Internal Advice Request; Dutiability of Royalty Payments for use of trademarks

HQ H029876 March 25, 2011 OT:RR:CTF:VS H029876 CMR CATEGORY: Valuation U.S. Customs and Border Protection Area Director 1100 Raymond BoulevardNewark, NJ 07102 RE: Internal Advice Request; Dutiability of Royalty Payments for use of trademarks Dear Area Director: This is in response to a request for internal advice from the port of New York/Newark with regard to the dutiability of certain royalty payments with regard to certain entries by Weeplay Kids LLC. (hereinafter, Weeplay). FACTS: Weeplay is a childrenswear company marketing its products to retailers. Weeplay imports merchandise into the United States primarily through the ports of entry in New York and Newark. Weeplay was the subject of an audit report dated May 30, 2008. One of the issues examined by the Office of Regulatory Audit in their review was the use of transaction value. It was agreed that internal advice would be sought from this office with regard to the dutiability of certain royalty payments paid by Weeplay for design work. The payments to the trademark holders are based on a percentage of net sales. This office received a copy of the audit report and copies of five licensing agreements to which Weeplay is a party. The port believes that the royalty payments are additions to the price actually paid or payable under transaction value pursuant to 19 U.S.C. § 1401a(b) and 19 CFR § 152.103(f). Weeplay believes that the payments are not dutiable. Weeplay contracts with companies overseas for production of the merchandise. While Weeplay deals with several manufacturers, for purposes of this internal advice request, the port requested purchase orders for certain specific entries. In the case of those entries, it is apparent that Weeplay contracted with a company in Hong Kong for the purchase of the merchandise. The Hong Kong company contracted with manufacturers in China who produced the merchandise and shipped it directly to the United States. Weeplay states that the manufacturers/sellers, Weeplay, and the Licensors are all unrelated parties. It is not clear whether the sellers are related or unrelated to the actual manufacturers. In addition to reviewing the licensing agreements and the purchase orders submitted by Weeplay, this office reviewed the entry summaries and commercial documents associated with certain entries identified by the port. No supply contract or purchasing agreement between Weeplay and the manufacturers was submitted as none allegedly existed. A summary of producer responsibilities was submitted in an effort to provide further information regarding the transactions. A review of the licensing agreements reveals key similarities among the agreements. Although there are drafting differences, each agreement contains provisions which, among other things: (1) specify the details of payment for the use of the trademark or other intellectual property subject to the agreement based on net sales of the imported merchandise  and subject to a minimum royalty guarantee, (2) assert the Licensor retains ownership of the trademark at all times, (3) detail the rights and obligations of both parties in the maintenance of records by the Licensee and review thereof by the Licensor, (4) provide for the protection of the trademark at various stages in the production of merchandise and in creation of advertising - the Licensor is able to review the use of the trademark and the quality of the product to be associated with the trademark and review the product to be produced by the Licensee so as to ensure quality and the protection of the Licensor’ reputation and that of the trademark, and (5) provide for the termination of the agreement, including termination due to breach of contract by one of the parties, and detailing the rights and responsibilities of each party in terminating the agreement. ISSUE: Are the royalty payments paid by Weeplay to the Licensors under the Licensing Agreements included in the transaction value for imported merchandise subject to the Agreements? 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 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, including "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) and (E). These additions apply only if they are not already included in the price actually paid or payable. For purposes of this decision, we assume that transaction value is the appropriate method of appraisement. With regard to royalties, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in relevant part: 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. (Statute) 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 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. (Regulation) Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., Pt II, at 443 – 444 (1979). Based on Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990), CBP presumes that all payments made by a buyer to a seller are part of the price actually paid or payable for the imported merchandise. However, the presumption is rebuttable and if it is evident that the royalty payments are not related to the sale of the imported merchandise for exportation to the United States, then the royalty payments will not be considered part of the price actually paid or payable. E.g., Chrysler Corp. v. United States, 17 Ct. Int’l Trade 1049, 1055-1056 (1993) (holding that certain shortfall and special application fees were not part of the price actually paid or payable). In this particular case, as the Licensors are not related to the manufacturers or seller, the royalty payments do not accrue to the benefit of the seller either directly or indirectly. However, royalty payments may also be included in transaction value as an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA. CBP has established a three-part test for determining the dutiability of royalty payments. This test appears in the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) ("Hasbro II ruling"). The test consists of the following questions: 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? Affirmative responses to factors one and two and a negative response to factor three would indicate that the payments were a condition of sale and, therefore, dutiable as royalty payments. 1. Was the imported merchandise manufactured under patent? In this case, the Licensing agreements do not relate to patents, but to trademarks and copyrights. So with regard to the first question of the dutiability test, the answer is no. 2. Was the royalty involved in the production or sale of the imported merchandise? The Licensing agreements permit the Licensee, Weeplay, to manufacture, distribute and sell certain merchandise utilizing the licensed trademarks and copyrights (Licensed Products). They also allow Weeplay to contract with third party manufacturers for the production of the Licensed Products, or components thereof. Therefore, the answer to this second question is yes to the extent that without the licensing agreement Weeplay would be unable to contract with the manufacturer for the production and purchase of goods containing the protected mark. However, with regard to the production agreement between Weeplay and the manufacturer, we understand it to be a verbal agreement memorialized only by purchase orders and invoices. Weeplay did submit a document prepared to provide guidance to manufacturers. We note the document makes no reference to the licensing agreement, nor to the purchase orders or invoices. The agreement for production of merchandise is separate from the licensing agreement and nothing leads us to believe it is a condition of the sale for importation of merchandise. Therefore, the answer to the second question is no. Could the importer buy the product without paying the fee? Yes, Weeplay could buy the product from the third party manufacturer without paying the fee as the contract with the manufacturer is separate and apart from the licensing agreement. In fact, Weeplay does buy the merchandise from the manufacturers without paying the royalty fee. The fees are structured so that a minimum guaranteed payment is made, divided in quarterly payments, to the Licensor. The royalty fees are based upon net sales of the imported product and such amount is offset by the quarterly payments sent prior to sales. As such, Weeplay may purchase and import the merchandise from manufacturers without making a payment to the Licensor. The payment terms begin according to time frames set in the Licensing Agreements. In addition, the royalties are based upon net sales of product so a sale is necessary by the Licensee to trigger the royalty payment (other than the minimum guaranteed payment). Therefore, product may be imported and not sold and thus not be subject to the royalty fee. See Headquarters Ruling Letter (HQ) 546146, dated May 10, 1996; HQ H034062, dated March 3, 2007; and (HQ 546675, dated June 23, 1999 (royalties paid for use of trademark and based on a percentage of net sales of licensed products not dutiable) The licensing agreements are directed to the protection of the trademark and any other intellectual property subject to the agreement and the protection of the reputation of the trademark and the trademark holder. The focus of these agreements is on the protection of the trademarks, not on the purchase and importation of merchandise by Weeplay bearing the trademarks. Therefore, the royalty payments at issue are not part of the price actually paid or payable or additions thereto under 19 U.S.C. § 1401a(b)(1)(D). Additionally, as the royalty payments go to a third party unrelated to the seller of the imported merchandise, the royalty payments do not benefit the seller, directly or indirectly, and are not proceeds under 19 U.S.C. § 1401a(b)(1)(E). HOLDING: The royalty payments in at issue are not part of the price actually paid or payable nor additions thereto and therefore are not dutiable. Sixty days from the date of this letter, Regulations and Rulings of the Office of International Trade will take steps to make this decision available to Customs and Border Protection ("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 and Special Programs Branch