Request for Internal Advice; Dutiability of Royalty Payments; Anti-copying Technology

HQ H009113 November 17, 2008 OT:RR:CTF:VS H009113 YAG CATEGORY: Valuation Port Director U.S. Customs and Border Protection Port of Seattle 1000 Second Ave., Suite 2100Seattle, WA 98104 RE: Request for Internal Advice; Dutiability of Royalty Payments; Anti-copying Technology Dear Port Director: This is in response to your memorandum, dated March 23, 2007, forwarding the internal advice request, submitted by the law firm of Gardner Carton & Douglas, on behalf of their client, the "Licensee,” concerning the dutiability of royalty payments paid to an unrelated U.S. patent holder. The royalty payments relate to a right to use an anti-copying technology designed to prevent users of DVD players from making unauthorized copies of DVDs. FACTS: Licensee purchases DVD players from unrelated suppliers located in various countries. Under a separate agreement with the “Licensor,” Licensee pays a fixed annual fee to Licensor for the right to purchase integrated circuits containing anti-copying technology from Licensor’s authorized suppliers, as well as for the technical data used by the Importer’s suppliers to incorporate those circuits into DVD players. Licensee then imports finished DVD players into the United States. None of the parties to this transaction, such as manufacturers, Licensee, and Licensor, are related to each other. Licensee argues that the license fee paid to Licensor is not directly related to the imported DVD players; therefore, the company seeks confirmation from CBP that the license fee is not part of the dutiable value nor is it a required addition to the value of the imported DVD players. The Port, on the other hand, disagrees with the Licensee and considers the royalty payment a condition of sale of DVDs for export to the United States pursuant to the Digital Millennium Copyright Act (“DMCA”), 17 U.S.C. §1201. The DMCA prohibits gaining unauthorized access to a work by circumventing a technological protection measure put in place by the copyright owner where such protection measure controls access to the copyrighted work. According to the Port’s interpretation, the DMCA requires the installation of anti-copying technology on all devices, not just on the analog recording devices. Thus, the Port states that the royalty payments are dutiable because the Licensee is required by the U.S. law to have the Licensor’s anti-copying technology installed into imported DVD players. Together with its request for internal advice, the Licensee submitted to CBP its DVD Manufacturing License Agreement (“License Agreement”), dated April 8, 2005, which covers the incorporation of the anti-copying technology into the digital devices. The License Agreement provides the parent company/licensee and its subsidiaries with the right to have the patented technologies incorporated by manufacturers in the DVD players. Specifically, Paragraph 2.1 of the License Agreement grants Licensee a royalty-free, indivisible, non-exclusive and non-transferable right to use the technology to purchase the circuits from authorized component suppliers, incorporate the device within one or more of its products, and use, import, offer for sale, and distribute products worldwide. Paragraph 2.6 states that Licensee shall pay to Licensor a license fee in the amount of $50,000.00, which is payable upon execution of the agreement by Licensee. On each anniversary of the effective date of the License Agreement, the Licensee pays an annual license fee of $25,000.00. If the Licensee has fewer than one hundred (100) items comprising products, manufactured in a given year, the annual license fee is reduced to $10,000.00. Paragraphs 2.6.1 and 2.6.2 of the License Agreement also include the possibility of additional license fees, as well as a product royalty fee calculated according to the Licensee’s wholesale price to its distributors; however, these fees become due only if the Licensee violates other provisions of the Agreement. Paragraph 4.2 of the License Agreement states that Licensee will implement the technology through the purchase of devices from authorized component suppliers of the Licensor. Additionally, Licensee is not prohibited from incorporating any other form of anti-copy technology, whether existing now or in the future, into its products. Licensee insists that it entered into the License Agreement to protect itself from the possibility of liability under a civil lawsuit related to infringement and that Licensee is not required to incorporate the Licensor’s technology into its DVD players from either a legal or a technical standpoint. The Licensee also claims that the Licensor’s technology is not integral to the functioning of the DVD players in that the technology is not necessary for the DVD players to perform the normal functions or to improve the ability of a DVD player to read the data contained on a DVD and transmit that data to a display unit. Finally, upon further request for additional information, the Licensee provided purchase orders and copies of two (2) Manufacturing Agreements between the Licensee and its manufacturers, as samples. There are no references in these agreements or in the purchase orders to the Licensor or any license fees paid to the Licensor.ISSUE: Whether the license fees under consideration constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D) or (E). 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 basis of appraisement under the TAA is transaction value, defined in Section 1401a(b)(1), as the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus amounts for enumerated statutory additions to the extent not otherwise included in the price actually paid or payable. The additions 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 the sale of the imported merchandise for exportation to the United States" and "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)(D)-(E). For purposes of this ruling, we assume that transaction value is the proper method of appraisement for the imported merchandise. With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action to the TAA provides, in pertinent part, that: 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: (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. Statement of Administrative Action ("SAA"), H.R. Doc. No. 153, 96 Cong., 1st Sess. (1979), reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (1981), at 48-49. In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), CBP articulated three factors or questions that assist in determining whether the royalty payments in question are related to the imported merchandise and are a condition of sale such that they are dutiable. As set forth in the notice, the questions are: 1. Was the imported merchandise manufactured under patent? 2. Was the royalty involved in the production or sale of the imported merchandise? 3. Could the importer buy the product without paying the fee? The General Notice indicates that affirmative answers or responses to the first and second questions, and a negative response to the third, point towards dutiability.  When analyzing the factors identified in the above-cited general notice, CBP has taken into account certain considerations, which flow from the language set forth in the SAA. These include, but are not limited to, the following: (i) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise generally will be dutiable); (ii) to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated third party); (iii) whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require the buyer’s purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other, or termination of the purchase agreement due to the failure to pay the royalties); and, (iv) payment of the royalties on each and every importation. See, e.g., Headquarters Ruling Letter ("HRL") 547148, dated September 12, 2002. In order to obtain a ruling with respect to the dutiability of royalty or license fees, copies of any royalty agreements relating to the payment of the royalty or license fees in question and any purchase or supply agreements relating to the sale of the imported merchandise for exportation to the United States must be submitted to CBP with the request. If there are no such written agreements, this must be indicated in the ruling request. See General Notice, "Notice to Require Submission of Royalty and Purchase Supply Agreements in Ruling Requests Regarding Dutiability of Royalty or License Fees," Vol. 29, No. 36, Cust. B. & Dec. at 10 (September 6, 1995). See also 19 C.F.R. §177.2(b). In the instant case, as discussed above, the Licensee submitted a license agreement, manufacturing agreements, and purchase orders for our review and consideration. In this case, based on the information provided, the responses to each of the three above-listed questions are as follows: 1. Was the imported merchandise manufactured under patent? The SAA provides that royalties paid for patents covering processes to manufacture the imported merchandise will generally be dutiable, and royalty fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise will not be dutiable. Statement of Administrative Action, H.R. Doc. No. 153, reprinted in Customs Valuation under the Trade Agreements Act of 1979 (1981), supra, at 48. In this case, Paragraph 2.2 of the License Agreement grants Licensee a royalty-free, indivisible, non-exclusive, non-transferable license under the copyrights . . . to use and to make such copies as are reasonably necessary to permit Licensee to use such specifications solely for internal purposes to exercise the rights granted to Licensee under the agreement. Additionally, the Licensee does not make any royalty payments or license fees to the foreign suppliers of the DVD players (imported merchandise). The payments are made to an unrelated third-party for the anti-copying technology and integrated circuits to be incorporated into the DVD players (imported merchandise). Therefore, the license fees are paid to the unrelated third party for the use of the copyrights. Accordingly, based upon the information submitted, the answer to the first question is “no.” 2. Was the royalty involved in the production or sale of the imported merchandise? The second question expands the analysis of the first question. See General Notice, “Dutiability of Royalty Payments,” supra, at 10. The Licensee is paying a royalty fee to an unrelated third party in connection with a technology to prevent the signal put out by the DVD players from being recorded by another device. License fees are not paid to the seller of the imported merchandise (DVD players) or to a party related to the seller. Paragraph 2.1 of the License Agreement grants Licensee the right to use the technology and purchase the circuits from authorized component suppliers of the Licensor. Therefore, the foreign suppliers of the Licensee purchase the circuits from Licensor’s authorized suppliers and pass along the cost of these circuits to the Licensee in the sales price of DVD players. However, the Licensee states that the License Agreement does not require Licensee to purchase the imported merchandise (DVD players) from an approved supplier, or place any restrictions on the Licensee’s sourcing of DVD players. Additionally, Paragraph 2.6 states that Licensee pays a fixed annual fee to Licensor for the right to purchase integrated circuits containing anti-copying technology from Licensor as well as to the technical data used by Licensee’s suppliers to incorporate those circuits into DVD players. Thus, considering the License Agreement, there is no connection between the license fees paid by Licensee for the anti-copying technology and the importation of DVD players. The licensee fees in question are clearly not paid upon each and every importation. In fact, the license fees are not related to the manufacture of DVD players at all. It appears that the license fees paid by the Licensee for the right to use the anti-copying technology are part of the entirely different transaction and do not relate to the importation of DVD players. In other words, the License Agreement does not establish a nexus between the license fees and the production of DVD players. Furthermore, under the terms of the two Manufacturing Agreements between the Licensee and its foreign suppliers, there is no mention that the royalty payments are linked to the right to produce the imported merchandise (DVD players); therefore, the payment of the royalties is not a "condition of sale" of the imported merchandise. See HRL 545379, dated July 7, 1995. There is no connection between the Manufacturing Agreements between the Licensee and its suppliers for the sale of DVD players and the License Agreement between the Licensee and a third-party licensor with respect to the anti-copying technology. The termination of the License Agreement does not result in termination of the Manufacturing Agreements. Since the Licensee will be able to manufacture and sell DVD players with or without integrating the anti-copying technology, the license fees are not involved in the production or sale of the imported merchandise. 3. Could the importer buy the product without paying the fee? The answer to this third question goes to the heart of whether a payment is considered a condition of sale. See General Notice, “Dutiability of Royalty Payments,” supra, at 11. Royalty payments and license fees are a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise. If the payments are optional and not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell in a designated area, they do not constitute additions to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D). See HRL 546675, dated June 23, 1999. Hence, we must analyze whether the royalty payments are actually a condition of sale of the merchandise for exportation to the United States. The Port believes that these royalty payments are a condition of sale because the Licensee is required by the U.S. law to have the Licensor’s anti-copying technology installed into imported DVD players. Thus, the Port argues that this legal requirement is a condition of sale of DVDs for export to the Unites States. Specifically, DMCA, 17 U.S.C. §1201(a) states that technological measures are required to be installed into electronic devices (both digital and analog) to protect copyright and trademark owners from unauthorized copying. We disagree with the Port’s argument. Further, as we previously discussed, no portion of the fee is paid to the seller of the DVD players or to a related party; the License Agreement and the Manufacturing Agreements do not reference each other; the license fees are not made upon each and every importation, but paid annually (fixed annual fee regardless of how many devices that the Licensee produces include the anti-copying technology) and since the anti-copying technology is optional and does not relate to the manufacturing of DVD players, the Licensee could manufacture and purchase the DVD players without paying the license fee. Therefore, the license fees or payments made by Licensee pursuant to the above-referenced License Agreement are not related to the manufacture, importation, or sale of the imported DVD players, and are not a condition of sale of the imported merchandise for export to the United States and do not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D). It is immaterial for purposes of Section 402 of the TAA, whether or not the DMCA requires the installation of anti-copying technology in DVD players. As noted above, the royalty is not paid to the seller or a party related to the seller, and is not a condition of sale of the imported DVDs. Consequently, the royalty payments are not included in transaction value as an addition to the price actually paid or payable under Section 402(b)(1)(D) of the TAA. Finally, under 19 U.S.C. §1401a(b)(1)(E), the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller will be an addition to the price paid or payable. Under this section, the "seller" of the merchandise is the Licensee’s supplier/manufacturer. The license fees are paid by the Licensee/Buyer, to an unrelated third party Licensor. Since the Licensor is also unrelated to the Licensee’s manufactures, the license fees do not constitute "proceeds to the seller" since these payments in no way accrue to the benefit of the Licensee’s suppliers/manufacturers. Accordingly, the royalty payments are not dutiable as proceeds and are not an addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(E). HOLDING: Based upon the information provided, we find that the licensee fees paid by Licensee to a third-party unrelated Licensor pursuant to the above-referenced License Agreement are not a condition of sale of the imported merchandise for export to the United States and do not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D)-(E). Please mail this decision to the internal advice applicant no later than sixty (60) days from the date of this letter. Sixty days from the date of this letter, the Office of International Trade: Regulations and Rulings will take steps to make the public version of this decision available to CBP personnel and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution. Sincerely, Monika R. Brenner, Chief Valuation & Special Programs Branch