United States International Trade Commision Rulings And Harmonized Tariff Schedule

faqs.org  Rulings By Number  Rulings By Category  Tariff Numbers

faqs.org > Rulings and Tariffs Home > Rulings By Number > 2007 HQ Rulings > HQ H004643 - HQ H005862 > HQ H004991

Previous Ruling Next Ruling
HQ H004991

---

April 2, 2007

VAL RR:CTF:VS H004991 HEF

CATEGORY: VALUATION

Mr. Joel R. Junker
Joel R. Junker & Associates
1191 Second Avenue, Suite 1800
Seattle, Washington 98101

RE: Dutiability of royalty payments

Dear Mr. Junker:

This is in reference to your letter dated December 29, 2006, on behalf of LaCrosse Footwear, Inc. (“LaCrosse”) requesting an advance ruling as to whether certain royalty payments are dutiable.

You request confidential treatment of the information identified within brackets in your ruling request. Customs and Border Protection (“CBP”) has concluded that the information for which confidential treatment has been sought was clearly identified and is commercial information that may cause substantial harm to the competitive position of your client or another interested party. CBP will extend confidential treatment in accordance with your request.

FACTS:

LaCrosse is a U.S. company that develops and markets footwear in the United States and internationally. One of the products marketed by LaCrosse is described as an overshoe designed to fit over a shoe or boot. Certain overshoes marketed by LaCrosse incorporate special soles that are said to provide increased traction on slippery surfaces. A Canadian company (hereinafter “licensor”) holds both U.S. and Canadian patents for the soles. The overshoes marketed by LaCrosse that incorporate these soles are manufactured by a Chinese company (hereinafter “seller”). The parties referenced above are not related to one another.

LaCrosse and the licensor entered into a License Agreement on December 19, 2000. A copy of the License Agreement was submitted with your request. Under the License Agreement, the licensor grants LaCrosse an exclusive license under the licensed patents to make, offer for sale, import, use, sell, and have others make for LaCrosse, the licensed products in the United States, its territories and possessions, and Canada. The License Agreement also grants a non-exclusive license to LaCrosse under the licensed patents to make, offer for sale, import, use, sell, and have others make for LaCrosse, the licensed products for all countries and territories worldwide, outside the United States, its territories and possessions, and Canada. The License Agreement defines the term “licensed patents” as referring to all patents and patent applications presently owned by the licensor which relate to, or may be used to formulate or produce, the soles. The License Agreement defines the term “licensed products” as those products manufactured, imported, used or sold by LaCrosse whose manufacture, importation, use, or sale in the absence of the License Agreement would infringe one or more of the claims of the licensed patents. The License Agreement also designates that the term “licensed products” only refers to those products that fit over a shoe or boot, and does not include products which would fit directly over the foot of the wearer. In the License Agreement, the licensor grants the use of its trademark to LaCrosse without charge. LaCrosse is required to use this trademark when it manufactures, uses, or sells licensed products incorporating the soles. The licensor has the right to monitor LaCrosse’s use of the trademark, including the right to sample all products bearing the mark for quality control purposes.

In exchange for the licenses granted, LaCrosse agreed to pay the licensor a minimum annual royalty and a specified sum per pair of licensed products sold. The latter royalty fees are calculated based on LaCrosse’s gross sales of the licensed products. Both types of royalties are to be paid in quarterly installments. In addition, LaCrosse was required to pay the licensor a fixed sum upon the signing of the License Agreement to cover development costs.

On March 31, 2006, LaCrosse and the licensor executed an Addendum to the License Agreement. The Addendum broadened the scope of the term “licensed products” to include all footwear products excluding certain athletic footwear. The Addendum amended the license from an exclusive license to a non-exclusive worldwide license and extended the term of the License Agreement. The Addendum requires that LaCrosse pay a higher minimum royalty and provides a new method for calculating the additional royalties. The additional royalties are based on a specified percentage of the gross sales per pair of licensed products sold. In addition, the Addendum includes new provisions stating that all studs used in the licensed products are to be supplied by the licensor and that quality control will be monitored by the licensor, as necessary.

On December 17, 2002, LaCrosse executed an agreement with the seller for the purpose of purchasing footwear from the seller. The agreement consists of a Vendor Acknowledgement and Agreement and a document entitled “Agreement and Vendor Manual Terms and Conditions” (hereinafter “Vendor Manual”). Copies of these documents were submitted with your request. The Vendor Manual contains the terms and conditions governing LaCrosse’s individual purchase orders to the seller. Neither the Vendor Acknowledgement and Agreement nor the Vendor Manual reference the licensed products specifically. In addition, no specific reference is made to the license agreement between LaCrosse and the licensor. The Vendor Manual does include general provisions intended to protect the intellectual property rights of the buyer and the confidentiality of information.

ISSUE:

Whether the royalty payments under consideration constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D) or (E).

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (“TAA”), codified at 19 U.S.C. § 1401a. The preferred basis of appraisement under the TAA is transaction value, defined in section 1401a(b)(1), as the “price actually paid or payable for the merchandise when sold for exportation to the United States” plus amounts for enumerated statutory additions to the extent not otherwise included in the price actually paid or payable. The additions include “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 “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)(D)-(E).

For purposes of this ruling, we assume that transaction value is the proper method of appraisement for the imported merchandise.

A. Royalties

With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action to the TAA provides, in pertinent part, that:

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 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 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 (“SAA”), H.R. Doc. No. 153, 96 Cong., 1st Sess. (1979), reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (1981), at 48-49.

In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), CBP articulated three factors or questions that assist in determining whether the royalty payments in question are related to the imported merchandise and are a condition of sale such that they are dutiable. As set forth in the notice, the questions are:

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?

The General Notice indicates that affirmative answers or responses to the first and second questions, and a negative response to the third, point towards dutiability.

When analyzing the factors identified in the above-cited general notice, CBP has taken into account certain considerations, which flow from the language set forth in the SAA. These include, but are not limited to, the following:
the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise generally will be dutiable);
to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated third party);
whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require the buyer’s purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other, or termination of the purchase agreement due to the failure to pay the royalties); and
payment of the royalties on each and every importation.

See, e.g., Headquarters Ruling Letter (“HRL”) 547148, dated September 12, 2002.

In order to obtain a ruling with respect to the dutiability of royalty or license fees, copies of any royalty agreements relating to the payment of the royalty or license fees in question and any purchase or supply agreements relating to the sale of the imported merchandise for exportation to the United States must be submitted to CBP with the request. If there are no such written agreements, this must be indicated in the ruling request. See General Notice, “Notice to Require Submission of Royalty and Purchase Supply Agreements in Ruling Requests Regarding Dutiability of Royalty or License Fees,” Vol. 29, No. 36, Cust. B. & Dec. at 10 (September 6, 1995). See also, 19 C.F.R. § 177.2(b). In the instant case, as discussed above, you submitted a license agreement, an addendum to the license agreement, a vendor acknowledgement and agreement, and a vendor manual.

In this case, the licensor owns U.S. and Canadian utility patents for the soles that are used in the production of the imported product. Nonetheless, your contention is that based on the language in the SAA adopted by Congress upon passage of the TAA, and as interpreted by CBP, the answer to question one is “no.” You base this conclusion on the fact that the patents do not cover processes to manufacture the imported product. In this regard, you note that the SAA provides that royalties paid for patents covering processes to manufacture the imported merchandise will generally be dutiable. Statement of Administrative Action, H.R. Doc. No. 153, reprinted in Customs Valuation Under the Trade Agreements Act of 1979 (1981), supra, at 48. You also cite HRL 545379, dated July 7, 1995, which held that license fees paid for rights to use an ornamental design in connection with U.S. sales of hair bands were not dutiable as royalties or proceeds of subsequent resale. The decision notes that the design patent was linked more to the appearance of the article, and thus was not for rights associated with its manufacture. You argue that the patents at issue are conceptually more similar to the design patent protecting the appearance of the hair band in HRL 545379 rather than a process patent protecting a process or method of manufacture. HRL 545379 concluded that the design patent at issue was akin to royalties and license fees paid for the right to use copyrights and trademarks.

We do not consider the patents covering the imported merchandise to be comparable to the patent covering the hair bands in HRL 545379. The hair bands were covered by a design patent pertaining to “the ornamental design for a hair or foot band as shown and described.” 35 U.S.C. § 171, entitled Patents for Designs, provides for the patentability of “any new, original and ornamental design for an article of manufacture.” To be patentable, a design must be new, inventive, and ornamental; it must be the product of aesthetic skill and artistic conception. See Bliss v. Gotham Indus., Inc., 316 F.2d 848, 850 (9th Cir. 1963). A design patent cannot be based upon elements which are concealed during the normal use of the device to which the design is applied. In Re Cornwall, 43 C.C.P.A. 824, 826, 230 F.2d 457, 459 (1956).

In contrast to the design patent covering the hair bands, the licensor-owned patents protect the soles’ physical composition, which imparts the soles’ ability to create traction on slippery surfaces. Further, any aesthetic features that the soles may possess are not visible when the soles are in their normal course of use. These patents are not design patents covering a product’s ornamental design. Nor are the patents comparable to royalties and license fees paid for the rights to use copyrights and trademarks. We find that the patents at issue are for the type of patent that was intended to come within the purview of question one. Thus, even if these patents do not technically cover the process by which the imported product is manufactured, we find that in the circumstances presented, the imported product was “manufactured under patent.” See HRL 545998, dated November 13, 1996 (finding that royalties paid for the use of a patent covering the chemical composition of a pharmaceutical product, but not its process of manufacture, were dutiable under 19 U.S.C. § 1401a(b)(1)(D)). Thus, the answer to question one is “yes.”

The second question indicated in the notice is whether the royalty is involved in the production or sale of the imported merchandise. The second question expands the analysis of the first question. See General Notice, “Dutiability of Royalty Payments,” supra, at 10. You state that the answer to this question is “no.” You contend that the patents at issue are like the design patent in HRL 545379, supra, and therefore the license fees in the instant case are similar to fees paid for the right to use trademarks and copyrights. As discussed above, we disagree that the patents in the instant case are comparable to the design patent in HRL 545379, supra.

The payments at issue are for the right to use the licensor’s patents to make, offer for sale, import, use, sell, and have others make for LaCrosse the licensed products. As compensation for the exercise of this right, LaCrosse is required to pay a royalty to the licensor upon the resale of the licensed products. The License Agreement defines the term “licensed products” as those products manufactured, imported, used or sold by LaCrosse whose manufacture, importation, use, or sale in the absence of the License Agreement would infringe one or more of the claims of the licensed patents. The licensed products, the soles, are incorporated into the imported merchandise. Therefore, without the License Agreement, the imported merchandise could not have been produced by the seller for LaCrosse. In addition, the Addendum to the License Agreement requires that all studs used in the licensed products be supplied by the licensor. Therefore, the royalty is involved in the production and sale of the imported merchandise.

The third question asks whether the importer could buy the product without paying the fee. The answer to this question goes to the heart of whether a payment is considered to be a condition of sale. See General Notice, “Dutiability of Royalty Payments,” supra, at 11. 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. If the payments are optional and not inextricably intertwined with the imported merchandise, or if they are paid solely for the exclusive right to manufacture and sell in a designated area, they do not constitute additions to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D). See HRL 546675, dated June 23, 1999.

You argue that since LaCrosse pays the royalty to a party unrelated to the seller based on the number of units sold, not imported, the royalty payment is not a condition of the sale of the imported merchandise for exportation to the United States. In addition, you also point to the fact that the minimum royalty payments are due regardless of the number of sales of the licensed products by LaCrosse. Based on the facts presented, we find that the royalty is a condition of the sale of the imported product.

First, it has been our position 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.” See General Notice, “Dutiability of Royalty Payments,” supra, at 12. See also, HRL 548489, dated August 4, 2004; and HRL 545710, dated October 30, 1998.

The fact that the royalty payments are made to an unrelated third party is not entirely determinative. This is because the SAA provides that a royalty payment made by a buyer as a condition of the sale of the merchandise for exportation to the United States will be added to the price actually paid or payable. CBP has generally interpreted this to mean that royalties will be dutiable, even if paid to third parties, if they constitute a condition of the sale for exportation.

In HRL 548489, supra, the licensee, a company involved in the production and marketing of air freshener products, concluded license agreements with two unrelated licensors for the use of their patented methods for aerosolizing a liquid. The agreements granted the licensee the right under the licensed patents to make, have made, use, sell, offer for sale and import the licensed product. An unrelated manufacturer was selected to make the air fresheners, which the manufacturer sold to the importer, an agent of the licensee. Based on an examination of the agreements, CBP found that the licensee would have been unable to purchase the licensed product from the manufacturer in the absence of the license agreements and their underlying contingencies, including the requirement to make royalty payments to the unrelated licensor. CBP held the royalty payments to be dutiable. See also, HRL 546034, dated May 6, 1997; HRL 545776, dated September 1, 1995; and HRL 545321, dated June 30, 1995.

In the instant case, the License Agreement grants LaCrosse a non-exclusive worldwide license under the licensed patents to make, offer for sale, import, use, sell, and have others make for it the licensed products. The License Agreement defines “licensed products” as those products manufactured, imported, used, or sold by LaCrosse whose manufacture, importation, use, or sale in the absence of the License Agreement would infringe one or more claims of the licensed patents. The term “licensed patents” means all patents and patent applications presently owned by the licensor which relate to, or may be used to formulate or produce the soles. Although the language of the Vendor Acknowledgement and Agreement and Vendor Manual does not specifically require the payment of the royalties to the licensor, it is clear from the terms of the License Agreement that the imported merchandise could not be manufactured or sold without the payment of the royalty to the licensor. Therefore, we find that LaCrosse could not buy the imported merchandise without paying the license fees.

Based on the above considerations, it is our position that the license fees relate to and are a condition of sale of the imported merchandise. Accordingly, we find that to the extent the licensed products are imported into the United States, the license fees are dutiable under 19 U.S.C. § 1401a(b)(1)(D). It follows that if there are no importations of the licensed products, the payment of minimum royalties would have no duty consequences. We also note that the fixed sum paid to the licensor to cover development costs at the signing of the License Agreement is not a royalty payment. Therefore, this sum is not included as an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D).

B. Proceeds

As indicated above, under 19 U.S.C. § 1401a(b)(1)(E), the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller will be an addition to the price paid or payable. The license fees at issue do not accrue, directly or indirectly, to the seller. Therefore, the license fees are not an addition to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1)(E).

HOLDING:

Based on the information provided, the license fees paid by LaCrosse to the licensor constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D).

The license fees do not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(E).

A copy of this ruling letter should be attached to the entry documents filed at the time this merchandise is entered. If the documents are filed without a copy, this ruling should be brought to the attention of the CBP officer handling the transaction.

Sincerely,

Monika R. Brenner, Chief

Previous Ruling Next Ruling