CLA-2 OT:RR:CTF:VS H024980 CMR
George R. Tuttle, III
One Embarcadero Center
Suite 730
San Francisco, CA 94111-4044
RE: Dutiability of royalty payments; patent; 19 U.S.C. § 1401a(b)(1)(D)
Dear Mr. Tuttle:
This is in response to your submission of March 17, 2008, requesting Customs and Border Protection (CBP) review the dutiability of a licensing agreement entered into by your client, The Sports Authority (TSA), and the holder of a patent on a snowboard binding system (hereinafter referred to as Licensor). On July 11, 2008, you were afforded a conference call with CBP personnel regarding your ruling request.
FACTS:
In November 2007, TSA entered into a three year licensing agreement with the Licensor granting TSA, in section 2.1 of the Licensing Agreement, a limited non-exclusive, non-transferable, non-sublicensable, worldwide license under the Licensor’s patent rights “to make, have made for TSA, and import Licensed Products, and to offer to sell, sell, and otherwise dispose of Licensed Products exclusively through TSA Stores.” The Licensed Product(s) is the patented snowboard binding system as defined in section 1.2 of the Licensing Agreement.
In consideration of the rights granted to TSA in section 2.1 of the Licensing Agreement, TSA will pay the Licensor a royalty fee of 5 percent of the gross sales price of the imported snowboard binding systems. The royalty fee is paid on an annual basis. If the binding system is imported mounted on a snowboard, a methodology for computing the value of the binding, less the value of the snowboard is set forth in the Licensing Agreement in section 1.7 wherein “Gross Sales Price” is defined for purposes of the agreement. “Gross Sales Price” is defined, according to a letter dated April 4, 2008 from TSA as the sales price at which a Licensed product is sold to a customer at TSA.
TSA is responsible for securing a manufacturer for the snowboard binding system. However, section 2.2 of the Licensing Agreement confers on the Licensor the right to raise any reasonable and good faith objection to TSA’s selection of manufacturer. While the agreement provides for TSA and the Licensor to confer in an effort to resolve Licensor’s objection if Licensor objects; if unresolved, TSA may not use the selected manufacturer and must seek another which will be acceptable to the Licensor. In short, the Licensor holds the right to reject TSA’s selection of manufacturer provided the objection is reasonable and made in good faith.
TSA contracts with Company A, located outside the United States, to have the snowboard binding system manufactured. Company A contracts with Company B, also located outside the United States, to actually manufacture the snowboard bindings. TSA, the Licensor and Company A are unrelated parties. Company B is not related to TSA or the Licensor, however, Company A and Company B are related parties.
The submitted vendor agreement provides no information relevant to our inquiry into the dutiability of the royalty payments at issue, however, the TSA’s Vendor Relationship Guide (VRG), referenced in the vendor agreement and containing policies, terms and conditions to which vendors are required to adhere, does contain relevant information in Chapter 8 of the VRG. Paragraph 12 of Chapter 8 provides, among other things, that all merchandise patents supplied by TSA shall be the property of TSA and used by the vendor only for TSA.
ISSUE:
Are the royalties paid by TSA to the Licensor under the Licensing Agreement included in the transaction value of the imported merchandise?
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 method of appraisement under the TAA is transaction value, defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain enumerated additions, including "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." 19 U.S.C. § 1401a(b)(1)(D). These additions apply only if they are not already included in the price actually paid or payable. For purposes of this decision we assume that transaction value is the appropriate method of appraisement. In general, royalty payments may be included in transaction value as part of the price actually paid or payable, or as an addition thereto under 19 U.S.C. § 1401a(b)(1)(D)-(E). General Notice, "Dutiability of Royalty Payments," Vol. 27, No. 6, Cust. B.
& Dec. 1, at 13 (February 10, 1993) ("Hasbro II ruling") (quoting H.R. Rep. No. 317, 96th Cong., 1st Sess. (1979) at 80 and S. Rep. No. 249, 96th Cong., 1st Sess., at 120 (1979).
In this case, it is clear that the royalty payments are not included in the price actually paid or payable to the seller, i.e. Company A, as the payments are made directly by TSA to the Licensor.
With regard to royalties, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in relevant 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 the sale of the imported merchandise for exportation to the United States. (Statute) 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 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. (Regulation)
Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., Pt II, at 443 – 444 (1979).
CBP has established a three-part test for determining the dutiability of royalty payments. This test appears in the General Notice, “Dutiability of Royalty Payments,” previously cited ("Hasbro II ruling"). The test consists of the following questions: 1) was the imported merchandise manufactured under patent; 2) was the royalty involved in the production or sale of the imported merchandise; and 3) could the importer buy the product without paying the fee? Affirmative responses to factors one and two and a negative response to factor three would indicate that the payments were a condition of sale and, therefore, dutiable as royalty payments.
In your submission of March 17, 2008, you acknowledge that the answer to the first question, i.e., was the imported merchandise manufactured under patent, is yes. You identify the patent as a utility patent and state the royalty relates to a patent to manufacture an article. An examination of the patent for the snowboard binding system reveals the objectives of the binding system are to provide a binding system for a snowboard that has several degrees of freedom along the surface of the board, that provides freedom about a normal to the surface of the board, that is collapsible for storage and transport, and that is simple and cost effective to manufacture. The royalty payments at issue would then seem to fall clearly within the language of the SAA cited previously, i.e. “. . . royalties and license fees for patents covering processes to manufacture the imported merchandise will generally be dutiable[.]”
However, with regard to the remaining two questions, you argue that the royalty payments are not part of the transaction value because the payments are made to a party other than the manufacturer of the snowboard bindings and you do not believe a “clear, substantial nexus” exists between the patented technology, the royalty payments for use of that technology and the imported merchandise. We, however, disagree.
As stated in previous rulings, payment of royalties to a third party for the right to use a patent is no bar to finding the royalties dutiable as part of the transaction value. See, Headquarters Ruling Letter (HQ) H004991, dated April 2, 2007, and HQ W548692, dated March 2, 2007. HQ H004991 and HQ W548692 each involved situations similar to the one at issue here in that royalty payments were made to unrelated third party licensors and not to the actual manufacturer or seller of the imported merchandise. In each case, the royalty payments were consideration for the right to use patents to, among other things, make or have made, import and sell certain products. In W548692, we stated:
. . . the language included in the SAA provides that royalties and license fees for patents covering processes to manufacture imported merchandise generally will be dutiable. Furthermore, we note that the relevant portions of both the TAA and SAA which refer to royalties required to be paid as a condition of sale, do not state to whom, or for whose benefit, in particular, the payment is made. Although a reference to the seller is included in the definition of the price actually paid or payable, it is conspicuously absent from the instant provision. In our opinion, this, along with the language included in the SAA, to wit, that royalties for patents covering manufacturing processes generally are dutiable, indicates that in regard to patents, the framers of the TAA recognized that royalties paid to unrelated third parties could constitute a condition of the sale and, hence, be dutiable. See Headquarters Ruling letter ("HQ") 546513, dated February 11, 1998; and HQ 545777, dated September 1, 1995.
Therefore, in considering royalties paid for the use of a patent covering manufacturing processes, it is of little to no relevance to whom the payments are made; what is relevant is whether the royalty is involved in the production or sale of the imported merchandise. In this case, it is.
The Licensing Agreement allows TSA “to make, have made for TSA, and import Licensed Products, and to offer to sell, sell, and otherwise dispose of Licensed Products exclusively through TSA Stores.” Emphasis added. Although TSA contracts with Company A to manufacture the merchandise, TSA would be unable to enter into a contract to manufacture the product covered under the Licensor’s patent or import and sell that product in the United States without having entered into the Licensing Agreement. Simply put, the patent protects the snowboard binding system which is imported and for which the royalty is owed after its sale. Therefore, as in H004991 and W548692, we find that the royalty is involved in the production or sale of the imported merchandise.
We believe, contrary to your argument, that there is a clear and substantial nexus between the imported merchandise and the royalty payments for use of the patent in producing the imported merchandise. You argue the lack of ties between the manufacturing agreement and the licensing agreement, such as termination of one upon the termination of the other, precludes finding the necessary connection to include the royalties in the transaction value. However, Section 4 of the Licensing Agreement provides for termination of the Licensing Agreement, including termination for cause such as failure by TSA to make royalty payments as provided for in the Licensing Agreement. Upon termination of the Licensing Agreement, TSA “shall cease and thereafter refrain from making, having made for TSA, using, importing, offering to sell, selling, and otherwise disposing of Licensed Products.” Section 4 of the Licensing Agreement. TSA cannot make (or have made for it) the snowboard binding system except as authorized under the Licensing Agreement. Therefore, it is CBP’s position that the royalty payment is required and is inextricably intertwined with the production and importation of the snowboard binding system such that it constitutes a condition of sale.
Although the Licensing Agreement does not require TSA to purchase merchandise from a particular seller, it does provide the Licensor with the right of approval or rejection of TSA’s choice of manufacturer. According to paragraph 12 of Chapter 8 of the VRG, TSA retains ownership of any patents supplied by TSA to the vendor and the vendor cannot use the patent for anyone else. Based on the Licensing Agreement, we believe TSA could not buy and import this product without paying the royalties provided for in the Licensing Agreement.
HOLDING:
Based on the information provided to CBP, the royalties paid by TSA to the Licensor are additions to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D). Having determined that the royalty payments are included in the transaction value as an addition under 19 U.S.C. § 1401a(b)(1)(D), it is not necessary to address the issue of whether the payments could also be included pursuant to 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
Valuation and Special Programs Branch