Internal Advice; Payments for the right to use trademarks and design consultation; assists; royalties; condition of sale

HQ 548368 December 24, 2003 RR:IT:VA 548368 MMC CATEGORY: Valuation Area Director Bureau of Customs and Border Protection JFK Airport, BLDG 77 Jamaica, NY 11430 Attn: Dianne Wickware RE: Internal Advice; Payments for the right to use trademarks and design consultation; assists; royalties; condition of sale This is in response to your undated memorandum (PRO-2 K:TO:B7 AZ/DW) concerning a request for internal advice received by this office on July 21, 2003. The March 24, 2003 request was made to your office by Robert A. Calandra, Esq. on behalf of Presidio International (PI). The request concerns the dutiability of trademark royalty payments and design and consulting fees and the proper classification of authenticity cards. On September 4, 2003, we forwarded the classification issue to the Textiles Branch. It will be addressed under separate cover. While you have not specifically requested confidentiality, we have chosen to provide it for certain information contained in this ruling. Any information we have deemed confidential is bracketed in this ruling and will not be disclosed in copies made available to the public. FACTS: According to counsel PI is a "vertically integrated" retailer of Giorgio Armani wearing apparel and accessories; meaning PI designs, sources, purchases (overseas and domestically) and retails "A/X Armani Exchange" products. PI operates 45 retail stores and hosts leases with buildings in which A/X Armani Exchanges stores are located. PI purchases the wearing apparel and accessories from a variety of unrelated overseas and domestic suppliers. All products imported by PI must be sold at PI owned A/X Armani Exchange retail stores. G.A. International Diffusion B.V. (Armani B.V.) is the licensor for the "A/X Armani Exchange" trademark and the provider of design and consultation services to PI. According to counsel PI is not related to Armani B.V. Leisure Holdings Inc.(LH) is the parent company of PI. The majority interest in LH is controlled by B. S. Ong and/or Christina Ong. According to counsel LH is not related to Armani B.V. A typical transaction occurs as follows. Purchase orders are issued by PI's merchandising department through a computer system. Each week an "open order report" with the shipping date as a reference is run so that lines of credit can be opened or updated for orders. Suppliers send out shipments by air or ocean freight and the freight forwarders inform PI of arriving shipments. Counsel has provided an example of a document trail of a sale between PI and an unrelated supplier for denim jackets. The documents include a purchase order, an open order report, a line of credit document, an airway bill and the supplier's invoice. The invoice references the submitted line of credit. Additionally, Counsel has provided both a copy of the Licensing Agreement and Design and Consulting Agreement executed between PI and Armani B.V. In the License Agreement PI serves as the licensee and Armani B.V. as the licensor. In the Design and Consulting Agreement, PI is purchasing design and consulting services from Armani B.V. According to Counsel, the license fees are not part of the agreement with the manufacturers. A review of the documents indicates that there is no reference to the license agreement or the royalty payment on the purchase orders or invoices between the sellers and PI. However, the License Agreement does reference the Design and Consulting Agreement. Licensing Agreement Under the Trademark License Agreement PI agrees to pay Armani B. V. a royalty fee which is a percentage of net retail sales for the exclusive right to produce, market, distribute and sell, to its boutiques and outlets products bearing the Armani Exchange trademarks. Additionally, the License Agreement requires PI to produce, market, package, display, distribute and sell products bearing the trademark strictly in accordance with specifications, quality standards, directions and instructions given or approved in writing from time to time by Armani B.V. More specifically, PI must submit its production schedule to Armani B.V. for its approval, manufacturers have to be approved by Armani B.V, PI has to buy the fabrics and raw materials, Armani B.V. can ask for information about timely delivery and shipping, PI must provide Armani B.V. with an inventory for each season stating number of units and value, and finally Armani B.V. must have access to all production and storage places. Furthermore, at its own cost and expense PI must prepare and submit for approval one sample of each product together with proposed prices for each product. Armani B.V. provides PI with the fabric labels and hang tags bearing the trademark and PI must use and affix such labels & hang tags to the products as directed or approved by Armani B.V. PI will let Armani B.V. know quarterly about inventory of labels and hang tags. Finally PI cannot use other labels and hang tags and cannot use any labels, tags, packaging, boxes, bags or other printed material bearing the trademark except in connection with the marketing, distribution and sale of the products. Concerning distribution, PI can only use the trademark in connection with the marketing, distribution and sale of the approved products to approved boutiques and outlets in the approved territory for sale to retail customers. PI has to establish a distribution team exclusively devoted to the marketing, distribution and sale of the products and has to undertake to respect the delivery dates of the products as agreed to with the boutiques and outlets. PI has to give Armani B.V. an identification of the boutiques and outlets to which the products will be offered together with any other information reasonably requested. Armani B.V. can approve or disapprove the boutiques or outlets but denial will only happen if the boutique or outlet "failed to maintain the approved image". Armani B.V. retains the right to revoke its approval of sale to any boutique or outlet in the event the distribution or sale of the products is likely to prejudice or harm the trademark or the Armani marks or the reputation or goodwill of Armani B.V. or companies in the Armani Group or to prejudice the best distribution of the products bearing the trademark or products bearing other of the Armani marks. Revocation cannot be based on location or design of boutique but must be based upon failure to maintain the approved image. No sales to wholesalers, stockists or jobbers or employees are allowed without prior approval. PI has to sell the products bearing the trademark at an adequate price for the position that the products have in the market, and for the position that the products have in relation to the products bearing other than Armani marks. PI agrees to consult with Armani B.V. with regard to the selling price of the products bearing the trademark for each season's collection taking into consideration the particular territorial, economic and social conditions of the territory and its regions. However the final decision with respect to selling prices will be made by PI. PI agrees not to increase the selling price in each selling season except based upon documented and justified increase in the price of the workforce and of the production costs. Finally, the License Agreement indicates that Armani B.V.'s rights are assignable, PI's are not. Control or ultimate indirect ownership of PI cannot be changed in a manner that would result in a decrease of the direct or indirect ownership interest of the Ongs. Design and Consulting Agreement PI and Armani B.V. also have a Design and Consulting Agreement. Armani B.V. provides assistance and consulting services in connection with the creation, design and approval of products bearing an Armani trademark. For these services PI pays [1] percent of net retail sales. The Design and Consulting Agreement references the License Agreement and acknowledges it was created on the same day. The Design and Consulting Agreement defines "designs" as the creations, designs, styles and models generated in connection with the agreement and created or approved by Armani. The agreement states that Armani B.V. is providing assistance and consulting services in connection with the development of a Collection of Products to be created, designed or approved by Armani B.V. and developed, produced, marketed distributed and sold by PI. Armani B.V.'s assistance and consulting services takes place in Milan and consists of: research and/or selection and/or approval of raw materials, fabrics and other textiles, the creation or approval of styles and designs of the products and of the collection and research and consulting in connection therewith, review and approval, including approval of all changes, modifications or alterations, if necessary of the textiles, raw materials and styles submitted by PI for approval by Armani B.V.; and review and approval or disapproval of samples of the products and the collection which shall be developed and produced, marketed, distributed and sold by PI in the territory. PI cannot produce, promote advertise, market distribute or sell products which have not been created and/or approved by Armani. Selections of products to be designed and created and included in the collection for each selling season are made jointly by the parties. Absent agreement on the selections, Armani B.V. has the right to make the final decision. PI at its own cost and expense has to set up a team dedicated exclusively for creating proposed designs and/or developing the product designs provided or approved by Armani B.V. PI also has to develop the products and the collection and produce, market, distribute and sell the products strictly in accordance with the License Agreement. Furthermore, PI must order and purchase for its own account the materials and the textiles necessary to produce the products, including samples, for approval. PI must also develop and produce the products based exclusively on the textiles and other materials approved by Armani B.V. and the designs provided or approved by Armani B.V. Once PI has developed a product it must provide a sample of each product and propose prices for wholesale, the boutique and outlet retail prices. Both the sample and the pricing are subject to approval or disapproval by Armani B.V. Armani B.V. has the right to inspect PI's premises and anyone associated with the production of the products to determine quality of the textiles and materials used in the production, conformity of products to design and the adequacy and punctuality of delivery. Finally, PI must consult with Armani B.V. on the timing and method of presentation, promotion and advertising of the products. The Design and Consulting Agreement also indicates that the designs are and shall be deemed to be owned exclusively by Armani B.V. Implementation of the Licensing and Design and Consulting Agreements According to counsel's submission there are 7 seasons or deliveries per year for the products and there are a series of steps that happen for each season. The series begins with the creation of a line plan. PI's merchandising and design teams meet to review the needs for the season. The line plan is based on sales information and business needs and growth opportunities. Then the PI design team creates a mood board. The purpose of this inspiration board is to set the direction for the season. Once a concept has been chosen, the design directors pass out this information to the rest of the PI design staff. PI contacts Armani B.V. to see if the concept corresponds to the direction they are taking from Armani B.V. The team next concerns itself with fabric. PI design staff sources fabric throughout the year by attending seasonal fabric fairs in Europe. Fabrics that have been chosen for consideration into the line are then selected for the season and included in the package. After fabric selection, design sketching begins. Each designer creates sketches according to the mood direction that has been established. The designers then review these sketches with their design director. PI design directors then incorporate these components and prepare a package that is reviewed with PI New York merchants and the president of PI. This package is then sent to Italy and Armani B. V. for review. Once reviewed by Armani B.V., the package is returned to PI with Mr. Armani's feedback. The returned package is then reviewed again with PI merchandising and the PI president before it is put into work with factories. Next the PI design team works with the PI technology team to prepare developmental packages for each style. This package will include sketches, measurements and fabric information. A prototype is then created. Prototypes are then "fit reviewed" in New York with representatives of the Hong Kong office. Corrections to style, fit and fabric are made at this time. Pictures of all first prototypes are taken and compiled into a book, which is sent to Armani B.V. for their reference. A second set with the changes made from the first fitting are briefly reviewed in New York and then a carnet of prototypes is prepared and all are brought to Italy. Approximately 500 prototypes per season are hand carried to Milan in a carnet and are arranged for presentation to Mr. Armani by PI's design and merchandising teams. The styles Mr. Armani approved for the line are subsequently reviewed with the Italy quality control team to ensure that the A/X product follows Armani's high quality standards. After getting the approval from Mr. Armani, the prototypes go through a final review in PI and orders are placed for bulk production. ISSUE: Whether the royalty payments made by the importer to licensor are included in the transaction value. Whether payments made for services performed under a design services agreement are dutiable as assists. 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 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. 19 U.S.C. § 1401a(b)(1). Related Parties However, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain "test values." 19 U.S.C. § 1401a(b)(2)(B). In the instant case, the importer and the seller of the imported merchandise are not related pursuant to 19 U.S.C. § 1401a(g)(1)(F). Additionally, counsel asserts that neither the seller nor importer is related to the licensor. Absent any information to the contrary, we have assumed for purposes of this ruling that none of the parties are related to each other. Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable of which two are relevant for purposes of this ruling. These include: the value, apportioned as appropriate, of any assist; 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. 19 U.S.C. § 1401a(b)(1)(C)-(D). Design Service Payments The first of the relevant additions to the price actually paid or payable is for the value, apportioned as appropriate, of any assist. The term "assist" refers to an item that is supplied directly or indirectly by the buyer, and free of charge or at a reduced cost, for use in connection with the production or sale for export of the imported merchandise. There are four categories of assists, including "engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise." 19 U.S.C. § 1401a(h)(1)(A)(iv). In Headquarters Ruling Letter (HRL) 546782 dated December 2, 1999, a licensor furnished sketches, together with written explanations relative to various clothing details, and, on request, paper patterns, free of charge to the importer, for the importer’s ready-to-wear collection. The licensor also undertook to make its chief designer available to the importer four times a year for a period of several days. The work in question was undertaken outside the U.S., was “supplied directly or indirectly” within the meaning of section 402(h)(1)(A) of the TAA, and conveyed general styling information to the importer and the seller. Customs held that the various intercompany design activities undertaken pursuant to the license agreement were used in designing the apparel for the ready-to-wear collection that the importer ultimately purchased from the seller. Accordingly, Customs concluded that the technical information was used in the production of the imported merchandise such that it constituted an assist under section 402(b)(1)(C) of the TAA. In HRL 542152 (also cited as TAA No. 13), dated December 4, 1980, we held that a design drawing and crude working model, undertaken outside the U.S. and provided free of charge by the buyer, constituted an assist. In contrast, HRL 543417, dated February 11, 1985, concerned the dutiability of payments to foreign designers for sketches of houseware and kitchenware articles. The sketches were provided free of charge to the manufacturer of the imported merchandise; however, they conveyed no technical information and in many instances were altered prior to the production stage. Accordingly, we determined that the drawings were conceptual in nature and therefore did not constitute “plans and sketches” whose value should be included to the price actually paid or payable for the imported merchandise. However, in so finding we noted that given the difficulty of establishing set rules as to whether sketches and drawings constituted assists, questions of this nature could only be decided on a case-by-case basis. HRL 543417 at 2. In HRL 544609, dated August 12, 1991, the issue was whether payments for design work and drawings were part of the price actually paid or payable for certain imported X-ray generators. There were two types of drawings: initial drawings by the engineering department; and subsequent drawings by the manufacturing department. The latter were more precise; nevertheless, we found the initial drawings were also necessary for the production of the imported merchandise. While the later drawings may have provided the blueprints actually "used" in the production of the article, the engineering that produced the initial layout for those blueprints was certainly "necessary" for the production of the imported article. The fact that the initial drawings were refined by the manufacturing department does not make the initial engineering required for the project any less necessary a step in producing the ultimate article. HRL 544609 at 4. Furthermore, we distinguished the drawings from the sketches at issue in HRL 543417, on the basis that the sketches of knives, kettles and flatware offered no assistance to the overall production of the plate. In contrast, we determined that the initial design work was significant in the case of a generator. In the instant case, the activities described in the design and consulting agreement are undertaken outside the United States in Italy and are necessary for the production of the garments. The design and consulting agreement indicates that the licensor provides assistance and consulting services in connection with the development of a Collection of Products to