DutiabiDutiability of Royalty Payments for the Use of Patents; Third Party Unrelated Licensors

HQ H161675 January 27, 2012 OT:RR:CTF:VS H161675 RSD CATEGORY: VALUATION Area Port Director U.S. Customs and Border Protection 330 2nd Avenue South Suite 560 Minneapolis, Minnesota 55401 RE: Dutiabi Dutiability of Royalty Payments for the Use of Patents; Third Party Unrelated Licensors Dear Director: This is in response to your memorandum dated March 23, 2011,forwarding an internal advice request submitted by Expeditors Tradewin, LLC on behalf of their client Rockler Companies, Inc. (Rockler) and its subsidiary, Bench Dog Tools, Inc. who is the importer buyer of imported merchandise. The issue concerns the dutiability of royalties paid to unrelated third party licensors. FACTS: The licensee, Rockler, imports various products used in the woodworking industry. Rockler has entered into ten licensing/royalty agreements with various licensors involving utility patents. The licensing agreements grant Rockler various rights related to the patents for the manufacture, production, sale, marketing, and distribution of products used in the woodworking industry. In consideration of these rights, Rockler agrees to pay royalties to the licensor based on a percentage of the net sales of the imported merchandise in the United States, and in some cases pays an upfront fee. The first licensing agreement is between Rockler doing business under the name of Bench Dog and a third party licensor (Licensor One) for a device described in a U.S. patent. The device could be used in making a product that the parties are interested in having Bench Dog produce, market, sell, and distribute. It involves a grant of an "exclusive transferable worldwide license to apply for and hold all rights to any patent related to the device or product. .. " including the right to grant and authorize sublicenses to make, have made, 'import, have imported, use, offer for sale and sell the licensed product in return for an upfront fee and a portion of the net sales. The agreement also specifies that Bench Dog shall pay Licensor One an advance fee against the future earned royalties, and that Bench Dog is also required to use reasonable efforts to sell commercially viable licensed products in commercially significant countries. The agreement indicates that sales of a designated number of units within twelve months of the agreement will constitute adequate performance, but sales below that amount will trigger a cooperative review by the parties. Following this review, if the designated number units are not sold, the parties shall be released from all obligations under the agreement. Rockler indicates that it contracts with a third party foreign vendor to have the product manufactured. None of the parties are related. Rockler further advises that there are no purchasing contracts with the foreign vendors and that the purchase orders for the product makes no mention of the licensing agreement. The second licensing agreement is with Licensor. Two. It concerns a method and apparatus for stabilizing a work piece. The licensing agreement provides for a non-exclusive, non-transferable, worldwide license to manufacture, import, market, use, and sell the licensed product in exchange for a percentage of net sales and states that a patent is pending. Rockler contracts with a third party foreign vendor to have the product manufactured, from which it buys the imported product. None of the parties are related. Rockler also advises that there are no purchasing contracts with foreign vendors and that the purchase orders for the product make no mention of the licensing agreement. The third licensing agreement is with Licensor Three for the exclusive manufacturing and marketing rights from Licensor Three for a licensed product in the United States. A utility patent has been issued. In exchange for the licensing rights, Rockler agrees to pay royalties based on a percentage of the net sales of the product. Rockler contracts with a third party foreign vendor to have the product manufactured. None of the involved parties are related. The purchase contracts with the foreign vendors and the purchase orders do not reference the license agreement with Licensor Three. The design work was undertaken in Canada, though the patent was obtained in the United States. In the fourth submitted agreement, Rockler purchased from Licensor Four the exclusive manufacturing and marketing rights for a product sold in the United States. In exchange for these rights, Rockler agreed to compensate Licensor Four a royalty based on a percentage of the net sales of the product. Rockler itself, has obtained a design patent for the product. It contracted with a third party foreign vendor to produce the product. None of the parties are related. Rockler advises that there are no purchasing contracts with the foreign vendor and the purchase orders for the product makes no mention of the license agreement. The design work was undertaken in the United States. The fifth submitted licensing agreement concerns an agreement in which " Licensor Five gives Rockler all the rights to a product including the rights to design, manufacture, and market the product. According to the importer's submission, Licensor Five made no attempt to patent the product and has not shown the product or licensed the product to any other party. Rockler will have an exclusive right to patent the product if it chooses to do so, and has since applied for a utility patent, which is currently pending. In addition to the licensing fees based on a percentage of the net sales, Rockler agreed to pay an upfront inventor's fee in exchange for the exclusive rights to be able to patent the product. Rockler has contracted with a third party vendor to have the product manufactured. None of the parties involved with the product are related. Rockler advises that there are no purchasing contracts with the foreign vendor and the purchase orders for the product do not make any mention of the license agreement. The sixth submitted agreement is an invention assignment, manufacturing and marketing agreement. It grants the exclusive worldwide rights to design, manufacture, and market a quick release mechanism. In return, Rockler will pay an upfront fee and a portion of the proceeds of the sales of the quick release product. The agreement also grants Rockler the right to apply for a patent of the quick release mechanism, and also contains a termination clause which requires that when the royalties paid fall below a certain amount per year, the rights shall be assigned back to the Licensor with Rockler retaining a non-exclusive right to manufacture and sell the product with continuing royalty payments to the Licensor. Rockler contracts with a third party foreign vendor to have the product manufactured. None of the parties are related. There are no purchasing contracts with the foreign vendor and the purchase orders for the products make no mention of the Invention Assignment Manufacturing and Marketing Agreement. Although in the licensing agreement the Licensor grants Rockler the option of applying for a patent, to date no patent has been issued. The seventh agreement is a Manufacturing and Marketing Agreement that grants Rockler the exclusive manufacturing and marketing rights to a product known as the Toggle Clamp Adapter, in exchange for a portion of the net sales of the product. It provides Rockler with all print drawings, CAD files, concept drawings and any other creative components related to the Toggle Clamp Adapter, design or manufacturing process. Rockler contracts with a third party foreign vendor to have the product manufactured. None of the parties are related. Rockler advises that there are no purchasing contracts with the foreign vendors and that the purchase orders for the product make no mention of the Manufacturing and Marketing Agreement. The product is not manufactured under patent. The eighth agreement is a Manufacturing and Marketing Agreement that grants Rockler the manufacturing and marketing rights for a screwdriver kit in exchange for a portion of the net sales; of the product. The agreement also allows the Licensor to purchase the product from Rockler at a specified price. Rockler contracts with their third party foreign vendor to have the product manufactured. Again, none of the parties are related. Rockler advises that there are no purchasing contracts with the foreign vendor and that the purchase orders for the product make no mention of the Manufacturing and Market Agreement. The product is not manufactured under patent. The ninth agreement is a marketing agreement that grants the Licensor an "inventor's fee in acknowledgement for his idea of the Dowling Block." No other rights are specified. Rockler contracts with a third party foreign vendor to have product manufactured. None of the parties are related. Rockler advises that there are no purchasing contracts with the foreign vendor and that the purchase orders for the product make no mention of the Manufacturing and Marketing Agreement. The product is not manufactured under patent. The tenth licensing agreement concerns a device which makes use of a Bench Dog product in a novel way. Bench Dog has styling and additional applications for the device resulting in a product that the parties would like Bench Dog to produce, market, sell and distribute. The license agreement grants Rockler the exclusive, transferable worldwide license to apply for and hold all rights to any patents related to the device or the product, including the right to grant and authorize sublicense to make, have made, import, have imported, use, offer for sale and sell the licensed product. As consideration for the license granted, Bench Dog shall pay the Licensor a royalty on the net sales of the licensed products. Rockler contracts with a third party foreign vendor to have the product manufactured. None of the parties are related. Rockler advises that there are no purchasing contracts with the foreign vendor and that the purchase orders for the product make no mention of the licensing agreement. The product is not manufactured under patent. ISSUE: Whether the royalty payments and other 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). 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 T AA is transaction value, defined as "the price actually paid Of 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." 19 U.S.C. § 1401a(b)(1)(D). These additions only apply 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. In general, royalty payments may be included in transaction value as part of the price actually paid or payable, or as an addition thereto under 19 U.S.C. § 1401a(b)(1)(D). General Notice, "Dutiability of Royalty Payments," Vol. 27, No.6, Cust. B. & Dec. 1, at 13 (February 10, 1993) ("Hasbro II ruling") (quoting H.R. Rep. No. 317, 96th Cong., 1st Sess. (1979) at 80 and S. Rep. No. 249, 96th Cong., 1st Sess., at 120 (1979)). Based on the information provided, the royalty payments are not part of the price actually paid or payable for the merchandise since they are not part of the total payment made for the imported merchandise by the buyer to, or for the benefit of, the seller. See 19 U.S.C. § 1401a(b)(4)(A). In the present matter, since the evidence indicates that the royalty payments are not part of the price actually paid or payable, we must consider whether the payments constitute an addition to the price as royalties under 19 U.S.C. 1401a(b)(1)(D). With regard to royalties, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TM, 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. 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 opyrights 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 were they 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 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, H.R. Doc. No. 153,96 Cong., 1st Sess., pt. 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49. 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. 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 SM. These include, but are not limited to the following: (i) the type of intellectual property rights at issue (e.g. patents covering process to manufacture the imported merchandise generally will be dutiable; (ii) to whom the royalty was paid (e.g. payment to the sell or a party related to the seller are more likely to be dutiable than are payment to an unrelated third party); (iii) whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provision in the 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 royalties on each and every importation. See Headquarters Ruling Letter (HQ) H127377 dated March 31, 2011 Therefore 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? In this instance, the answer to the first question for the most part is yes, because under most of the agreements the royalty payments were made for the use of utility patents related to tools used in the woodworking industry. Most of the agreements concern, products, devices, mechanisms and designs that are covered by patents. The royalties at issue are paid to various parties in consideration for the right to make, have made, to use, to import, have imported, to market and to sell the licensed products in the licensed territory. Even though the royalties are paid for the right to use patents, it is not paid to the seller of the merchandise, nor does any portion of the royalties accrue directly or indirectly to the seller. Rather, it is paid by the U.S. Licensee, Rockler and its related company, to the Licensors of the patents. Accordingly, while the imported merchandise is manufactured using a number of patents, it is not manufactured under patents that are owned by the sellers or parties related to the sellers. 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, "Dutiablllty of Royalty Payments," supra, at 10. Rockler as the Licensee is paying royalties to unrelated licensors for the rights to use certain patents in connection with the importation and sale of its merchandise. Royalty payments are not made to the sellers of the imported merchandise or to a party related to the sellers. There is nothing in any of the licensing agreements that obligates or requires Rockler to purchase merchandise from a particular manufacturer or seller. In fact, the opposite is true. Rockler has the right to use third-party factories selected by it for the limited purposes of manufacturing the licensed articles, and it has the right to have the merchandise manufactured anywhere in the world. Hence, in this case, Licensors supply patents to Rockler, which it can use to have the imported merchandise manufactured. There is no evidence that the licensed fee is linked to individual sales agreements or purchase orders. See HQ W563382, dated May 25, 2006 (where we held that the royalty payments were not involved in the production or sale of the imported merchandise, because the Licensee was paying the royalty to an unrelated third party and there was nothing in the agreement or the record to show the Licensee's obligation to purchase merchandise from particular manufacturers or sellers). In this case, the License Agreement is a contract between the Licensor and the Licensee - not between the Licensee/Buyer and the seller - that sets forth the rights and obligations governing the Licensee's use of the Licensor's intellectual property. The royalty is the fee that the Licensee pays for these rights. Here, the royalties are paid to the sellers for rights arising under separate contractual arrangements, and there is no indication that they are tied in any manner to the sale for exportation of the imported merchandise. Based on the record before us, it is our opinion that the royalty is 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 the 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. § 1401 a(b)(1 )(0). In HQ H047360 dated July 31, 2009, it was noted that 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. Some factors which CBP has considered in answering question three (Could the importer buy the product without paying the fee?) include to whom the royalty is paid (§.:.9.:., payments to the seller, as opposed to an unrelated third party, are generally dutiable); whether the purchase of products and the payment of royalties are inextricably intertwined (§.:.9.:., Are they set forth in the same agreement? Do the agreements make reference to one another? Is the purchase agreement terminated if the buyer fails to pay the royalties?); and whether royalties are paid on every importation. See also HQ 544991 dated September 13, 1995; HQ 545380 dated March 30, 1995; HQ 545361 dated July 20, 1995; and the General Notice. In HQ H024979, dated May 6, 2009, the Licensee entered into a license agreement with a Licensor, a U.S. corporation to manufacture, design, advertise, promote, distribute, and sell wearing apparel, golf clubs and golf-related accessories including bags, balls, umbrellas, etc., bearing various trade name marks, and designs manage by a Licensor. The Licensor was the exclusive licensing agent for the owner for the marks and designs. The Licensee was not related to Licensor. The Licensee sourced the merchandise from various vendors and paid a royalty fee to the Licensor for the use of the patents and trademarks in accordance with the terms of the license agreement provided to CBP. None of the parties to the transaction, such as the manufacturers in China, the vendors, the Licensee, and Licensor were related to each other. The requestor also submitted a declaration, executed by the Licensee's Vice President of Product Development stating that the Licensee did not sublicense the use of marks to any vendor or manufacturers. The Licensee's declaration also stated that although the Licensee had other agreements with its vendors for the manufacture of the goods, it did not have a provision either in the manufacturing agreement or any other agreement regarding the use of the marks licensed by Licensor. Based upon the information provided, CBP determined that the license fee paid by the Licensee to a third-party unrelated to the Licensor pursuant to the license agreement for trademarks and patents was not a condition of sale of the imported merchandise for export to the United States and did not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D). In the present case, Rockler, as the Licensee makes royalty payments to several unrelated parties in consideration for the rights granted by the various Licensors. In such cases, we have previously indicated in numerous prior decisions, while the fact that royalty payments are made to an unrelated third party is not entirely determinative (because the SAA provides that a royalty payment made by a buyer as a condition of the sale of the merchandise for exportation to the United States will be added to the price actually paid or payable), the relationship of the parties is an important factor to consider in analyzing the transactions. See HQ H174030 dated November 15, 2011. We also note that under the licensing agreements before us, Rockler has the right to choose it own manufacturers to make the licensed merchandise and the Licensors do not have any control over who produces the imported merchandise. Furthermore, there are no references to the royalty payments on the purchase orders, vendor agreements, or entry documents. None of the aforementioned licensing agreements indicate that the royalty payments must be paid for Rockler to be able to have the merchandise manufactured or imported. The licensing agreements and the purchase orders do not indicate that Rockler must pay the royalty fee in order to purchase the imported merchandise from its suppliers. In other words, the sale for exportation between the Rockler and its various suppliers does not trigger the obligation to any royalties or licensing fees to the licensors for the use of the patents in producing the imported merchandise: The payments made by Rockler to the vendors for the imported merchandise are transactions that are separate and apart from the obligation to pay royalties to the licensors. Should Rockler fail to pay the royalty fees to the various licensors, their remedy against Rockler would be through the licensing agreements and not through the purchase agreements with the manufacturers that produce the imported merchandise. Consequently, it is our opinion that the agreements and transaction documents demonstrate that the royalty payments paid to unrelated third parties are separate and distinct from the payments made to vendors for the merchandise, and that Rockler as the Licensee is able to purchase such merchandise without having to pay the licensing fees to the Licensors. Accordingly, we find that the royalties paid for the use of the patents and other technical know-how in the United States is not a condition of the sale of the imported merchandise. Although the imported merchandise is manufactured using patents held by various licensors, we hold that the royalty payments at issue are not part of the price actually paid or payable or an addition thereto under 19 U.S.C. § 1401a(b)(1)(O). HOLDING: Based upon the information provided, we find that the license fees paid by the importer to third party licensors pursuant to the various licensing agreements are not conditions of sale of the imported merchandise for export to the U.S. and do not constitute a dutiable addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(O). 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