VAL RR:IT:VA 545752 LR

Port Director
U.S. Customs Service
Great Falls, Montana

RE: Royalties; Proceeds; 402(b)(1)(D); 402(b)(1)(E) of the TAA Dear Sir:

This is in response to the August 2, 1994, letter submitted by the former district director regarding the dutiability of certain royalties the U.S. importer, DashAmerica Inc., pays Pearl Izumi, Inc., the Japanese seller. Additional information was submitted by fax on July 17, 1995. We regret the delay in responding.

FACTS:

Pearl Izumi Inc. (hereinafter referred to as "the seller") is a Japanese corporation engaged in the design, production, sale and export of cycling apparel and accessories distributed under its own trademarks. DashAmerica, Inc. (Hereinafter referred to as "the buyer") is an unrelated U.S. company which both imports and sells cycling apparel and accessories and produces its own cycling apparel for sale in the United States. In May 1989, the companies entered into two agreements, a Technology and Trademark License Agreement (1989 License Agreement) and a Distribution Agreement (1989 Distribution Agreement). In January 1992, the parties signed a Restated and Amended Technology and Trademark License agreement (1992 License agreement) and a Restated and Amended Distribution Agreement (1992 Distribution Agreement). Copies of the 1989 License Agreement and the 1992 Distribution Agreement were submitted. For purposes of this ruling we assume that the terms of the 1992 License Agreement is similar in all material respects to the 1989 License Agreement.

There are two royalties payments at issue. The first is provided for in the 1989 License Agreement granting to the buyer an exclusive right and license to use the seller's technical information to produce cycling products at its plant and to sell such products to customers in the specified territory. Under the agreement, the seller also grants the buyer an exclusive right to use the seller's trademarks on and in connection with the advertising, promotion and sale of the products produced by the buyer by using the seller's technical information. In consideration of the technology and trademark license and the rights granted, the buyer agrees to pay an initial license fee and a running royalty to the seller based on a percentage of the sales in the territory to be paid quarterly.

Royalties are also payable under the 1992 Distribution Agreement, in which the seller appoints the buyer as its sole and exclusive distributor in the specified territory for the sale of all cycling products manufactured by the seller. Under this agreement, the buyer agrees to devote itself to engaging in marketing, promoted and selling and otherwise representing the cycling products manufactured by the seller. Section 2.3.5 provides for the payment of a running royalty from the buyer to the seller for a specified percentage on products sold in the territory based upon all sales in the quarter. In addition to the provision regarding royalties, this agreement also provides the terms of sale regarding the purchase of the imported products by the buyer from the seller. For example, it provides that the seller shall sell and the buyer shall purchase the products at issue, subject to the provisions of the Agreement, solely for distribution in the Territory. The agreement covers the method of purchase, delivery and payment and provides that "all terms and conditions of sale, such as prices, terms of payment and terms of delivery, shall be subject to this Agreement" unless otherwise agreed in writing. See section 2.3, Terms of Sale.

Your position is that the royalty payments described above are dutiable as "proceeds of a subsequent resale" pursuant to section 402(b)(1)(E) of the TAA. The importer's position is that they are not dutiable because they relate only to the use of the seller's trademark and provide little, if any, tangible value to the design, manufacture or distribution of the products it sells.

ISSUE:

Whether the royalty payments to the seller are included in the transaction value of the imported merchandise either as royalties or proceeds of a subsequent resale.

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; 19 U.S.C.  1401a). The preferred basis 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. The additions to the price actually paid or payable 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 sale of the imported merchandise for exportation to the United States" 19 U.S.C.  1401a(b)(1)(D) and "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)(E). An addition is to be made only to the extent these amounts are not included in the price actually paid or payable.

Pursuant to section 402(b)(2)(A) of the TAA, transaction value is acceptable only in certain circumstances, e.g., where the buyer and seller are not related, or where related, the relationship does not influence the price actually paid or payable. Since you have advised that the buyer and sellers are unrelated, we have assumed, for purposes of this ruling, that transaction value is the appropriate basis of appraisement. We have also assumed that the royalty payments are not part of the price actually paid or payable for the imported merchandise and our analysis is limited to whether they are additions under section 402(b)(1)(D) or 402(b)(1)(E) of the TAA..

Royalties

Under section 402(b)(1)(D) of the TAA, an addition to the price actually paid or payable is made 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), H.R. Doc. No. 153, 96 Cong., St. 1st Sess., reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49, which forms part of the legislative history of the TAA, distinguishes payments to third parties from payments to the seller of imported merchandise. It states:

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: (1) 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 for the United States (emphasis added).

Although the SAA provides that determinations about the dutiability of royalty payments are to be made case-by-case, it is more likely that the royalty will be dutiable when the licensor and seller are one and the same and the royalty is paid directly to the seller. Under these circumstances, payment of the royalty is more likely to be a condition of the sale for exportation of the imported merchandise than when the royalty is paid to an unrelated third party. See HRL 545361, July 20, 1995 (trademark royalties dutiable when paid to the seller/licensor but not when paid to a third party unrelated to the seller).

After reviewing the language of the statute along with the legislative history and prior case law, Customs concluded that the following three questions are relevant in determining whether the requirements of section 402(b)(1)(D) are met: 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. An affirmative answer to question 1 and 2 and a negative answer to question 3 points to dutiability. Question 3 goes to the heart of whether the payment is considered to be a condition of sale. See General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) ("Hasbro II ruling").

In the Hasbro II ruling, we determined that the royalty, paid to the seller, was involved in the sale of imported merchandise because the individual sales agreements and purchase contracts were subject to the terms of the royalty agreement. In HRL 544991, September 13, 1995, we held that a royalty was involved in the sale of the imported merchandise payment of the royalty was closely tied to the purchase of the imported product. For example, in that case, the terms and conditions related to the purchase of the imported products were set forth in the license agreements. See also HRL 545380, March 30, 1995 (royalty related to the production or sale of the imported merchandise where under the terms of the licensing agreement, importer was required to purchase components from the seller).

Some factors which Customs has considered in answering this question three, i.e., could the importer buy the product without paying the fee, include to whom the royalty is paid (e.g. payments to the seller, as opposed to a unrelated third party are generally dutiable); whether the purchase of products and the payment of royalties are inextricably intertwined (e.g. are they set forth in the same agreement, do the agreements make reference one another, is the purchase agreement terminated if the buyer fails to pay the royalties); and whether royalties are paid on each and every importation. See HRL's 544991, 545380; 545361; and Hasbro II, supra.

Royalties under the 1989 License Agreement The royalties under the 1989 License Agreement do not relate in any fashion to the merchandise that the buyer purchases and imports from the seller. Rather, these fees are paid in connection with the sale of products which the buyer manufactures at its plant utilizing technical assistance from the seller. The fees are also paid for the right to use the seller's trademark in connection with these products. It is our understanding that the buyer does not use any of the products it purchases and imports from the seller under the 1992 Distribution Agreement to manufacture these products for which royalties are to be paid. These fees are not involved in the production or sale of imported merchandise and are not a condition of the sale of imported merchandise from the seller. Inasmuch as these royalties relate exclusively to the products manufactured by the buyer and are not a condition of sale of the products which the buyer purchases and imports from the seller, they are not to be included in the transaction value of the imported merchandise as royalties under section 402(b)(1)(D).

License fees under the 1992 Distribution Agreement

In contrast to the royalty payments discussed above, the royalty payments covered by the 1992 Distribution Agreement are paid by the buyer to the seller, for the right to distribute and sell the imported products. Although there is no information available concerning whether the imported merchandise is manufactured under patent, as explained below, these payments relate to the sale of the imported products and are a condition of their sale for exportation to the United States. Under the terms of the 1992 Distribution Agreement, the royalty payments to the seller are closely tied to the purchase of the imported products to the seller. Both the purchase price and the license fees relating to the imported merchandise are covered by the agreement. The agreement specifically provides that all terms and conditions of sale, such as prices, terms of payment and terms of delivery, shall be subject to the distribution agreement unless otherwise agreed upon in writing by the parties. The agreement indicates how the prices are to be determined and the amount of royalties to be paid of the imported products. Also, the agreement provides that in the event that the buyer fails to make any and all payments the seller may terminate the agreement. Based on these provisions, we find that the royalties are involved in the sale of the imported merchandise. In addition, the royalty payment is not optional. That is, it must be paid to the extent that the buyer earns revenue by reselling the imported products. Moreover, the royalties paid to the seller are inextricably intertwined with the sale for exportation of the imported products. Each imported product will be subject to a royalty payment upon its sale in the territory. In other words, the buyer cannot purchase the imported merchandise from the seller without having to pay the royalty. And, as discussed above, the terms of sale and the payment of royalties are set forth in the same agreement and are closely tied together. Accordingly, Customs considers the payment of royalties covered by the 1992 Distribution Agreement to be a condition of the sale for exportation to the U.S. of the imported merchandise.

Based on the above considerations, the royalty payments covered by the 1992 Distribution Agreement are an addition to the price actually paid or payable of the imported merchandise under section 402(b)(1)(D) of the TAA.

Proceeds

Under 402(b)(1)(E) of the TAA, one of the additions to the price actually paid or payable is for "proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller. With regard to proceeds, the SAA provides that:

[a]dditions for the value of any part of the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrues directly or indirectly to the seller, do not extend to the flow of dividends or other payments from the buyer to the seller that do not directly relate to the imported merchandise. Whether an addition will be made must be determined on a case-by-case basis depending on the facts of each individual transaction.

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

In the Hasbro II ruling, Customs determined that the royalty payments were dutiable either as royalties under section 402(b)(1)(D) or proceeds under section 402(b)(1)(E). The ruling states that "Customs finds that HRL 544436 involves the type of situation that Congress explained in the Committee reports by stating 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. 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 that case, pursuant to a contract between the importer/buyer and the seller, the importer/buyer was obligated to pay the seller 7% of the resale "invoice price" of the imported merchandise. The sales agreement between the parties, i.e., the purchase contract, was subject to the terms and conditions of the contract requiring the 7% payment. Customs determined that the payments constituted proceeds of the subsequent resale of the imported merchandise that accrued to the seller and thus dutiable under section 402(b)(1)(E).

The royalties payable under the 1989 License Agreement do not constitute dutiable proceeds under section 402(b)(1)(E) because they do not relate to the subsequent resale, disposal, or use of the imported merchandise. As discussed above, the fees under this agreement relate to the sale of merchandise produced by the buyer at its plant.

However, as discussed above, the royalties fees payable under the 1992 Distribution Agreement do relate to the resale, disposal, or use of the imported merchandise and accrue directly to the seller. Therefore, they would be dutiable under section 402(b)(1)(E). Like the situation in Hasbro II, the buyer here entered into an agreement with the seller of the imported merchandise and in consideration for this right, the buyer is to pays royalties fees which accrue to the seller upon the resale of the imported merchandise. The proceeds here exemplify the types of payments that section 402(b)(1)(E) was designed to cover.

HOLDING:

In conformity with the foregoing, the royalties fees covered by the 1989 License Agreement are not included in the transaction value of the imported merchandise under either section 402(b)(1)(D) or section 402(b)(1)(E) of the TAA. The royalties covered by the 1992 Distribution Agreement are included in the transaction value of the imported merchandise under either under of these sections. .

This decision should be mailed by your office to the importer no later than sixty days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS, and to the public via the Diskette Subscription Service, the Freedom of Information Act, and other public access channels.
Sincerely,

Acting Director
International Trade Compliance Division