HQ 544978 - Request for Internal Advice; foreign-trade zones; transaction value; royalties; price actually paid or payable; design and development; technical assistance agreements - United States International Trade Commision Rulings

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HQ 544978

April 27, 1995

VAL R:C:V 544978 IOR

CATEGORY: VALUATION

District Director
Cleveland, Ohio

RE: Request for Internal Advice; foreign-trade zones; transaction value; royalties; price actually paid or payable; design and development; technical assistance agreements

Dear Sir:

This is in response to your inquiry dated April 10, 1992 regarding the dutiability of royalty payments made by [**************************] (hereinafter referred to as "the buyer"), a U.S. corporation, to its parent companies [******************* ] (hereinafter referred to as "S-1") and [********************] (hereinafter referred to as "S-2"), both corporations of the exporting country. We have received submissions from the importer dated June 19, 1992, November 14, 1994 and November 28, 1994. This letter follows a meeting between members of my staff and counsel on behalf of the buyer. We regret the delay in responding. In response to the buyer's request for confidentiality, the information contained in brackets will be deleted from the public versions of this decision.

FACTS:

The buyer is a joint venture between S-1 and S-2, both manufacturers of automobiles. The buyer operates an automobile and light truck assembly plant in the U.S. Pursuant to various agreements, the buyer has imported automobile parts, and production equipment for the purpose of manufacturing passenger automobiles in a Foreign Trade Subzone (FTSZ) operated by the buyer. Pursuant to the agreements the buyer has imported press dies, stamping dies, injection molds and equipment jigs (hereinafter collectively referred to as "dies and jigs") from S-1, for the manufacture of automobiles, and automotive parts from S-1 and S-2 for the manufacture of automobiles. The dies and jigs consist of all the equipment necessary for the production of the automobiles. Production equipment was first imported in 1987, and since then new production equipment is imported for each model year and automobile parts are imported continuously as needed.

The buyer files separate automobile entry summaries for nonprivileged foreign parts and privileged foreign parts. The dutiable value reported on the automobile entries consists of 1) the dutiable value of all nonprivileged foreign parts and steel used in the production of automobiles, station wagons and sports utility vehicles and entered at the automobile rate and 2) the dutiable value of all privileged foreign parts used in the production of light trucks and entered at the individual parts rate. After production, the vehicles are sold by the buyer to [****** ********* ****] ("U.S.-1") through [****** *********** ***.] ("[***]") and to [***** ****** ******* ****] ("U.S.-2"). All parties are related within the meaning of §402(g) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. 1401a (g)).

Information regarding the parties was obtained from Regulatory Audit Report Number 311-92-FT2-001, dated March 15, 1993. The buyer was audited for the period from October 1, 1989 to June 30, 1992. It is our understanding from Regulatory Audit and the submitted agreements that the design and development of the vehicles, the imported parts and the production process took place in the exporting country. Construction of the plant began in [**** ****] and production of the vehicles began on [********* *** ****]. According to the audit report the vehicles are manufactured from both domestic and foreign components.

This file is somewhat involved because eight relevant legal agreements between the parties have been submitted to Customs. The agreements consist of a Technical Assistance Agreement, Dies and Jigs Sales Contract, Purchase Agreement and Parts Supply Agreement between the buyer and S-1, and a Technical Assistance Agreement, Consultation and Service Agreement for Construction of Plant and Installation of Machinery and Equipment, Trademark License Agreement and Memorandum of Understanding between the buyer and S-2. These are each discussed herein.

A. Agreements between the buyer and S-1

On June 6, 1989 S-1 and the buyer entered into the Technical Assistance Agreement (hereinafter referred to as the "'89 TA Agreement"), called for in the D&J Sales Contract (see infra), pursuant to which the buyer is to manufacture S-1 designed passenger cars for sale to U.S.-1 through [***]. U.S.-1 is to pay the buyer for the vehicles and not S-1 (according to a June 6, 1989 agreement between S-1 and U.S.-1 supplementing a 1969 distributorship agreement). The '89 TA Agreement states that S-1 has provided and will provide the buyer with technology and engineering services for installation of machinery and equipment in the plant constructed by the buyer, in the start-up of the plant.

Article 2 of the '89 TA Agreement grants to the buyer non-exclusive license "to install machinery and equipment and to use the layout of manufacturing processes to manufacture" the vehicles and parts, non-exclusive license "to manufacture, have manufactured, use and sell to [U.S.-1] through [***] the Products in the Territory, and a non-exclusive license to sell the Products to such other party than [U.S.-1]" and non-exclusive license "to manufacture, have manufactured and use the licensed Parts for the manufacture of the Products and to sell to [U.S.-1] through both [***] and [S-1] such Licensed Parts as replacement parts...and a non-exclusive license to sell to such other party than [U.S.-1]." The '89 TA Agreement defines "Product" as passenger cars which conform to certain basic specifications and "Licensed Parts" as those component parts and parts necessary for the manufacture of the Products which are specified by S-1, which have been developed and designed by S-1, and as to which S-1 owns and has the right to dispose of know-how.

Article 5 of the '89 TA Agreement provides for the following payments to be made by the buyer to S-1 in consideration of the licenses and rights granted under article 2 and the disclosure of know-how:

1. An engineering fee for the plant and equipment. According to the buyer's response to a request for information, this fee consists of reimbursement to S-1 for its actual labor cost incurred for consultation and advice rendered in connection with the layout and selection of machinery and equipment for the buyer's facility. The work ensured the proper layout and operation of the entire S-1 side of the production facility. The buyer states that the fee was paid substantially in connection with work undertaken by the project office in the U.S. The labor elements included in the fee are salaries, bonus payments, welfare expenses, retirement annuities and retirement allowances.

2. A documentation fee consisting of a) a specified documentation fee for the products and licensed parts for the initial year, which is to represent a reasonable estimate of the actual costs of preparing and delivering documents for the products and licensed parts for the initial year models up to September 30, 1989 and b) additional documentation fees for documents furnished to the buyer by S-1 after September 30, 1989 upon terms to be agreed upon by the parties.

3. A royalty fee for the initial year models for the licenses granted.

4. A continuing royalty per vehicle manufactured and sold by the buyer.

The buyer states that the initial royalty is based on two elements: 1) an amount for equipment trial in the exporting country; and 2) an amount for the pre-production costs S-1 incurred in the exporting country in analyzing the production system and production line integrity. The buyer claims that the first element was paid for know-how and information, which is consideration separate and distinct from the purchase price of imported machinery and equipment. The buyer claims that the second element is not dutiable because the payment was not tied to the sale for exportation of any specific merchandise. The buyer states that the continuing royalty consists of an amount for technical information on the [*******] model and parts, an amount for non-labor costs of the U.S. project office, and an amount for U.S. Department of Transportation emission standards compliance. The buyer claims that the fee paid for technical information is not dutiable, and that the costs of the U.S. project office are not dutiable because they were not incurred in connection with the importation of any merchandise. The buyer claims that the DOT costs are not dutiable because they were not part of the price of the imported merchandise and are not covered by any of the five statutory additions to the price actually paid or payable.

With respect to the specific sale of production equipment, the buyer and S-1 entered into two agreements. Prior to entering into the '89 TA Agreement, the buyer and S-1 entered into a Dies and Jigs Sales Contract (hereinafter referred to as the "D&J Sales Contract") dated March 31, 1988, pursuant to which S-1 agreed to sell to the buyer dies and jigs for body assembly and trim fit in order for the buyer to manufacture vehicles based on S-1 licensed technology. The D&J Sales Contract required S-1 and the buyer to sign a technology support contract for [********] vehicle licensed production by the buyer. The buyer and S-1 also entered into a Purchase Agreement (hereinafter referred to as "'90 Purchase Agreement") dated June 4, 1990 pursuant to which S-1 agrees to sell to the buyer dies and jigs which are necessary for the buyer to manufacture [********] vehicles in accordance with the '89 TA Agreement. The '90 Purchase Agreement requires the buyer to order dies and jigs from S-1 from specifications prepared by the buyer in accordance with the know-how under the '89 TA Agreement. See paragraphs 1 and 2 of the '90 Purchase Agreement.

With respect to the specific sale of automobile parts, the buyer and S-1 entered into a Parts Supply Agreement (hereinafter referred to as the "Parts Agreement") dated June 6, 1989, pursuant to which S-1 agrees to sell to the buyer component parts required for manufacturing the motor vehicles which the buyer is licensed to manufacture pursuant to the '89 TA Agreement. Article 2 of the Parts Agreement requires S-1 to sell and the buyer to purchase parts to be used in manufacturing the vehicles in accordance with the terms and conditions in the '89 TA Agreement, and the Parts Agreement is only to continue to be effective for so long as the '89 TA Agreement is in effect.

B. Agreements between the buyer and S-2

S-2 and the buyer entered into a Technical Assistance Agreement (hereinafter referred to as "'87 TA Agreement") effective March 17, 1987, pursuant to which S-2 agrees to furnish the buyer with technical information and assistance relating to the manufacture of motor vehicles. In article 4 of the '87 TA Agreement S-2 grants to the buyer a non-exclusive right to 1) use the technical information furnished under Article 2 to make and use licensed vehicles in the U.S. and sell those to U.S.-2 or to any other third party as otherwise agreed, 2) to make, have made and use licensed components for use in production of licensed vehicles, and 3) to make, have made, use, and sell licensed components to U.S.-2, or any other party as agreed to by the parties. The '87 TA Agreement defines "Licensed Vehicle" as a vehicle which utilizes a significant portion of the technical information furnished to the buyer by S-2 under the "87 TA Agreement, and "Licensed Components" as vehicle components which utilize any portion of the technical information furnished to the buyer by S-2 under the '87 TA Agreement.

Article 5 provides that the buyer shall pay S-2 a royalty for each vehicle it sells. It is the buyer's position that the royalty is based on a percentage of each vehicle value exclusive of the imported parts and as such is not dutiable. The buyer and S-2 entered into a separate Trademark License Agreement in 1989 (hereinafter referred to as the "Trademark Agreement"). The Trademark Agreement gives the buyer a license to use S-2's trademarks on vehicles manufactured under the '87 TA Agreement. The Trademark Agreement does not provide for any separate payments from the buyer to S-2.

The buyer and S-2 entered into a Consultation and Service Agreement for Construction of Plant and Installation of Machinery and Equipment (hereinafter referred to as the "C&S Agreement"), dated June 13, 1989 which was retroactive to March 17, 1987. Pursuant to the C&S Agreement S-2 agrees to prepare and furnish the buyer with technical information in connection with constructing the plant in the U.S. and installing machinery and equipment for the purpose of producing the vehicles and their respective parts and components. S-2 also agrees to provide various services to the buyer in connection with machinery and equipment including determination of specifications, purchase order placement, completion of temporary installation and repair of pilot production. In consideration of S-2's providing technical information and consulting advice, and rendering services, the buyer agrees to pay S-2 a fee. According to the buyer's response to a Request for Information, the fee is composed of the following:

1. Expenses incurred by the engineering department for planning and engineering;

2. Expenses incurred for engineering in setting up and testing production line in the exporting country, and producing over 300 pilot vehicles in the exporting country;

3. A fee to install and test equipment at the buyer and integrate and make compatible all equipment on the buyer production line.

According to the audit report, S-2 sold production equipment to the buyer after testing the machinery in the exporting country. However, Customs has not been provided with any equipment supply agreement between the buyer and S-2.

The buyer and S-2 entered into a Memorandum of Understanding (hereinafter referred to as the "Memorandum") which was executed by S-2 on March 7, 1990 and the buyer on March 12, 1990. Pursuant to the Memorandum S-2 agrees to sell automotive parts to the buyer for the manufacture of motor vehicles. The Memorandum provides for the parties to enter into a Supply Agreement as soon as practicable after the execution of the Memorandum. The buyer and S-2 entered into six separate parts supply contracts, from July 20, 1989 to July 11, 1991 pursuant to which S-2 and the buyer agreed to purchase automotive parts described in an "Engineering Parts List" for certain vehicle models. The selling prices of the parts are set forth in a list attached to each contract.

You have inquired whether the payments made by the buyer pursuant to the Technical Assistance and Consultation Agreements are included in the transaction value of the imported merchandise.

ISSUE:

Whether the fees paid and royalty payments made by the buyer to its suppliers of automotive parts and production equipment are included in the transaction value of the imported merchandise.

LAW AND ANALYSIS:

Production equipment brought into a Foreign Trade Zone (FTZ) is subject to duty under §402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. §1401a ), as is any other imported merchandise, under authority of 19 U.S.C. §§1500 and 1401a.

The dutiable value of the component parts admitted into a FTZ and subsequently entered into U.S. Customs territory, is determined under 19 C.F.R. §146.65 (b)(2). That regulation provides that the dutiable value of such merchandise is:

...the price actually paid or payable for the merchandise in the transaction that caused the merchandise to be admitted into the zone, plus the statutory additions contained in section 402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a(b)(1)), less, if included, international shipment and insurance costs and U.S. inland freight costs. If there is no such price actually paid or payable, or no reasonable representation of that cost or of the statutory additions, the dutiable value may be determined by excluding from the zone value any included zone costs of processing or fabrication, general expenses and profit and the international shipment and insurance costs and U.S. inland freight costs related to the merchandise transferred from the zone.

While the parts and production equipment are subject to different appraisement regulations, the term "price actually paid or payable" for either analysis is defined in TAA §402(b)(4)(A) 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.

The buyer is importing the merchandise from its parent companies, and as the parties are related, pursuant to §402(b)(2)(B) of the TAA, transaction value is acceptable only if an examination of the circumstances of the sale indicates that the relationship between the buyer and seller did not influence the price actually paid or payable or if the transaction value of the imported merchandise closely approximates the transaction value of identical or similar merchandise in sales to unrelated buyers in the U.S. or the deductive or computed value for identical or similar merchandise. The file does not provide enough information to determine whether transaction value is an acceptable basis of appraisement in this case, however, for the purposes of this response, we are assuming that transaction value is the appropriate basis of appraisement.

The agreements pursuant to which payments at issue are made, and the respective payments will be discussed separately herein to determine whether the payments are part of the price actually paid or payable, or are to be added to the price actually paid or payable as one of the statutory additions.

A. 1989 Technical Assistance Agreement between the buyer and S-1

The '89 TA Agreement provides for the buyer's payment of an engineering fee, documentation fee, initial royalty, and a continuing royalty to S-1. The engineering fee and initial "royalty" pertain to the imported dies and jigs (production equipment), and the documentation fee pertains to the imported automobile parts. The continuing royalty pertains to both the imported production equipment and the imported automobile parts.

Price Actually Paid or Payable

It has been the longstanding position of the Customs Service that all monies paid to the foreign seller, or a party related to the seller, are part of the "price actually paid or payable" for the merchandise under transaction value. Two court cases have addressed the meaning of the term "price actually paid or payable." In Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990), the issue before the court was whether quota charges paid to the seller on behalf of the buyer were part of the price actually paid or payable for the imported goods. In reversing the decision of the lower court, the appeals court 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].

Id. At 380.

In Chrysler Corporation v. United States, Slip Op. 93-186 (Ct. Int'l Trade September 22, 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.

Based on Generra, there is a presumption that all payments made by a buyer to a seller are part of the price actually paid or payable for the imported merchandise. However, this presumption may be rebutted by evidence which clearly establishes that the payments, like those in Chrysler, are totally unrelated to the imported merchandise.

Payments for Production Equipment

Engineering Fee for Plant and Equipment and Initial "Royalty" Fee

It is the buyer's position that the engineering fee was not paid in connection with any importations, and the labor reimbursement expenses assumed by the buyer are not dutiable unless rendered in connection with assists provided by the buyer. The buyer cites TAA #33 (HRL 542324) dated June 22, 1981, 542377 (TAA #32) dated June 16, 1981, 542696 dated February 22, 1982, and 543436 dated December 14, 1984. We do not find these decisions dispositive in this case as they pertain to assists and services provided by the buyer of imported merchandise and that is not what is at issue here.

With respect to the engineering fee, the D&J Sales Contract between the buyer and S-1 requires that the parties enter into the '89 TA Agreement. The '90 Purchase Agreement requires that merchandise be ordered in accordance with specifications provided for in the '89 TA Agreement. We find that the purchase of the merchandise under the D&J Sales Contract and the '90 Purchase Agreement is conditioned upon the buyer's payment of the engineering fee provided for in the '89 TA Agreement. The engineering fee is essentially a design and development fee. Customs has consistently held that payments for design and development work are part of the price actually paid or payable for imported merchandise. See e.g. HRL 545278 dated April 7, 1994, HRL 544381 dated November 25, 1991, HRL 544516 dated January 9, 1991 and HRL 543324 dated August 8, 1984. We find that the payments for the development of the assembly system, the components of which were purchased from S-1 pursuant to the D&J Sales Contract and the '90 Purchase Agreement, are related to the imported dies and jigs. Therefore, the engineering fee is part of the price actually paid or payable for the imported dies and jigs. There is no authority to deduct from the price actually paid or payable, amounts paid to the seller, related to the imported merchandise, for work undertaken in the U.S. prior to importation of the merchandise into the U.S.

The foregoing analysis is also applicable to the initial "royalty." This "royalty" is not for a right to use a process or sell a product, but is instead a payment for equipment trial in the exporting country, and for pre-production costs. As stated above, research and development costs paid by a buyer to the seller are included in the price actually paid or payable for imported merchandise. Although it is called a "royalty" it is a payment to the seller which is related to the imported merchandise and as such is part of the price actually paid or payable for the merchandise imported pursuant to the D&J Sales Contract and the '90 Purchase Agreement. Based on the foregoing, we find that the engineering fee and the initial "royalty" fee are part of the price actually paid or payable for the imported dies and jigs.

Payments for Automobile Parts

Documentation Fee

The Parts Agreement is in effect only while the '89 TA Agreement is in effect and requires that merchandise be ordered in accordance with the terms and conditions set forth in the '89 TA Agreement. The documentation fee is required to be paid pursuant to the '89 TA Agreement for the "products" and component parts. We find that the fee clearly is related to the imported parts as it is a fee for preparing and delivering documents for those parts. To the extent that the documentation fee pertains to the imported parts, as opposed to the "products," it is part of the price actually paid or payable by the buyer to the seller for the parts imported pursuant to the Parts Agreement. See e.g. Generra, supra and Chrysler, supra. There is no authority for the deduction of these types of fees from the price actually paid or payable by the buyer to the seller. Therefore, we find that the documentation fee is part of the price actually paid or payable for the imported automobile parts. You may apportion the fee if the buyer can establish what portion, if any, of the documentation fee pertains to the preparing and delivery of documents for the Products (ie. The vehicles).

Payments for Production Equipment and Automobile Parts

"Continuing Royalty"

1. Entries made prior to May 11, 19931

TAA §402(b)(1)(D) provides for an addition to the price actually paid or payable for "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." The Statement of Administrative Action (SAA), specifically adopted by Congress when the TAA passed, contains an explanation of §402(b)(1)(D). In the SAA, Congress explained 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." See Customs Blue Book, 10/81, at p.48. In the February 10, 1993 Customs Bulletin, we issued a General Notice regarding the dutiability of "royalty" payments which set forth a method of analysis. However, that analysis is in effect only for merchandise entered on or after May 11, 1993.

Regarding the continuing royalty, with respect to merchandise entered prior to May 11, 1993, we need to consider prior Customs rulings. In prior rulings, with respect to §402(b)(1)(D), in order to make the determination of whether a royalty payment is "related to the imported merchandise" and is "paid as a condition of the sale of the imported merchandise," Customs has looked to whether the payments are connected to the importation or ownership of the imported merchandise, and Customs has examined the basis of the royalty fee calculation. See C.S.D. 92-12 (HRL 544656) dated June 19, 1991 and HRL 543773 dated August 28, 1986.

In C.S.D. 92-12, where the royalty payments were for technical information and know-how related to the assembly of imported components into manufacturing machines, we found that the payments were not connected to the importation or ownership of the imported components. C.S.D. 92-12, p. 8. Where the royalties are based on the post importation sales of the "finished" product in the U.S., and not the value of the imported product, we have found the royalties are not related to the imported merchandise and are not a condition of sale of the imported merchandise. See C.S.D. 92-12 at pp. 8-9; see also HRL 544727 dated December 4, 1991.

In support of the buyer's position that the continuing royalties are not dutiable, the buyer relies on our prior decisions in HRL 544611 dated July 29, 1991, HRL 544102 dated August 16, 1988, HRL 544105 dated March 25, 1988, HRL 543617 dated June 8, 1987 and HRL 543773 dated August 28, 1986. In those decisions, royalty payments made by the importer were determined to be not dutiable because they were not connected to the ownership of the imported merchandise and the payments were separate and apart from the imported merchandise. However, in none of those decisions did the facts indicate that the agreements to purchase the imported merchandise were subject to or conditioned upon the royalty or license agreement. We find that in this case, the individual sales agreements consisting of the D&J Sales Contract, the Parts Agreement, and the '90 Purchase Agreement are subject to the terms and conditions of the '89 TA Agreement. In the instant case, agreement to pay the continuing royalty payment was required of the buyer before S-1 would sell the production equipment (dies and jigs) to the buyer because S-1 required that the buyer enter into the '89 TA Agreement as a condition of the D&J Sales Contract. With respect to the dies and jigs imported pursuant to the '90 Purchase Agreement, the buyer is required to order such merchandise in accordance with the know-how provided under the '89 TA Agreement. This in effect requires the buyer to have entered into the '89 TA Agreement before ordering merchandise under the '90 Purchase Agreement. The royalty is thus a condition of the sale of the dies and jigs. With respect to the merchandise imported pursuant to the Parts Agreement, as the Parts agreement is in force only for so long as the '89 TA Agreement is in force, and parts must be purchased in accordance with the '89 TA Agreement, the buyer is in effect required to pay the royalty as a condition of the sale of the parts. Therefore, the continuing royalty payment is required to be paid by the buyer as a condition of the sale of the merchandise under the D&J Sales Contract, the '90 Purchase Agreement and the Parts Agreement.

Customs has previously determined that license fees are dutiable in those fact situations where the payment is connected to the sale of the imported merchandise, and where the right to purchase the imported merchandise is terminated upon failure to pay the license fee. This was the situation in HRL 544420 dated July 8, 1991, in which case payment of the license fee was determined to be related to the imported merchandise and a condition of sale of the imported merchandise. Similarly, in HRL 543070 dated July 28, 1983, a license fee for a process was part of the contract for the purchase of the imported merchandise. The contract also covered the prices for the equipment as well as the process. In HRL 543070, we found that the license fee for the process was related to the imported merchandise and the buyer was required to pay the fee as a condition of sale of the imported merchandise for exportation to the United states.

In this case, with respect to merchandise imported pursuant to the '90 Purchase Agreement, the Parts Agreement and the D&J Sales Contract, although the royalties are based on the product finished in the U.S., and not the value of the imported components, because the payment of the royalty is tied to the ownership of the imported merchandise, the royalty is related to the imported merchandise and is a condition of the sale of the imported merchandise. Therefore, the royalty is to be added to the price actually paid or payable for the imported production equipment and imported automobile parts.

2. Entries made on or after May 11, 1993

The General Notice on the dutiability of "royalty" payments published by Customs in the February 10, 1993 Customs Bulletin, identifies three questions that assist in determining whether a royalty payment is related to the imported merchandise and 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?

U.S. Customs Service General Notice, 27 Cus. Bull. 6. (Hereinafter referred to as the "General Notice"). Negative responses to the first and second questions, and an affirmative response to the third, point toward non-dutiability. The General Notice includes a review of HRL 544436 (C.S.D. 91-6; Vol. 25 Cus Bull. No. 18 dated February 4, 1991, commonly known as the "Hasbro ruling." The General Notice is referred to as "Hasbro II."

Prior to Customs' issuance of the General Notice, a factor for determining that royalties were not dutiable under the "royalties" provision, was that the royalty payments were calculated on the basis of sales that occurred subsequent to the importation of the merchandise. See e.g HRL 544351 dated October 29, 1990, HRL 544129 dated August 31, 1988 and HRL 544102 dated August 16, 1988. However, Customs has since concluded that the method of calculating the royalty--e.g. on the resale price of the goods--is not relevant to determining the dutiability of the royalty payment. General Notice, at p.12. Instead, Customs must now look to the answers to the above three questions for assistance in determining whether the payments are related to the merchandise and were a condition of sale.

In this case, from the language in the '89 TA Agreement it appears that the merchandise imported under the Parts Agreement is manufactured under patent. It is unclear whether the merchandise imported under the D&J Sales Contract and the '90 Purchase Agreement is manufactured under patent. Therefore, this question is answered in the affirmative with respect to the imported automobile parts.

According to the general Notice, this second question expands the analysis of question one. In Hasbro II, Customs found that where individual sales agreements or purchase agreements were subject to the terms and conditions of the royalty agreement, there is a basis for finding that the royalty was involved in the sale of the imported merchandise. We find that in this case, the individual sales agreements consisting of the D&J Sales Contract, the Parts Agreement, and the '90 Purchase Agreement are subject to the terms and conditions of the '89 TA Agreement. As previously stated, S-1 required that the buyer enter into the '89 TA Agreement as a condition of the D&J Sales Contract, the Parts agreement is in force only for so long as the '89 TA Agreement is in force, and parts must be purchased in accordance with the '89 TA Agreement, and the '90 Purchase Agreement requires the buyer to order merchandise in accordance with the know-how provided under the '89 TA Agreement.

Further, the fee is for the right to use the imported production equipment and parts in the production of cars, as well as for the use of the production system. The '89 TA Agreement specifically grants a license "to manufacture, have manufactured, use and sell" both the vehicles and the automobile parts and for the installation of the machinery and equipment and use of the layout to manufacture the automobiles. Thus, in the instant case, the royalty payments from the buyer to S-1 are involved in the sale of the imported merchandise, and this question is answered with a "yes." According to the analysis in the General Notice, an affirmative answer to this second question points to the conclusion that the royalty payment is dutiable.

With respect to the third question, in this case the buyer does not have to pay the fee upon importation of the merchandise, but upon the manufacture and sale of a vehicle that is produced by means of the imported merchandise. The royalty is triggered upon sales of the completed vehicles, not by sales of the imported parts or production equipment. We have previously determined that in transactions in which the royalty becomes due upon the U.S. sale of the imported merchandise or the finished product, the response to the third question is "yes," the importer can buy the imported merchandise without paying the fee. See HRL 545307 dated February 3, 1995, HRL 545370 dated March 4, 1994, HRL 544781 dated March 4, 1994 and HRL 544923 dated February 22, 1994. However, in the cited decisions, the royalty or license fee agreements were not tied to the agreements to purchase the imported merchandise. In this case, the sales agreements pertaining to the imported merchandise are subject to the terms of the royalty agreement, the '89 TA Agreement. The various purchase agreements refer to the '89 TA Agreement and condition one upon the other. This fact indicates that the importer cannot buy the product without paying the royalty, and this question is answered in the negative. The General Notice states that the "answer to question three goes to the heart of whether a payment is considered to be a condition of sale." We conclude that the continuing royalty payments at issue
are a condition of sale of the imported dies and jigs and automobile parts.

Based on this analysis, we find that the royalty payments are related to the imported merchandise and they are a condition of the sale of the imported merchandise for purposes of TAA §402(b)(1)(D). Therefore, the continuing royalty payments for merchandise imported on or after May 11, 1993 are to be added to the price actually paid or payable for the imported merchandise as royalties under TAA § 402(b)(1)(D).

Customs also has the authority to examine the "proceeds" provision under TAA §402(b)(1)(E) to determine the dutiability of "royalty" payments. See U.S. Customs Service General Notice, 27 Cus. Bull. 6, at p. 1, 12-13; HRL 544436 dated February 4, 1991 (C.S.D. 91-6; 25 Cus. Bull. 18, at p. 19). HRL 544436 was modified in the General notice to the extent that the subject payments made by the importer were found to be dutiable both as a royalty and as proceeds. General Notice, pp. 12-13. The "proceeds" provision requires that "the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller" be added to the price actually paid or payable for the imported merchandise to determine the transaction value of the merchandise. The royalty payments made to S-1 are based upon the sale of vehicles manufactured by the use of the imported dies and jigs and automobile parts. However, the completed vehicles are comprised of both imported and domestic parts.

In C.S.D. 92-12 (HRL 544656 dated June 19, 1991), royalties were paid on the invoice sales price of machines made from both imported and domestic components. In that case, with respect to proceeds we stated that:

[T]he payments are not based on the resale of the imported product. Rather, the payments are based on the resale of a finished product that includes U.S. components. Thus, a substantial portion of the payments is based on components that were not imported. As a result, we hold that the payments made by the importer...are not dutiable under section 402(b)(1)(E) of the TAA.

Applying C.S.D. 92-12, we have determined in other transactions that where a royalty is based on the resale of a finished product that includes a substantial percentage of domestic components, the royalty payments are not dutiable under TAA §402(b)(1)(E). See HRL 545307 dated February 3, 1995 and HRL 545114 dated September 30, 1993. Therefore, in this case the "royalty" payments from the buyer to S-1 do not constitute proceeds of the use of the imported merchandise within the meaning of TAA §402(b)(1)(E) and are not to be added to the price actually paid or payable for the imported merchandise as proceeds.

B. 1987 Technical Assistance Agreement between the buyer and S-2

1. Entries made prior to May 11, 1993

Under the '87 TA Agreement S-2 requires the payment of a fixed amount royalty for each vehicle sold by the buyer. S-2 agrees to provide the buyer with non-exclusive rights to use technical information and to make, have made and use licensed components in the manufacture and sale of the licensed vehicles. In order to determine whether the royalty payments are to be added to the price actually paid or payable for the imported merchandise the reasoning set forth above in part A.1 is to be applied.

With respect to the '87 TA Agreement, there is no evidence that the Memorandum or the parts supply contracts were conditioned upon the buyer entering into the '87 TA Agreement, or that the buyer was required to purchase parts from S-2. The royalties are based on the finished product in the U.S., and not the value of the imported product. The buyer states in its responses to the field's requests for information, that the royalty calculation formula specifically excludes the value of the imported vehicle kits. In HRL 542900 (TAA #56) dated December 9, 1982, we stated that "inasmuch as the value of the imported components specifically is excluded from the royalty computation formula, it is our opinion that the fee is not 'related to the imported merchandise,' as those words are used in subparagraph (D)."

Based on the facts, we find that the royalty payments from the buyer to S-2 provided for in the '87 TA Agreement were not connected to the importation or ownership of the imported merchandise, and were not related to the imported merchandise and were not a condition of the sale of the imported merchandise for purposes of TAA §402(b)(1)(D). We have previously ruled that payments for the right to manufacture, process and use imported merchandise are not dutiable royalties. See HRL 543890 dated August 18, 1987. Therefore, these royalty payments are not to be added to the price actually paid or payable for the imported merchandise as royalties under TAA §402(b)(1)(D).

2. Entries made on or after May 11, 1993

In order to determine whether the royalty payments are to be added to the price actually paid or payable the analysis contained in the General Notice is to be applied. As set forth above in part A.2, the first question is whether the imported merchandise was manufactured under patent. It is unclear whether the imported parts were manufactured under patent.

The second question to be answered is whether the royalty was involved in the production or sale of the imported merchandise. According to the analysis in the General Notice, a finding that the fee was for the right to manufacture the imported merchandise would result in an affirmative answer to this question. In this case, the right is for the use of the imported parts to manufacture vehicles in the FTSZ, as well as for the right to use the technical information provided. In Hasbro II it was determined that the royalty was involved in the sale of the imported merchandise based on the fact that the individual sales agreements or purchase contracts were subject to the terms and conditions of the royalty agreement. In this case, the Memorandum and parts supply contracts between the buyer and S-2 are not subject to the terms and conditions of the royalty agreement. It does not appear that the royalty is involved in the production or sale of the imported merchandise, but is part of a separate transaction. Thus, this question is answered in the negative, pointing to the conclusion that the royalty payment is not dutiable.

The third question of the analysis is whether the buyer could buy the product without paying the fee. In this case the buyer does not have to pay the royalty upon importation of the parts, but upon the sale of each vehicle manufactured in the FTSZ. We have previously determined that in certain transactions in which the royalty becomes due upon the U.S. sale of the imported merchandise or the finished product, the response to the third question is "yes," the importer can buy the imported merchandise without paying the fee. See HRL 545307 dated February 3, 1995, HRL 545370 dated March 4, 1994, HRL 544781 dated March 4, 1994 and HRL 544923 dated February 22, 1994. In this case, the buyer argues that the payments are based on a percentage of the completed vehicle value, exclusive of the imported parts. According to the General Notice the method of calculating the royalty is not relevant to determining the dutiability of the royalty payment. We conclude that the answer to the third question is "yes." Consistent with our prior decisions, we conclude that the continuing royalty payments at issue are not a condition of sale of the imported automobile parts. Based on this analysis, given a negative answer to the second question and an affirmative answer to the third question, we find that the continuing royalty payments for the merchandise purchased on or after May 11, 1993 are not to be added to the price actually paid or payable for the imported parts under TAA §402(b)(1)(D).

With respect to the "proceeds" provision, the royalty payments made to S-2 are based upon the sale of merchandise manufactured by the use of both imported and domestic parts. Based on the analysis applied in A.2., because the royalties are based on the U.S. sale of vehicles manufactured from both domestic and foreign components, in this case the "royalty" payments from the buyer to S-2 do not constitute proceeds of the use of the imported merchandise within the meaning of TAA §402(b)(1)(E). Therefore the payments are not to be added to the price actually paid or payable for the imported merchandise as proceeds.

C. Consultation and Service Agreement for Construction of Plant and Installation of Machinery between the buyer and S-2

The C&S Agreement provides for payment from the buyer to S-2 of planning and engineering fees, fees for set up and testing of a production line and production of pilot vehicles in the exporting country, and a fee for installation and testing of equipment at the buyer's plant. According to the buyer's responses to Customs requests for information the planning and engineering fees were for work undertaken by S-2 to establish machinery and equipment specifications to process automobile parts. The fee for a production line set up and testing and production of pilot vehicles was, according to the buyer, for analyzing the integrity of an entire production line. In a response to a Request for Information, the buyer states that it is well established that engineering fees incurred in the establishment of process specifications are not subject to Customs duties, citing HRL 542498 dated June 16, 1981. HRL 542498 is not relevant to the issue at hand, as it concerned engineering payments to a third party, and the question of whether such payments are assists.

This office was not provided with any agreement pursuant to which the buyer purchased production equipment from S-2. Without reviewing the terms of such an agreement, we cannot state with certainty that these payments are for the production merchandise imported by the buyer. However, this payment is from the buyer to its seller, S-2, and as such would ordinarily be part of the price actually paid or payable for the imported merchandise. The payments appear to be for the design and development of production equipment. If the planning and engineering fees were not included in the transfer price between the related importer and seller, we would be unable to find that the price was not affected by the relationship between the parties, as the transfer price would not be adequate to ensure the recovery of all costs of the seller. Therefore, assuming that the buyer imported production equipment from S-2, the planning and engineering fees for set up and testing of a production line and production of pilot vehicles in the exporting country, are part of the price actually paid or payable for the imported merchandise. According to the buyer the fee also included payment for installation and testing of equipment at the buyer. If such portion of the fee is separately identified and is reasonable, then pursuant to TAA §402(b)(3)(A)(i), such fee is not included in the transaction value of the imported merchandise, because it is for technical assistance provided with respect to the merchandise after it has been imported into the U.S.

HOLDING:

Whether merchandise is entered as production equipment or automobile parts, our analysis is based upon whether the amounts paid are part of the price actually paid or payable for the imported merchandise or an addition thereto. Under the '89 TA Agreement between the buyer and S-1, the payments for the engineering fee and the initial royalty are included in the price actually paid or payable for the imported dies and jigs purchased from S-1. The documentation fee provided for in the '89 TA Agreement is included in the price actually paid or payable for the imported automobile parts purchased from S-1. The continuing "royalty" payments made pursuant to the '89 TA Agreement are additions to the price actually paid or payable for the imported merchandise as a royalty under TAA §402 (b)(1)(D). The continuing "royalty" payments made pursuant to the '87 TA Agreement are not additions to the price actually paid or payable for the imported merchandise, either as a royalty under TAA §402 (b)(1)(D) or as proceeds under TAA §402(b)(1)(E).

Provided an agreement between S-2 and the buyer for the purchase of production equipment does not require a different conclusion, payments made by the buyer to S-2 under the C&S Agreement are part of the price actually paid or payable for the imported production equipment purchased from S-2.

The Office of Regulations and Rulings will take steps to make this decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels 60 days from the date of this decision. Sincerely,

John Durant, Director
Commercial Rulings Division

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