Request for Reconsideration and Clarification of HRL 545526;price actually paid or payable; royalties; proceeds

HQ 546478 February 11, 1998 VAL RR:IT:VA 546478 LR CATEGORY: Valuation John M. Peterson, Esq. Neville, Peterson & Williams 80 Broad Street 34th Floor New York, New York 10004 RE: Request for Reconsideration and Clarification of HRL 545526; price actually paid or payable; royalties; proceeds Dear Mr. Peterson: This is in response to your letters dated August 16, 1996, July 2, 1997 and July 3, 1997, submitted on behalf of your client, [xxxxxxxxxxxxxxxxxxxxxxxxxxxx] (the "importer"), seeking reconsideration and clarification of Headquarters Ruling Letter ("HRL") 545526, November 30, 1996. That ruling held that certain sublicensee fees paid by the importer to a related affiliate, [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] (the "sublicensor"), were included in the transaction value of merchandise the importer purchased from a related foreign manufacturer. Specifically, Customs held that the payments form part of the price actually paid or payable for such merchandise. We regret the delay in replying. You disagree with Customs' determination that the fees in question are part of the price actually paid or payable for the imported merchandise. You also seek clarification of the following issues: the scope of HRL 545526, and assuming it is upheld, its effective date and the proper method of declaring the fees. A meeting was held with you and representatives of the importer on June 4, 1997. Subsequent to the issuance of HRL 545526, you submitted additional information concerning the subject sublicense fees. For this reason, your request is being treated as a request for a new ruling based on the additional facts presented. In accordance with your letter dated July 3, 1997, we continue to grant the request for confidential treatment of the identities of the parties, the description of the merchandise covered by the applicable agreements, and the rates and amounts of royalties and license fees paid products and the amount of the royalties involved in the subject transactions. In the public version of this decision, we have excised the bracketed confidential information. FACTS: You advise that the importer is part of the worldwide group of companies, (hereinafter referred to as "Group X") whose ultimate parent company is headquartered in France. Group X established [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] (the licensor), a Swiss company, which is the owner of substantially all of Group X's proprietary patents, trade secrets, trademarks, copyrights and trade names (Licensed Rights) in countries other than France. The licensor licenses the technology to other Group X companies around the world. Using revenues received from licensing, the licensor is responsible for funding all Group X research and development activities. In the United States, the licensor has licensed all of its technology rights to its wholly-owned subsidiary, the sublicensor, which in turn sublicenses that technology to Group X manufacturing and sales subsidiaries throughout North America, including the importer. You indicate that the sublicense fees which the sublicensor receives are used to fund another affiliate, [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] (Company A), based in South Carolina, and which conducts research and development activities designed to support Group X's manufacturing activities in North America. You advise that the ultimate responsibility for funding Company A lies with the licensor. Thus, in any year where the sublicensor's revenues are insufficient to fund Company A, the licensor is required to make up the difference. Similarly, where the sublicensor's revenues exceed those needed to fund Company A, the balance is remitted to the licensor, which uses it to fund other Group X research. The sublicense fees in question arise under a 1985 Sublicense and Technical Assistance Agreement (Sublicense Agreement) executed by the importer and the sublicensor. Under the Sublicense Agreement, the sublicensor has granted the importer a "sublicense" to use the licensed rights, e.g. patents, trademarks and technology (the licensed rights) it obtained from the licensor for the purpose of manufacturing, selling and using [xxxxxxxxxxxxxxxxx]" (the licensed products) in a territory comprising the United States and Puerto Rico. An analysis of the Sublicense Agreement indicates that it requires the payment of sublicense fees in connection with two classes of covered importer activity in the United States: (1) the manufacture of Licensed Products from raw materials and components, and (2) the resale of imported Licensed Products acquired from other sublicensees of the Licensed Rights. In consideration of the sublicense, Article 8.2 of the Sublicense Agreement requires the importer to pay the sublicensor a yearly sublicense fee in an amount "equal to [x]% of Annual Net Sales", which is defined as "the total amounts invoiced during a calendar year by the importer for its sale of all licensed products in any country in the territory, exclusive of any sales tax and after deducting therefrom all discounts, returns, refunds, credits and reduction of any nature." However, Article 8.2 of the Agreement also specifies that: ...for that portion of licensed products purchased by the importer from another Licensee of the licensed products and resold within or outside the Territory, "Annual Net Sales" shall also include that portion but shall be calculated only on the value added by the importer. Thus, you indicate that when the importer produces in the United States a product featuring the Licensed Rights, the sublicense fee is measured as [x]% of the net sale price of the finished article. However, when the importer resells an imported finished article which already incorporates the Licensed Rights at the time of entry, the royalty is [x]% of the "value added", that is the importer's resale mark-up. The importer purchases various finished Licensed Products from foreign affiliate/sellers for resale in the United States. You indicate that these foreign affiliate/sellers are licensed by the licensor to use the Licensed Rights in connection with the manufacture and sale of such products for which they pay royalties to the licensor. You advise that these payments are included in the foreign affiliate/seller's price to the importer. Upon resale of these products in the United States, the importer pays sublicense fees to the sublicensor, as described above. It is the sublicense fees which are at issue here. In HRL 545526, November 30, 1995, Customs held that sublicense fees paid by the importer to the sublicensor form part of the "price actually paid or payable" for imported merchandise [xxxxxxxxxxxxxxxxx] which the importer purchases from its foreign affiliate/sellers. Although the sublicensor is the not "seller" of the imported merchandise, Customs concluded that the importer's sublicense fees are paid "to the sublicensor who is related to the foreign affiliate/sellers of the imported merchandise and represent part of the total payment made to or for the benefit of the foreign affiliate/sellers." Based on this finding, Customs did not determine whether the payments could alternatively be dutiable royalties under 19 U.S.C. 1401a(b)(1)(D) or "proceeds of resale" which accrue to the benefit of the seller under 19 U.S.C. 1401a(b)(1)(E). ISSUES: 1. What is the scope of HRL 545526? 2. Whether the sublicense fees paid by the importer to the related party sublicensor are dutiable as part of the price actually paid or payable of the merchandise the importer purchases from its foreign affiliate/sellers. 3. If not, whether the sublicense fees are dutiable as additions to the price actually paid or payable either as royalties or proceeds. 4. Whether HRL 545526 applies to entries filed prior to its issuance? 5. Assuming the sublicense fees are dutiable, how should they be reported to Customs? LAW AND ANALYSIS: 1. Scope of HRL 545526 You first seek clarification regarding the scope of HRL 545526. Although the Sublicense Agreement covers the payment of fees to the sublicensor for both products manufactured by the importer in the U.S. (in part from imported raw materials and components) and finished products which the importer purchases from the foreign affiliate/sellers, you seek confirmation that the ruling covers only finished products which the importer purchases from its foreign affiliate/sellers. The Sublicense Agreement specifies that on these products, the importer is to pay a sublicense fee of a specified percentage on the importer's markup. HRL 545526 was intended to cover only the sublicense fees paid by the importer to the sublicensor in connection with the resale of imported finished merchandise. The ruling was not intended and did not address the dutiability of the sublicense fees paid up resale of the imported merchandise that undergoes further processing by tin the United States. Insufficient information was provided regarding the dutiability of sublicense fees paid by the importer in connection with the products it manufactures in the United States using some imported components. If the importer would like a ruling on the dutiability of such sublicense fees, specific information regarding the imported components that are incorporated into the finished product, whether such components are themselves licensed products, whether any domestic components are utilized, and the manufacturing operations performed by the importer, should be provided. 2. Price Actually Paid or Payable The "price actually paid or payable" is defined in 19 U.S.C. 1401a(b)(4)(A) as the "total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise...) made, or to be made for the imported merchandise by the buyer to, or for the benefit of, the seller." The determination in HRL 545526 that the sublicense fees the importer paid to the sublicensor, a party related to the seller, were dutiable as part of the price actually paid or payable was based on Customs' position that there is a presumption that all payments made by the buyer to the seller, or a party related to the seller, form part of the price actually paid or payable of the imported merchandise, citing Generra Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990); Chrysler Corporation v. United States, CIT Slip Op. 93-186 (September 22, 1993); and, HRL 545194, September 13, 1995. This presumption may be rebutted by evidence which clearly establishes that the payments are completely unrelated to the imported merchandise. In HRL 545194, supra, which also involved license fees paid by the importer to a party related to the seller, Customs analyzed whether the fees were dutiable as part of the price actually paid or payable. In that case, Customs determined that such fees were part of the total payment for the imported merchandise. Citing to HRL 545663, July 14, 1995, Customs concluded that the Generra standard applies regardless whether payments are made directly to the seller or to a party related to the seller. The decision explains that such "position is consistent with the definition of the price actually paid or payable' as the total payment made directly or indirectly by the buyer to, or for the benefit of, the seller. In our opinion, payments to a party related to the seller represent indirect payments made to, or, at the very least for the benefit of, the seller." You disagree with this analysis. Your position is that the dutiability of royalties should be determined only by the application of 19 U.S.C. 1401a(b)(1)(D) and (E). You argue that to do otherwise would effectively revoke much of the transaction value law, as applied to related party transactions in general, and transactions involving multinational companies in particular. This is because virtually any transfer of funds or other consideration from the buyer to another related entity within the multinational group could be presumed to have been made to, or for the benefit of the seller, and included in transaction value. This, you claim, would render largely nugatory the provisions of 19 U.S.C. 1401(a)(b)(1)(A) through (E), pertaining to additions to the price actually paid or payable, in related party situations. You indicate that payments made to a "related party" as that term is defined in 19 U.S.C. 1401a(g) should not be automatically be deemed part of the "price actually paid or payable" to the seller for the imported goods but should be examined regarding whether the payments are permissible additions to the "price actually paid or payable" pursuant to 19 U.S.C. 1401a(b)(1)(D) or (E). We do not agree with your argument that a price actually paid or payable analysis is not relevant to the dutiability of the sublicense fees. Although 19 U.S.C. 1401a(b)(1)(D) and (E) are relevant in determining when royalty payments are proper additions to the price actually paid or payable under the language of 19 U.S.C. 1401a(b)(1), this provision also specifically states that the price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the items described in subparagraph (A) through (E) (including royalties and proceeds) only to the extent that each such amount is not otherwise included within the price actually paid or payable. . . . " (emphasis added). Based on the emphasized language, we conclude that it is appropriate to consider whether certain payments are included within the price actually paid or payable before determining whether they are to be added to the price actually payable. However, we agree that a payment made by the buyer to the seller or a party related to the seller is not part of the price actually paid or payable if the importer can demonstrate that it does not represent payment for the imported merchandise such as the shortfall and Special Application fees payments in the Chrysler case and/or if the importer can demonstrate that the payments are not paid to or for the benefit of the seller. Although you contend that Customs has an affirmative duty to inquire into the circumstances of the transaction to determine whether the third party remitted the funds, in whole or in part, to the seller, or whether the third party payments were for the benefit of the seller, we adhere to our position that payments made to a party related to the seller are presumed to be part of the price actually paid or payable and that the burden is on the importer to provide evidence to rebut this presumption. Absent such presumption, payments for the merchandise could easily be funneled through an affiliated company and Customs would be engaged in endless fact finding in order to ascertain the nature of such payments and whether they are to be included in transaction value. This is the type of fact-finding which the court in Generra determined was not required by Customs. Rather, the burden is on the importer to provide Customs with sufficient evidence to determine whether such payments are dutiable. You contend that the presumption is overcome in the instant case. As set forth in the Sublicense Agreement, in the case of the finished merchandise the importer purchases from a company in Group X (the imported merchandise at issue) the sublicense fees paid by the importer to the sublicensor are a specified percentage of the value added by the importer (which you explain is the importer's markup). See Article 8. For example, if the importer purchases a product from the foreign affiliate/seller for $40 and resells it for $50, the importer must pay royalties based on the application of the specified percentage to the $10 markup. You explain that this reflects the fact that the importer is only exploiting the marketing-related intellectual property (i.e., trademarks) in the territory and not any production-related intellectual property (e.g. patents, trade secrets) which may be incorporated in the imported products. You state that the related entity which manufactured and sold the product to the importer will have already paid to the licensor the royalty due on production-related intellectual property. In addition, you state that the manufacturing company treats this royalty payment as a cost of manufacture and includes it in its selling price. Thus, you state that the price actually paid or payable which the importer declares to Customs upon importation of the product already reflects this amount. You indicate that none of the sublicense fees which the importer pays to the sublicensor are ever remitted to the seller. In fact, you indicate that the principal beneficiary of these payments is ultimately the buyer, since via its licensing agreement with the sublicensor, the importer's payments are used by the sublicensor to fund another related company, which performs research and development work related to North American operations. Upon review of the submitted information, we agree that the sublicense fees are not an element of the price actually paid or payable of the imported merchandise. Since the licensed rights for which the sublicense fees are paid relate solely to the distribution and sale of the products in the United States and the value of the imported products is not taken into account when determining the amount of the sublicense fees, we find that such fees do not relate to the sale for exportation of the imported merchandise. In contrast, the payments at issue in HRL 545194, supra, were based on the price the importer pays to the seller. In addition, there is nothing which links the payment of the sublicense fee to the sale for exportation of the imported merchandise. Unlike HRL 545194, supra, there is no reference on the seller's invoices to the payment of the sublicense fees and you have advised that there are no supply agreements between the importer and the foreign affiliate/sellers. Thus, based on the evidence presented, we find that the payment of the sublicense fees is not related to the sale for exportation of the imported merchandise. You also argue that the payments in question are neither direct nor indirect payments made to, or for the benefit of, the seller since none will be paid over to the seller. Rather, they are used mainly to fund Company A's research and development activities in the U.S. which are designed to support Group X's manufacturing activities in North America. However, in view of the fact that the ultimate responsibility for funding Company A lies with the licensor rather than the sublicensor and any excess funds paid to the sublicensor may be used to fund another research group within Group X, it appears that at least some of the royalties at issue may benefit the seller. Without documentary evidence tracing the payments in question, we cannot conclude that such payments do not indirectly benefit the seller. Nonetheless, as discussed above, since the sublicense fees are not related to the imported merchandise, we find that they do not form part of the price actually paid or payable of the imported merchandise. 3. Royalties/Proceeds Having determined that the payments in question are not part of the price actually paid or payable for the imported merchandise, we must address whether they should be added to the price actually paid or payable as royalties under 19 U.S.C. 1401a(b)(1)(D). Under this provision, an addition is to be made for the value of any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to