girls. The licensee agrees that all trademarks, goodwill, rights and entitlements all remain the sole and exclusive property of the licensor. The licensee has agreed to devote its best efforts to manufacture and ship each accepted order for licensed products within a reasonable time of receipt of the order or by the delivery date specified in the
order. The initial term of the agreement is for three years, with the option of extending the agreement for an additional period of three years. The option of extending the term will be granted if the licensee achieves a minimum amount of sales.

In exchange for the use of the licensor=s trademark, the licensee agrees to pay the licensor a fee of 7% of the dollar amount of all net sales of the licensed products. In addition, the licensee agrees to sell a minimum amount of licensed products. If at the end of a calendar year the licensee has not paid the licensor the minimum amount of royalty and advertising payments equaling the minimum royalty for that year, the licensee pays the licensor the balance due on such royalties and advertising payments.

In your submission of May 12, 1998, you have clarified paragraph 20.2 of the license agreement between the licensee and licensor. Paragraph 20.2 of the agreement provides that the licensee=s rights under the agreement may be sublicensed by the licensee. The paragraph further provides that such a sublicense/subcontract may only be obtained with the express written consent of the licensor. You have advised us that there are no sublicensees or subcontracts in this matter, and that the agreement is solely between the licensee and licensor. You have further stated that there are no quality control agreements between Pan Pace, the seller, and OP, the licensor, and that there are no conditions imposed on the seller by the licensor. Further, you state no express written approval from the licensor to the seller exists because such is not required. The agreement is solely a trademark agreement between Op, the licensor, and The Freestyle Group, the licensee.

ISSUE:

Whether the license fees paid by The Freestyle Group, to the unrelated licensor, Ocean Pacific Apparel, are part of the transaction value of the imported merchandise.

LAW AND ANALYSIS:

Transaction value, pursuant to section 402(b) of the TAA, is defined as Athe price actually paid or payable for the merchandise when sold for exportation to the United States . . . Aplus certain additions specified in section 402(b)(1)(A)-(E). More specifically, section 402(b)(1)(D) provides for an addition the price actually paid or payable 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.

With regard to royalties, the Statement of Administrative Action (SAA), adopted by Congress with the passage of the TAA, provides that:

[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 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.

In a General Notice on the Dutiability of Royalty Payments (Vol. 27 Cust. Bull. No. 6, dated February 10, 1993), Customs set forth a three-part analysis designed to provide importers with a uniform approach in determining whether payments constitute dutiable royalties. The following three questions were set forth, the answers to which assist in determining whether a royalty or license payment is related to the imported merchandise and whether it is a condition of sale:

1) Was the imported merchandise manufactured under patent? 2) Was the royalty involved in the production or sale of the imported merchandise? 3) Could the importer buy the product without paying the fee?

Negative responses to the first two questions and a positive response to the third question tend to indicate that the payments are not a condition of sale and therefore, not dutiable as royalty payments.

With regard to the first question, the merchandise is not manufactured under patent. Rather, the agreement gives the importer/licensee the right to use a licensed
trademark in connection with the manufacture and sale in the United States of the imported merchandise.

The second question is also answered in the negative. The license fees are paid in consideration for the right to use the licensor=s trademark in connection with the manufacture, advertising, use, distribution and sale of the trademarked merchandise in the United States. In addition, there is no indication that the license fee is subject to the terms of the sale for exportation to the United States of the imported merchandise. The right to use the licensor=s trademark is not only separate from the manufacturing process, but also, given that the licensor and seller and unrelated, from the sale for exportation to the U.S. of the imported merchandise. The license fee is not linked to individual sales agreements or purchase orders for the imported merchandise. Accordingly, it does not appear that the license fee is involved in the sale of the imported merchandise. Consequently, based upon the information presented, the response to the second question is in the negative.

The third question, i.e., whether the importer could buy the merchandise without paying the fee, is crucial in the determination of whether the license fee is a condition of sale. Payments that must be made for each imported item are a condition of sale. Royalty payments and license fees are a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise. However, if the payments are optional and not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell in a designated area, they are not dutiable.

In this case, the license fee is not paid to the seller, nor has any evidence been presented which ties the license fee to the sales agreement or purchase order for the imported merchandise, i.e., a requirement by the seller that the buyer pay the licensee fee to the licensor. It appears as if the buyer may purchase the imported merchandise without having to pay the fee. Although the payment is not optional, that is, it must be paid to the extent that the licensee earns revenue by reselling the product, it is not a condition of sale of the imported merchandise. Therefore, the license fee is not an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA.

In addition, the payments are not considered Aproceeds@ within the meaning of section 402(b)(1)(E) of the TAA. That section provides an addition to the price actually paid or payable for Aproceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller.@ The payments at issue in this case do not accrue to the seller, neither directly nor indirectly.

HOLDING:

The license fees paid by the importer (licensee) to the unrelated licensor are not included in the transaction value of the imported merchandise under section 402(b)(1)(D) of the TAA. In addition, the payments are not added to the price actually paid or payable pursuant to section 402(b)(1)(E) of the TAA as proceeds of a subsequent resale of the imported merchandise.

Sincerely,

Thomas L. Lobred, Chief

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