VAL CO:R:C:V 544436 VLB
District Director
909 First Avenue
Room 2039
Seattle, Washington 98174
RE: Dutiability of Royalty Payments; IA 69-89
Dear Sir:
This is in response to your memorandum (APP-6 SE:C:D VY),
dated November 3, 1989, requesting internal advice on the
dutiability of payments made by Hasbro Industries, Inc.
(hereinafter referred to as "the importer") to Takara Co., Ltd.
(hereinafter referred to as "the seller"). We regret the delay
in responding.
FACTS:
The importer, in a letter dated August 10, 1989, states that
it buys and imports toys from the seller, who is the licensor.
Upon the resale of the toys in the U.S. the importer must make a
royalty payment to the seller. The importer has provided a copy
of an Agreement that was executed between the importer, the
seller, and Takara U.S. on November 1, 1983.
Under the Agreement, Takara U.S. agreed to release its
rights to sell certain toys within a specified territory that
included the U.S. Agreement, page 2, para. 1. The seller agreed
to make certain products available for exclusive sale within the
territory, and the importer agreed to buy the products that were
manufactured by the seller. Agreement, page 3, para. 2. The
individual sales agreement, the "Purchase Contract", made between
the parties is subject to the terms and conditions of the royalty
agreement. Id.
Further, the seller granted the buyer the exclusive right to
sell the products within the territory, as well as the right to
manufacture or subcontract the manufacturing of the products.
Agreement, page 3, para. 3. In consideration for these rights,
the importer agreed to pay Takara U.S. a royalty rate between 5%
and 7% of the "Invoice Price" of the products, regardless of
whether the importer purchased the products from the seller, or - 2 -
manufactured the products. The specific royalty rate varied by
product depending upon the profit level of the importer.
Agreement, page 7, para. 8.
The "invoice price" is defined as the importer's "Invoice
Price minus Seven Percent (7%) to cover any and all deductions
and allowances." All royalties that were due to Takara U.S.
accrued upon the sale of the products regardless of the time of
collection by the importer. The products were considered to be
"sold" on "the date when it is billed or invoiced, shipped or
paid for, whichever occurs first". Agreement, page 8, para.
8(1).
Finally, the importer must pay a minimum royalty of
$1,000,000 annually to maintain the exclusiveness of its right to
the listed products. Id. If the importer fails to pay the
minimum royalty, Takara U.S. has the option of cancelling the
Agreement or of converting the Agreement to a nonexclusive right
to sell the products.
Subsequently, on July 31, 1984, the Agreement was amended
"to more accurately reflect the relative contributions of Takara
Co., Ltd. and Takara Toys Corporation [Takara U.S.] in the
implementation of the Agreement and to reflect the fact that
Takara Co., Ltd's involvement has been far more than originally
anticipated while Takara Toys Corporation's [Takara U.S.]
involvement has been far less than originally anticipated".
Under the amendment, as of August 1, 1984, the royalties that the
importer was to pay to Takara U.S., were to be split. Ninety
percent of all royalty payments were to be paid by the importer
directly to the seller. Ten percent of the royalty payments were
to be paid to Takara U.S.
A Supplemental Agreement was executed between the parties on
November 18, 1985. The Supplemental Agreement extended the sales
territory and addressed television and motion picture rights
involving the listed products and derivations of the products.
In addition, the minimum royalty was raised to $1,500,000
annually. Supplemental Agreement, page 6, para. h.
Finally, a Continuation Agreement was executed on September
1, 1986, to extend the term of the Agreement and to remove Takara
U.S. from the terms of the Agreement. All rights and duties of
Takara U.S. under the Agreement were assumed by the seller.
- 3 -
ISSUE:
Whether the payments made by the buyer to the seller
pursuant to the Agreement, the Supplemental Agreement, and the
Continuation Agreement are included in the dutiable value of the
merchandise.
LAW AND ANALYSIS:
Transaction value, the preferred method of appraisement is
defined in section 402(b), Tariff Act of 1930, as amended by the
Trade Agreements Act of 1979 (19 U.S.C. 1401a(b); TAA), as the
"price actually paid or payable for the merchandise when sold for
exportation to the United States."
In addition, sections 402(b)(1)(D) and (E) of the TAA
provide for additions to the price actually paid or payable for:
(D) any royalty or license fee related to the imported
merchandise that the buyer is required to pay, directly
or indirectly, as a condition of the sale of the
imported merchandise for exportation to the United
States; and
(E) the proceeds of any subsequent resale, disposal, or
use of the imported merchandise that accrue, directly
or indirectly, to the seller.
There does not appear to be any dispute that transaction
value is the proper method of appraisement for the imported
merchandise.
The importer contends that the royalty payments are not
dutiable under section 402(b)(1)(D) of the TAA for several
reasons. First, the importer argues that the royalty payments
are based on future sales of the toys. That is, the payments are
triggered upon the resale of the product rather than on the
importation of the product.
In addition, the importer asserts that the royalty payment
is paid for rights that are separate and apart from the right of
ownership. Thus, the importer concludes that the royalty
payments are not dutiable because the payments are not a
condition of sale of the imported merchandise. The importer
cites Headquarters Ruling Letters (HRL's), 542844, dated June 17,
1982, 544061, dated May 27, 1988, and 544129, dated August 31,
1988, to support its position.
- 4 -
In HRL 542844, the importer and the exporter entered into a
license agreement that granted the importer the exclusive right
to manufacture and distribute the exporter's products in North
America. In consideration for the exclusive rights the importer
agreed to pay a multi-year, multiple factor, royalty payment
package to the exporter. The ultimate annual royalty payment to
the exporter was determined by a percentage arrangement based on
the importer's U.S. business. No royalty payments were due on
products purchased from the exporter.
Customs held that the royalty payments were not dutiable
under section 402(b)(1)(D). The rationale of the holding was
that the importer would have been able to purchase the
merchandise from the exporter regardless of whether the royalty
fee was paid. Therefore, the payments were not a condition of
the sale of the imported merchandise.
In addition, in HRL 542844, Customs stated that the royalty
agreement specifically excluded the value of imported merchandise
from the royalty computation formula. Thus, the fees were not so
inextricably intertwined with the imported merchandise as to be
considered part of the purchase price of the goods. Customs did
not address the applicability of section 402(b)(1)(E).
HRL 544061, dated May 27, 1988, involved a situation wherein
the importer entered into a license agreement with the licensor
who owned certain proprietary rights in a product. The agreement
granted the importer an exclusive, unrestricted and unlimited
right and license to manufacture, use and sell the product in the
U.S. under the conditions set forth in the agreement. Two
payments of $50,000 each were paid within 12 months from the date
of execution of the agreement. The importer also paid the
licensor a royalty based upon the net sales of the product only
in situations where the importer purchased the product from a
party other than the licensor.
Customs held that the royalty payments were not to be added
to the price actually paid or payable for the merchandise under
section 402(b)(1)(D) of the TAA. Customs found that the payments
were not a condition of sale of the imported goods. The payments
were not tied to the importation of the product but rather, were
paid for the right to manufacture and use the product in the U.S.
Moreover, if the imported product was used for testing or
research, i.e., uses which did not produce sales, no royalty was
owed by the importer. Once again, Customs did not address the
applicability of section 402(b)(1)(E).
In HRL 544129, dated August 31, 1988, the importer made
royalty payments to a licensor that was related to the seller.
The royalty payments were for the exclusive right to use and sell
a drug in the U.S. The royalty was 5% of the importer's net - 5 -
sales. The importer also acquired the right to manufacture the
drug in the U.S. if the manufacturer could not fulfill the
requirements in the supply agreement. The importer also was
granted the right to use the licensor's know-how. Finally, the
amount owed to the licensor was reduced by payments made to an
unrelated company in the U.S. that was originally involved in the
early developments of the product.
In HRL 544129, Customs held that the royalty payments were
not dutiable under section 402(b)(1)(D) of the TAA. The basis of
the holding was that the payments were not a condition of the
sale of the imported merchandise. The payment was for rights
that were separate and apart from the right of ownership on
payment of the purchase price. The royalty payments were
triggered upon the resale of the product rather than the
importation of the product. Customs cited HRL 544061, supra, as
authority for this position. Customs did not address the
applicability of section 402(b)(1)(E) in HRL 544129.
The facts in the present case are analogous to the facts in
the cases cited by the importer. That is, the royalty payments
are for the right to sell the imported products within a
specified area, as well as to manufacture the products. Under
the cited rulings these payments would not be considered to be a
condition of sale of the imported goods. Therefore, the payments
would not be dutiable royalties under section 402(b)(1)(D) of the
TAA.
However, an examination of only section 402(b)(1)(D) does
not provide a complete analysis of the issue presented. As
previously discussed, section 402(b)(1)(E) of the TAA provides
for proceeds of any subsequent resale of the imported merchandise
that accrue to the seller to be added to the price actually paid
or payable for the imported merchandise. In the legislative
history of the TAA Congress clearly stated that section
402(b)(1)(E) of the TAA must be examined in cases such as this
one.
Specifically, in the Report of the Committee on Ways and
Means, House of Representatives (H.R. Rep. No. 317, 96th Cong.,
1st Sess. (1979), at p. 80) concerning the adoption of the TAA,
the Committee pointed out that "certain elements called
"royalties" may fall within the scope of the language under
either new section 402(b)(1)(D) or 402(b)(1)(E) or both"
(emphasis added).
- 6 -
In the present case, there is no dispute that the royalty
payments become due upon the importer's resale of the imported
merchandise. These proceeds of the subsequent resale clearly
inure to the benefit of the seller. Therefore, we hold that the
"royalty" payments that the importer pays to the seller pursuant
to the Agreement, the Supplemental Agreement, and the
Continuation Agreement are to be added to the price actually paid
or payable for the imported merchandise under section
402(b)(1)(E) as proceeds of subsequent resale.
As previously discussed, the importer must pay a minimum
royalty of $1,500,000 annually. If the proceeds of the
subsequent resale are not sufficient to meet this requirement,
the importer will be required to pay the remaining amount to meet
the minimum royalty. Any amount that the importer must pay
beyond the proceeds of the subsequent resales will not be
dutiable. This is due to the fact that there will not be any
imported merchandise to which the payment would apply.
Finally, Customs recognizes that there are several
Headquarters Ruling Letters that contain a general statement that
when a royalty or license fee is determined not to be part of
transaction value under section 402(b)(1)(D), no authority exists
for including the fee in transaction value as proceeds of a
subsequent resale under section 402(b)(1)(E).
Upon reviewing these statements in the context of the clear
language of the statute, and the previously cited House Ways and
Means Committee Report, we have determined that the position
taken in the prior rulings is contrary to the Congressional
intent of the TAA and renders meaningless the proceeds of
subsequent resale provision in the TAA. As a result, the
following HRL's are modified accordingly: 542900 (12-9-82),
542926 (1-21-83), 543529 (10-7-85), 543773 (8-23-86), 544102 (2-
17-89).
- 7 -
HOLDING:
The payments made by the buyer to the seller pursuant to the
Agreement, the Supplemental Agreement, and the Continuation
Agreement are proceeds of a subsequent resale that accrue to the
seller. Therefore, the payments are to be added to the price
actually paid or payable under section 402(b)(1)(E).
Sincerely,
John Durant, Director
Commercial Rulings Division