IA 35/96; Related Parties; Royalties; Proceeds

HQ 546787 January 11, 1999 VAL RR:IT:VA 546787 DWS CATEGORY: Valuation Port Director of Customs JFK International Airport Building #77 Jamaica, NY 11430 RE: IA 35/96; Related Parties; Royalties; Proceeds Dear Port Director: This is in response to your memorandum (APP-1-K:TC:B5 AZ) dated October 18, 1996, forwarding a request for internal advice submitted by counsel for GFT Apparel Corp. (GFT) and its sister companies, Giorgio Armani Fashion Corp. (Armani) and CK Apparel Corp. (CK), concerning the dutiability of certain royalty payments. Counsel supplemented their initial request with further submissions dated April 25, 1995, November 11, 1996, and May 8, 1997. Counsel met with members of my staff on October 31, 1997. We have also received a memorandum dated July 1, 1997, from the Chief, Textiles & Apparel Branch, National Commodity Specialist Division of Customs, New York. We regret the delay in responding. FACTS: GFT is a U.S. corporation which imports men’s and women’s wearing apparel from its parent company, GFT, S.p.A. (SpA), which bear the SpA trademark. Armani and CK also import from SpA. It is our understanding that GFT, Armani, and CK are related to SpA within the meaning of 19 U.S.C. 1401a(g). Copies of licensing agreements between GFT and SpA and Armani and SpA have been provided to us. Counsel claims that there is no written agreement with regard to CK, but CK has made royalty payments to SpA in the same manner as Armani. For the purposes of this ruling, we will focus on the licensing agreement between GFT and SpA, which commenced January 1, 1989. In pertinent part, this agreement permits the following:  Section 2.1 of the license agreement grants to GFT the right to: “(a) use the Trademark ‘GFT’ in its corporate name to read ‘GFT Apparel Corp.’; and (b) to affix the Trademarks to Products produced exclusively for the Licensee [GFT] by a manufacturer approved by the Licensor [SpA], which shall be sold only with the Trademarks affixed thereto and to use the Trademarks in connection with the distribution, advertising and sale of the Products.” Section 4.1.2 provides that SpA “is the owner of the Trademarks and has full right and authority to give and grant all rights and licenses for the use of the Trademarks in the Territory in connection with the manufacture and sale of the Products.” Section 5.2 provides that “Licensee [GFT] shall hold Licensor [SpA] harmless from any claims which third parties may assert against Licensor relating to the Products contemplated by this Agreement, including the claimed infringement of the Trademarks or other property rights.” In return, GFT pays SpA a 2% royalty based upon net sales made by GFT (i.e., in the U.S.). Counsel states that the licensing agreements of Armani and CK provide for a 1% royalty based upon use of the trademark but not as part of the corporate name. According to counsel, the importers also source their merchandise from unrelated vendors as well as from SpA, the licensor and trademark owner receiving the royalty payments. SpA receives the royalty payment regardless of whether the importers purchase the merchandise from the unrelated vendors or SpA. Supply agreements among GFT, Armani, CK, and the unrelated vendors have not been provided to us. Without these supply agreements, we cannot determine whether the royalty payments made to SpA constitute a condition of sale between the importers and the unrelated vendors. Therefore, we cannot comment on whether the royalties paid pursuant to such agreements are dutiable. Customs published a general notice entitled “Dutiability of ‘Royalty’ Payments” [27 Cust. Bull. No.6 (February 10, 1993)] (General Notice). Because of their concern that the application of this general notice may affect the dutiability of the royalty payments at issue, counsel, in accordance with 19 CFR 162.74, submitted a prior disclosure to the Area Director of Customs at JFK International Airport, and reported royalty payments which GFT, Armani, and CK have made to SpA in connection with the use of trademarks applied to imported merchandise during the time period 1989 to present. These payments were not added to or included in the appraised value of the imported merchandise. Internal advice was requested under 19 CFR 177.11 in the event your office did not agree with GFT that the royalty payments are non-dutiable. This ruling constitutes a response to counsel’s request for internal advice and does not address any other issues which may exist in the context of counsel’s prior disclosure, including whether the prior disclosure is valid. ISSUE: Whether royalty payments by the importers/licensees, GFT, Armani, and CK, to the seller/licensor, SpA, made in connection with entries of imported merchandise both prior to and after the effective date of the General Notice (90 days from February 10, 1993, the date of publication of the General Notice in the Customs Bulletin), supra, constitute additions to the price actually paid or payable within the meaning of section 402(b)(1)(D) or(E) of the TAA, and are included in the transaction value of the imported merchandise. LAW AND ANALYSIS: The preferred method of appraising merchandise imported into the United States is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. §1401a. Section 402(b)(1) of the TAA provides, in pertinent part, that the transaction value of imported merchandise is the “price actually paid or payable for the merchandise when sold for exportation to the United States” plus enumerated statutory additions. Counsel states in their November 11, 1996, submission that they have: discovered that the previously-identified “[S.p.A]-Produced Merchandise” (identified as such in the earlier submissions) in actuality covers a substantial portion of merchandise purchased by [S.p.A.] from both related and unrelated factories. We believe that the merchandise sourced from [S.p.A.] which is, in turn, manufactured by separate factories constitutes first-cost sales which should qualify as the basis of appraisement under Nissho Iwai America Corp. v. United States and Synergy Sport International v. United States. Under this analysis, the factory is the “seller” of the merchandise and the “buyer” is [S.p.A.]. In such case, the dutiability of the royalty would not be in question since the factory receives no benefit from the royalty payment. The issue is presently the subject of a protest and application for further review which is pending at Customs Headquarters (Protest No. 1001-96-103579). The issue above to which counsel refers involving Protest 1001-96-103579 was the subject of HQ 546535, dated December 19, 1997. However, in that ruling, we stated that: [i]n the instant case, [GFT] is claiming that under Nissho, the transaction value for the imported merchandise should be based on the transaction between [S.p.A.] and the unrelated Italian manufacturer. In determining whether this claim is valid, the first question to be addressed is whether there was a bona fide sale between [S.p.A] and the manufacturer. ***** Turning to the first part of the two-part test in Nissho, in the transaction between the manufacturer and [S.p.A], the evidence must establish that the garments were clearly destined to the U.S. at the time they were sold to [S.p.A.]. ***** For purposes of determining transaction value based on the sale between the [S.p.A] and the manufacturer, the evidence submitted does not establish that the merchandise was clearly destined for the U.S. under the Nissho standard. Consequently, [GFT] has not met its burden to establish that the merchandise should be appraised on a transaction other than that between [S.p.A.] and the [GFT]. You have advised us that the entries in the above protest, which were the subject of HQ 546535, supra, are the same entries involved herein. Consequently, because it was determined in HQ 546535, supra, that the imported merchandise should be appraised on the transaction between S.p.A. and GFT and not on the transaction between SpA and the manufacturer, the issue raised by counsel as to whether we can even consider whether the royalty payments from GFT to S.p.A. are dutiable because the seller receives no benefit is moot. For the purposes of this ruling, because of the similarity in relationships and that counsel has not submitted evidence to the contrary, the findings in HQ 546535, supra, will also apply to the entries at issue involving Armani and CK. ROYALTY PAYMENTS AFTER EFFECTIVE DATE OF GENERAL NOTICE The transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between such buyer and seller did not influence the price actually paid or payable or if the transaction value of the imported merchandise closely approximates certain “test values”. In this case, the import transactions at issue involve SpA and its related companies, GFT, Armani and CK. No information has been provided regarding the acceptability of the transfer price and we do not address this issue here. This ruling only addresses the issue of whether the subject royalty payments are included in the transaction value of the imported merchandise, assuming transaction value applies. For purposes of transaction value, the "price actually paid or payable" is "the total payment (whether direct or indirect ***) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller." Section 402(b)(4) TAA; 19 U.S.C. §1401a(b)(4). The price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the enumerated additions only to the extent that each such amount is not otherwise included within the price actually paid or payable; and is based on sufficient information. Section 402(b)(1) TAA. Among the enumerated additions are: (D) any royalty or license fees 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; and (E) 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). Counsel contends that the royalty payments made by GFT, Armani, and CK to the licensor/seller, S.p.A., do not constitute additions to the price actually paid or payable within the meaning of either section 402(b)(1)(D) or (E) of the TAA, and are not included in the transaction value of the imported merchandise. 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: [a]dditions 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 casebycase 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 supplied). 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, supra. Although the SAA provides that determinations about the dutiability of royalty payments are to be made on a casebycase basis, 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. In this case, the party to whom the royalties are paid (S.p.A) is both the seller and the licensor. According to the SAA, any royalty or license fee paid to the seller is part of transaction value unless the importer can establish that it is distinct from the price actually paid or payable for the imported merchandise and that such payment was not a condition of the sale of the imported merchandise for exportation to the U.S. In other words, there is a presumption that royalties paid to the seller are dutiable unless the importer can show otherwise. As pointed out in the General Notice, supra, the method of calculating the royalty, i.e., based upon the resale price, is not relevant in determining its dutiable status. Thus, in HQ 545361, dated July 20, 1995, the fact that liability for the payment of a trademark royalty was triggered by the resale of the products after importation did not preclude a finding that the payments were dutiable under section 402(b)(1)(D). Therefore, in view of the fact that the royalty payments are made to the seller of the imported merchandise in the instant case, we disagree with counsel that the sale of the merchandise for exportation to the U.S. is separate from the payment of the royalties. In HQ 545361, supra, Customs considered whether royalties paid by the licensee/buyer to the trademark owner for the right to use the latter’s trademark were dutiable under section 401(b)(1)(D) or (E) as an addition to the price actually paid or payable of the imported licensed products. Three scenarios were presented; the underlying facts in each scenario were the same except with regard to who the royalties were paid. In each case, the royalties were based on a percentage of the net sales price of all products manufactured and sold by the licensee using the licensed trademark. As mentioned above, liability for payment of the royalty was triggered by the resale of the trademarked product by the licensee/buyer. We will deal with the second scenario in HQ 545361, supra, as it appears to directly pertain to the instant case. In the second scenario, the licensor and the seller are the same entity, and the royalty payment is made to the licensor/seller. Under these circumstances, Customs found that the royalty payment was a condition of the sale of the merchandise for exportation to the U.S. and dutiable under section 402(b)(1)(D): Although we have assumed above that the royalty payment is distinct from the price actually paid or payable, it is still necessary to determine whether the payment is a condition of sale. Repeating the threestep analysis, the first and second questions once again return negative responses. However, in this situation, where the licensor and the seller are the same person, and the payment is made to the licensor/seller, we consider the royalty to be a condition of the sale of the merchandise for exportation to the U.S. The payment is not optional, but must be made to the licensor in its capacity as seller of the merchandise. The agreement provides that the licensee/buyer must pay an amount equal to a percentage of the net sales price of all products that use the licensor/seller's trademarks and trade names, and an equal percentage amount on the net sales price of all products sold to trademarked retail shops. Draft License Agreement at 5. Therefore, to the extent that the products described by the draft agreement are imported, the payment of the royalty is a condition of sale and as such, an addition should be made to the price actually paid or payable. As with the parties in HQ 545361, supra, the royalty payments made by GFT, Armani, and CK per their license agreements with S.p.A. are not optional and must be made to S.p.A. as licensor in its capacity as seller of the imported merchandise. GFT’s agreement provides that it must pay SpA a 2% royalty based upon net sales made by GFT (i.e., in the U.S.) for use of the trademark including as part of its name. Armani’s and CK’s agreements provide that they must pay S.p.A. a 1% royalty based upon use of the trademark but not as part of the corporate name. Therefore, the royalty payments made by GFT, Armani, and CK to S.p.A. are a condition of the sale of merchandise for exportation to the U.S. As such, an addition should be made to the price actually paid or payable. As to whether the royalty payments from GFT, Armani, and CK constitute proceeds as described in section 402(b)(1)(E), HQ 545361, supra, is again instructive. In that ruling, we stated that: [s]ection 402(b)(1)(E) of the TAA provides that an addition to the price actually paid or payable should be made for the proceeds of any subsequent resale, disposal or use of imported merchandise that accrue directly or indirectly to the seller. Here, the agreement requires that a royalty be paid based on a percentage of the net sales price of all products manufactured and sold by the licensee using the trademarks/trade names and technical data, as well as an additional percentage based on the net sales of trademarked products sold to trademarked retailers. Consistent with the above analysis, where the licensor and seller are unrelated, we do not consider the payment to be an addition to the price actually paid or payable under section 402(b)(1)(E) since, under the facts presented, the payments are not made to the seller of the imported merchandise. If, however, the licensor and the seller are the same legal person, or if the seller is related to the licensor, it is our position that the payment would constitute a proceed of a subsequent resale, disposal or use within the meaning of section 402(b)(1)(E) of the TAA. The result would be the same if the seller were related to the licensor unless the buyer/importer could establish that no portion of the proceeds accrued directly or indirectly to the seller. (emphasis supplied). Likewise, because S.p.A., as licensor and seller, is the same legal entity, the royalty payments made by GFT, Armani, and CK to S.p.A. constitute proceeds of a subsequent resale, disposal, or use within the meaning of section 402(b)(1(E). ROYALTY PAYMENTS PRIOR TO EFFECTIVE DATE OF GENERAL NOTICE In HQ 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 payment was 5% of the importer’s net sales in the U.S. 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, and the importer 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 holding that the royalty payments were not dutiable, we stated that: [i]n this case, is [sic] appears as if the royalties at issue are not a condition of the sale of the imported merchandise. The payment owed is for rights which are separate and apart from the right of ownership on payment of the purchase price. The royalty payments are triggered upon the resale of the product rather than the importation of the product. In a similar situation, Headquarters ruled that royalty payment [sic] by the importer to the licensor for the use, sale, and manufacture of the product in the United States was not part of the transaction value of the imported merchandise. In that case, the payment was not a condition of the sale nor was it tied to the importation of the product. See, Headquarters Ruling No. 544061, dated May 27, 1988. (emphasis supplied). Therefore, we agree with counsel that any royalty payments made by GFT, Armani, and CK to S.p.A. in connection with entries of imported merchandise prior to the effective date of the General Notice, supra, which were calculated on the basis of sales which occurred subsequent to the importation of the merchandise, are not dutiable as royalties under section 402(b)(1)(D). When considering whether the subject royalty payments constitute proceeds under section 402(b)(1)(E), HQ 543773, dated August 28, 1986, is instructive. In that ruling, we stated that: when a royalty or license fee is not part of transaction value under section 402(b)(1)(D) of the TAA, then it is not part of transaction value as “the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue directly or indirectly to the seller” provided for in section 402(b)(1)(E) of the TAA. Therefore, in accordance with the legal authority above, it is our position that the subject royalty payments made by GFT, Armani, and CK to S.p.A. in connection with entries of imported merchandise prior to the effective date of the General Notice, supra, do not constitute proceeds as described in section 402(b)(1)(E). With regard to the proceeds issue, we note that HQ 543773 was modified by HQ 544436, dated February 4, 1991, which was the subject of the General Notice, supra. HOLDING: The subject royalty payments by the importers/licensees, GFT, Armani, and CK to the seller/licensor, SpA, made in connection with entries of imported merchandise after the effective date of the General Notice, supra, constitute additions to the price actually paid or payable within the meaning of either section 402(b)(1)(D) or (E) of the TAA, and are included in the transaction value of the imported merchandise. The subject royalty payments by the importers/licensees, GFT, Armani, and CK to the seller/licensor, SpA, made in connection with entries of imported merchandise prior to the effective date of the General Notice, supra, do not constitute additions to the price actually paid or payable within the meaning of either section 402(b)(1)(D) or (E) of the TAA, and are not included in the transaction value of the imported merchandise. Sincerely, Thomas L. Lobred Chief, Value Branch