HQ 548420 - Commissions; Sourcing Fee; Design Fee; Royalty Payments; Assists; Clearly Destined; Arm’s Length - United States International Trade Commision Rulings

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HQ 548420

January 13, 2004

VAL RR:IT:VA 548420 CRS

CATEGORY: VALUATION

William D. Outman, II, Esq.
Baker & McKenzie
815 Connecticut Avenue, N.W.
Washington, D.C. 20006-4078

RE: Commissions; Sourcing Fee; Design Fee; Royalty Payments; Assists; Clearly Destined; Arm’s Length

Dear Mr. Outman:

This is in reply to your letter of October 14, 2003, under cover of which you requested a ruling on behalf of your client, Esprit Macao Commercial Offshore Limited (EMCO), relative to the appraised value of merchandise imported into the United States. EMCO will act as non-resident importer of record in respect of the transaction described below.

As a preliminary matter, we note that you requested that certain information contained in your submission and identified by brackets be accorded confidential treatment pursuant to section 177.2(b)(7), Customs Regulations (19 C.F.R. § 177.2(b)(7). See also, 19 C.F.R. § 177.8(a)(3). In this regard you submitted a public version of the ruling request with the bracketed information redacted. Inasmuch as the confidential information was clearly identified in the ruling request and the reason for which confidentiality was sought, viz., harm to EMCO’s competitive position, was explained, your request for confidential treatment is approved. Any such information appearing in this ruling has been bracketed and will be deleted from public versions of this decision.

FACTS:

The distribution of products bearing the Esprit® trademark will be effected pursuant to a distribution agreement between EMCO and its related party, Esprit U.S. Distribution Ltd. (EUSD), a Delaware corporation. Pursuant to the agreement, EUSD will place orders for merchandise with EMCO, which, in turn, will purchase the products from various unrelated foreign manufacturers in Asia, Europe and Africa.

In connection with these purchases, EMCO also entered into a sourcing agreement with Esprit de Corp. (Far East) Limited (EDCFE), Hong Kong, a wholly-owned subsidiary of EMCO’s parent company, Esprit Holdings Limited. In return for the services provided, EDCFE will be paid a “sourcing fee” of [****************************************************************************************]. In addition, EMCO has entered into a licensing agreement with Esprit IP Limited (IP), a British Virgin Islands corporation, permitting EMCO to use the Esprit trademark, and other intellectual property owned by IP, in connection with products sold in the U.S. In return for the right to use the intellectual property in the U.S., EMCO will pay IP a royalty based on a percentage of sales of the products in the U.S. Lastly, EMCO has entered into an agreement with Esprit Design und Product Development GmbH (EDPD), a German corporation. Under the terms of the agreement, EDPD will be responsible for developing a global collection for various subsidiaries of Esprit Holdings Limited, EMCO’s parent. For its services, EDPD will be paid a design fee. The distribution agreement, the sourcing agreement and the license agreement are all dated April 30, 2003. All three agreements are signed by and on behalf of the parties thereto by the same individuals. The design agreement enclosed with your submission is undated and unsigned. Copies of the agreements were enclosed as confidential Exhibits A-D to your submission.

EMCO will arrange with EDPD for the design of merchandise to be imported into the U.S. Upon receiving the designs, EMCO will furnish them to EDCFE, which will be responsible for locating vendors in the Far East and elsewhere who are able to produce the goods to EMCO’s specifications and requirements. After identifying qualified vendors, EDCFE will obtain product samples and supply them to EMCO. If the product samples meet with EMCO’s approval, EMCO will forward the samples to EUSD for the purpose of soliciting orders. EUSD will place purchase orders for merchandise directly with unrelated vendors, but with the assistance of EDCFE. Under the terms of the purchase orders the goods will be ordered for the U.S. market.

In order to insure the integrity of shipments destined for export to the U.S., the standard EMCO purchase order number will be coded to be country specific. For example, [****] designates a shipment for the U.S, whereas [****] designates a shipment for Germany. Garment style numbers are also coded to be country specific. For example, in respect of style numbers, in style number [************], the [****] would designate a season, while the [****] would designate the U.S. Garment labels will be marked in compliance with U.S. apparel labeling requirements, including EUSD’s RN number and care labeling instructions. Vendors will be required to pack the goods in cartons bearing marks and labels indicating that the goods are destined for the U.S. For each shipment destined for the U.S., the vendor will be required to furnish invoices showing EUSD as the consignee and Los Angeles as the port of discharge. Other documentation specific to the U.S. will include quota charge statements, single country or multi-country textile declarations and quota/visa documentation.

In addition to the agreements, copies of the following were submitted with your ruling request: EUSD’s puchase order to EMCO; EMCO’s purchase order to an unrelated vendor; the unrelated vendor’s invoice to EMCO; a packing list from the unrelated vendor to EMCO; EMCO’s invoice to EUSD; an air waybill; a multicountry textile declaration; a quota charge statement; an export license; and a certificate of origin.

In connection with these purchases, EDCFE will be responsible for performing market research relative to price, quality and delivery, use commercially reasonable efforts to ensure that vendor/manufacturers execute trademark protection letters and comply with trademark protection procedures, ensuring quality control and inspecting the goods. Other duties include implementing shipping instruction to facilitate export, making logistic arrangements for the goods, and providing advice relative to international textile agreements. EMCO has the right to purchase goods without employing the services of EDCFE, and EDCFE does not have the right to sign any document for or on behalf of EMCO.

The sourcing agreement provides at clause 1(b) that the relationship between EMCO and EDCFE “is that of independent contractors, and nothing contained in this Agreement shall be construed to create a partnership or the relationship of principal and agent, or the relationship of employer and employee.” The agreement provides further at clause 3(d) that EDCFE is a sourcing contractor and that nothing in the agreement is to be construed to allow it to sell the goods or conduct any sales activities for or on behalf of EMCO. Pursuant to clause 3(e), EMCO does not have the right to sign any document in the name of or on behalf of EMCO.

Under the terms of the design agreement, EDPD is responsible for developing a global collection for various subsidiaries of Esprit Holdings Limited, based on certain pricing and fashion considerations. To this end, EDPD develops, elsewhere than in the U.S., styles necessary for the production of products for the U.S. market, and furnishes EMCO with all materials, information, patterns and styles pertinent thereto.

Under the terms of the license agreement, EMCO pays IP a royalty for the right to use certain intellectual property owned by IP in connection with the manufacture, sale and distribution of the imported merchandise in the U.S. and in the Caribbean. As used in the agreement, the term “intellectual property” includes certain trademarks, as well as copyrights, designs, patterns, trade secrets, know-how, and other proprietary rights. IP is a wholly-owned subsidiary of Esprit Holdings Limited, EMCO’s parent company. It is not related to any of the sellers or manufacturers of the imported merchandise.

In this regard, you advise that the imported merchandise is not manufactured under patent. Further, you note that “the intellectual property at issue is limited to non-manufacturing rights only, including the right to use the “Esprit” trademarks, trade name and trade dress formats in advertising, store use and signage. The payments are not made to the sellers of the imported merchandise, nor do they inure to the benefit of the sellers.

ISSUE:

The issues presented are: (1) whether the imported merchandise was clearly destined for the U.S. and the subject of an arm’s length sale such that it may be appraised under the transaction value method on the basis of the sale between the seller(s) and EMCO; (2) whether the sourcing fee paid to EDCFE is included in transaction value as an addition to the price actually paid or payable; (3) whether certain design work undertaken by EDPD constitutes an assist such that its value is included in transaction value as an addition to the price actually paid or payable; and (4) whether the royalty paid by EMCO to IP Limited is related to the imported merchandise and is paid as a condition of the sale for exportation to the U.S. such that it is included in transaction value.

LAW AND ANYALYSIS:

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 method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. The additions include: the packing costs and any selling commissions incurred by the buyer with respect to the imported merchandise; the value, apportioned as appropriate, of any assist; and 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. 19 U.S.C. § 1401a(b)(1). Transaction value is not acceptable if the buyer and seller are related and the relationship influences the price actually paid or payable and there are no test values that establish the validity of the transaction value.

Sale for Exportation

In Nissho Iwai American Corp. v. United States, 786 F. Supp. 1002 (Ct. Int’l Trade 1992), rev’d in part, aff’d in part, 982 F.2d 505 (Fed. Cir. 1992), the Court of Appeals for the Federal Circuit reviewed the standard for determining transaction value when there is more than one sale which may be considered as being a sale for exportation to the United States. In so doing, the court reaffirmed the principle of E.C. McAfee Co. v. United States, 842 F.2d 314 (Fed. Cir. 1988), that the manufacturer's price, rather than the middleman's price, is valid so long as the transaction between the manufacturer and the middleman falls within the statutory provision for valuation. Nissho Iwai, 982 F.2d 505, 511. In reaffirming the McAfee standard the court stated that in a three-tiered distribution system:

The manufacturer's price constitutes a viable transaction value when the goods are clearly destined for export to the United States and when the manufacturer and the middleman deal with each other at arm's length, in the absence of any non-market influences that affect the legitimacy of the sales price....[T]hat determination can only be made on a case-by-case basis.

Id. at 509. See also, Synergy Sport International, Ltd. v. United States, 17 C.I.T. 18 (1993).

As a general matter, CBP presumes that the price paid by the importer constitutes the basis of transaction value. In order to rebut this presumption, and base transaction value on sale involving another party, such as, a middleman, the importer must provide evidence, in accordance with Nissho, that establishes that the manufacturer’s price was a statutorily viable transaction value. To this end, the importer must provide detailed information that the goods were clearly destined for export to the United States, and that the manufacturer and the middleman dealt with each other at arm’s length, absent any non-market influences affecting the legitimacy of the sales price. T.D. 96-87, 31:1 Cust. B. & Dec., 30:52 Cust. B. & Dec. (1997). See also, Customs and Border Protection, Dep’t Homeland Security, Informed Compliance Publication, Bona Fide Sales and Sales for Exportation, http://www.cbp.gov/xp/cgov/import/informed_compliance/ (rev’d Jan. 2000).

In this instance, EMCO, the non-resident importer of record, purchases merchandise from unrelated suppliers in various foreign locations. As described above, the goods are produced to EMCO’s specifications, labeled with EUSD’s RN number, and coded with country specific markings. Purchase orders are designated with country specific codes, the commercial invoices show EUSD as the consignee, and other documents such as visaed invoices and single/multi-country designations indicate that the goods are clearly destined for the U.S. Based on the information submitted, the sale between the vendors and EMCO is an arm’s length transaction and the goods are clearly destined for the U.S. Accordingly, assuming that EMCO has available the requisite evidence specified in T.D. 96-87, including, for example, the complete paper trail and evidence of payment, the sale between the vendors and EMCO may be used as a basis for determining transaction value.

Sourcing Fee

Pursuant to section 402(b)(4) of the TAA, the term "price actually paid or payable" is defined in pertinent part as "the total payment (whether direct or indirect...) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller. 19 U.S.C. § 1401a(b)(4). Selling commissions incurred by the buyer constitute are an addition to the price actually paid or payable. 19 U.S.C. § 1401a(b)(1)(B). Bona fide buying commissions, however, are not an addition to the price actually paid or payable. Pier 1 Imports, Inc. v. United States, 708 F. Supp. 351, 354, 13 CIT 161, 164 (1989); Rosenthal-Netter, Inc. v. United States, 679 F. Supp. 21, 23, 12 CIT 77, 78 (1988); Jay-Arr Slimwear, Inc v. United States, 681 F. Supp. 875, 878, 12 CIT 133, 136 (1988).

The existence of a bona fide buying commission depends upon the relevant factors of the individual case. E.g., J.C. Penney Purchasing Corp. v. United States, 451 F. Supp. 973, 983, 80 Cust. Ct. 84, 95, C.D. 4741 (1978). However. the importer has the burden of proving the existence of a bona fide agency relationship and that the payments to the agent constitute bona fide buying commissions. Rosenthal-Netter, 679 F. Supp. 21, 23; New Trends, Inc. v. United States, 645 F. Supp. 957, 960, 10 CIT 637 (1986).

In this case, the agreement expressly provides that the relationship between EMCO and EDCFE is not one of principal and agent, but rather that of independent contractors. Sourcing Agreement at clause 1(b). Thus, we find that the sourcing fees do not constitute bona fide buying commissions. However, we note that EDCFE and EMCO are affiliated in that both are wholly-owned subsidiaries of Esprit Holdings Limited. Based on the information submitted, EDCFE’s sourcing activities are undertaken solely for EMCO’s benefit pursuant to the terms of the sourcing agreement.

CBP has found that similar payments made to a party unrelated to the seller do not constitute part of the price actually paid or payable. For example, in HRL 544143, dated July 5, 1988, the buyer paid an unrelated party for consultation services rendered in locating quota holding companies. The payments were made pursuant to an agreement that was separate and apart from the purchase of the imported merchandise and therefore were not part of the price actually paid or payable. In HRL 544684, dated July 31, 1992, the buyer hired employees who engaged in activities normally associated with a buying agent. The employees worked exclusively for the buyer/importer and did not manufacture, buy or sell independently. Inasmuch as the payment at issue were not made to the seller, they were not part of the price actually paid or payable.

Similarly, the information submitted in regard to the instant case supports a finding that the fees are paid in respect of activities normally associated with a buying agent. For example, EDCFE will be responsible for locating vendors in the Far East and elsewhere who are able to produce the goods to EMCO’s specifications and requirements. After identifying qualified vendors, EDCFE will obtain product samples and supply them to EMCO. If the product samples meet with EMCO’s approval, EMCO will forward the samples to EUSD for the purpose of soliciting orders. EUSD will place purchase orders for merchandise directly with unrelated vendors, but with the assistance of EDCFE. EDCFE will be responsible for performing market research relative to price, quality and delivery, using commercially reasonable efforts to ensure that vendor/manufacturers execute trademark protection letters and comply with trademark protection procedures, ensuring quality control and inspecting the goods. Other duties include implementing shipping instruction to facilitate export, making logistical arrangements for the goods, and providing advice relative to international textile agreements. Accordingly, it is our position, based on the information submitted, that the sourcing fee is not part of the price actually paid or payable for the imported merchandise.

Design Fee

EDPD is responsible for developing a global collection for subsidiaries of Esprit Holdings Limited, based on certain pricing and fashion considerations. To this end, EDPD develops styles necessary for the production of products for the U.S. market, and furnishes EMCO with all materials, information, patterns and styles pertinent thereto. EMCO pays EDPD a design fee for its work in this regard. The fee is based on the [*************] as defined in the design agreement. The basis on which this is determined may be re-calculated periodically. As noted above, EMCO pays EDPD a pre-payment on the [*****************]. An adjustment of the final amount due will be fee will be declared on Customs Form 7501 as an estimate equal to [************************************************************************* **********************************] in the sale of merchandise sold to EMCO. All such entries [************************************************************************************* **************************] once the final amount has been determined by the parties on the basis of the annual statement.

As noted above, transaction value includes the value, apportioned as appropriate, of any assist. 19 U.S.C. § 1401a(b)(1). The term "assist" refers to any goods and services supplied directly or indirectly, and free of charge or at reduced cost, by the buyer for use in connection with the production or the sale for export to the U.S. of the imported merchandise. Assists include, among other things, "engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise." 19 U.S.C. § 1401a(h)(1)(A)(iv).

The design work undertaken by EDPD is provided by EMCO free of charge or at a reduced cost to the seller/manufacturers of the imported merchandise. The work is undertaken elsewhere than in the U.S. and is necessary for the production of the imported merchandise. Consequently, it constitutes an assist, the value of which should be included in transaction value as an addition to the price actually paid or payable.

Royalty Payment

As general matter, royalty payments may be included in transaction value as part of the price actually paid or payable, or as an addition thereto under section 402(b)(1)(D)-(E) of the TAA. General Notice, “Dutiability of Royalty Payments,” 23:6 Cust. B. & Dec. 1, 11 (February 10, 1993); see also 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. The General Notice identified three questions as being relevant in determining whether royalty payments are dutiable. Was the imported merchandise manufactured under patent? Was the royalty involved in the production or sale of the imported merchandise? Could the importer buy the product without paying the fee? Affirmative answers to the first and second questions, and a negative response to the third, point towards dutiability. 23:6 Cust. B. & Dec. at 9-11.

In regard to the dutiability of royalty payments, 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, 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 off 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 sale of the merchandise, and such payment was not a condition of 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 the sale of the merchandise for exportation to the United States, an addition will be made. As a further example, 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. Thus, under the TAA, any royalty paid by the buyer to the seller will be included in transaction value unless the buyer can establish that the payment is distinct from the price actually paid or payable and not a condition of the sale for exportation to the U.S.

In the instant case, the license agreement gives EMCO the right to use the “intellectual property,” defined as certain trademarks, service marks, trade names, trade dress, copyrights, designs, patterns, trade secrets, know-how, and other proprietary rights, in connection with the manufacture, promotion, distribution and sale of the imported merchandise in the U.S. You have advised that the imported merchandise is not manufactured under patent. Further, you note that “the intellectual property at issue is limited to non-manufacturing rights only, including the right to use the “Esprit” trademarks, trade name and trade dress formats in advertising, store use and signage. The payments are not made to the sellers of the imported merchandise, nor do they inure to the benefit of the sellers. Provided the royalties are not paid for rights related to a process of manufacture, they are not included in transaction value.

Nevertheless, we note that the term “intellectual property,” as defined in the license agreement, includes designs, patterns, trade secrets and know-how. The term “trade secret” refers generally to information such as a formula, pattern, compilation, program, device, method, technique or process. 14 U.L.A. 433 (1990). To the extent that the royalty is paid for a trade secret or a design, it is more likely to be related to a process of manufacture, and paid as a condition of the sale, in which case the amount of the royalty would be included in transaction value as an addition to the price actually paid or payable. However, based on the statement in your submission, i.e., that “the type of intellectual property is limited to non-manufacturing rights only,” it is our position that the royalty payments are not included in transaction value.

As a final matter, we note that, in addition to the license agreement, you submitted copies of pertinent documentation relative to the transaction, e.g., copies of purchase orders, invoices, packing lists, etc. We have assumed that there are no other relevant purchase agreements, purchase contracts, or other documentation relative to the transaction between the buyer and seller. In a general notice published in the Customs Bulletin, we advised that in order to obtain a ruling on the dutiability of royalties or license fees, any royalty agreements relating to the royalty payments of license fees, and any purchase/supply agreements would have to be submitted. 29:36 Cust. B. & Dec. 10, 12 (September 6, 1995). While you submitted the agreements and documentation referenced above, we note for the record that no purchase, supply or other agreements between EMCO and the manufacturers/vendors, pertaining to the Esprit® trademark or other intellectual property rights owned by IP, EMCO or Esprit Holdings were submitted. We have assumed that there are no such agreements, or if there are, that there is nothing in such agreements that would render the royalty payments a condition of the sale for exportation to the U.S.

HOLDING:

In conformity with the foregoing, and assuming the availability of the requisite evidence specified in T.D. 96-87, the imported merchandise was clearly destined for the U.S. and the subject of an arm’s length sale such that it may be appraised under the transaction value method on the basis of the sale between the seller(s) and EMCO.

The sourcing fee paid by EMCO to EDCFE is not paid to or for the benefit of the seller or a party related to the seller. It is not a selling commission. The amount of the sourcing fee is not included in transaction value.

The design work undertaken by IP constitutes an assist, the value of which is included in transaction value an addition to the price actually paid or payable.

Based on the information submitted, the royalty payment to IP for the right to use the intellectual property in the U.S. is a not paid in respect of manufacturing rights. It is not condition of the sale for exportation to the U.S. and is not paid to the seller(s) or a party related to the seller(s) and, consequently, is not included in transaction value as an addition to the price actually paid or payable.

Sincerely,

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