Internal Advice Request; Dutiability of royalty payments; Trademark; Dutiability of a Service Fee

HQ H172356 January 9, 2012 OT:RR:CTF:VS H172356 BGK CATEGORY: Valuation Area Port Director U.S. Customs and Border Protection Port of Cleveland 6747 Engle Road Middleburg Heights, Ohio 44130 RE: Internal Advice Request; Dutiability of royalty payments; Trademark; Dutiability of a Service Fee Dear Area Port Director: This is in response to a letter from your office, dated June 16, 2011, requesting internal advice on behalf of Redcats USA, L.P. (“Redcats USA” or “the Company”), regarding the dutiability of certain royalty payments and service fees made pursuant to a Trademark License Agreement and Collection Sharing Agreement for the Supply of Services (CSA), respectively. In issuing our response, we have given consideration to a submission on behalf of Redcats USA, dated March 30, 2011, a submission sent to our office on June 30, 2011, in response to a request for more information from our office, as well as submissions from the U.S. Customs and Border Protection (CBP) Office of Regulatory Audit attaching the results of the Quick Response Audit (QRA) issued to Redcats USA. FACTS: Redcats USA makes royalty payments pursuant to substantially similar trademark license agreements to Redcats SA and Ellos AB, both related companies. The Company also makes payments pursuant to separate Collection Sharing Agreements to La Redoute, a related French corporation, and Ellos AB. The QRA addressed only the Redcats SA and La Redoute agreements, both related to the Taillissime trademark (the Mark). The agreements with Ellos AB both relate to the ELLOS trademark. Redcats USA entered into a Trademark License Contract with Redcats SA, to be effective October 1, 2007 through December 31 2009, that gives Redcats USA the nonexclusive right to use the Taillissime trademark on women’s wearing apparel and accessories in the U.S. In consideration for this right, Redcats USA owes Redcats SA a royalty on the net annual sales of goods bearing the mark. The royalty is to be paid in advance based on a quarterly invoice from Redcats SA using the budget for the current year as a basis. An adjustment is made at the end of year based on actual annual sales, excluding taxes. The Trademark License Contract gives Redcats SA the right to inspect the use of the Mark and to verify that the use of the Mark is of the proper quality and in accordance with the specifications provided to Redcats USA by Redcats SA. Redcats SA also has the right to request specimens of the use of the Mark. Both these provisions require Redcats SA to provide prior written notice to Redcats USA. Redcats USA guarantees that the goods and services they provide will not be lower than the quality of the goods and services of Redcats SA. The parties also agreed to consult with each other with regard to a possible adjustment of the royalty should the conditions of the market change, or should the position of the Mark be modified. The License Agreement Contract provides that it is to run concurrently with the CSA between La Redoute and Redcats USA, which also became effective October 1, 2007. Additionally, the two agreements are structured to terminate concurrently. The CSA provides that La Redoute will transmit 16 page spreads from its Taillissime catalogue to Redcats USA. This includes (1) ektachromes, (2) the supplier’s coordinates and buying terms, (3) technical files, and (4) the products sales descriptions for the clients. Ektachromes are the pictures and layouts. The supplier’s coordinates and buying terms are the suppliers used by La Redoute and the related terms of sale. The technical files are drawings with specifications for the various collection items, and the products sales descriptions are the descriptions used for clients in the marketing materials. The CSA also provides that the above listed services will allow Redcats USA to contact and place orders with La Redoute suppliers, and that La Redoute will provide Redcats USA with access to their suppliers, at Redcats USA’s request. Under the CSA, Redcats USA agreed to undertake to use the provided pages in their entirety, and must request prior permission from La Redoute to deviate from the page lay-out, or garment quality or type. This permission may not be unreasonably withheld. Under the CSA, Redcats USA must submit all advertising and promotions for Taillissime merchandise to La Redoute for approval. This includes, but is not limited to, the standard articles before manufacture, the page lay-outs for Redcats USA’s catalogue or website, and any promotional or advertising material using the Taillissime label. This permission also may not be unreasonably withheld. As consideration for the services provided under the CSA, Redcats USA pays La Redoute a fee calculated as a percentage of the net turnover (gross sales, exclusive of taxes, minus customer returns) on products sold under the agreement. Additionally, as stated above, the CSA runs concurrently with, and is coterminous with, the Trademark License Contract. Although the CSA allows Redcats USA the right to use La Redoute’s suppliers, and provides for La Redoute to assist Redcats USA in using their suppliers, it is stated by Redcats USA that this does not occur. It is stated that at the outset, Redcats USA placed a few orders with La Redoute’s suppliers, but has since sourced from its own suppliers. According to Redcats USA, Redcats USA and La Redoute use different buying agents that source from different suppliers; however, according to the commercial documents submitted, Redcats USA has used “Redcats India” also known as “Redcats Asia” as its buying agent. Redcats USA also states that although the CSA allows La Redoute to assist in negotiations with suppliers for the purchase of the products, this has never occurred. The suppliers are stated to be unrelated. In fall 2010, Redcats USA filed a prior disclosure declaring an undervaluation of the apparel imported under the CSA. Although the technical files were not used directly to manufacture the merchandise because Redcats USA created its own technical packs due to customer size differences, Redcats USA acknowledged that the portion of the service fee allocable to the technical files provided under the CSA should be dutiable as a design assist. To calculate the amount to be included as an assist, Redcats USA obtained a breakdown of the design costs for each of the garment styles that are produced by La Redoute and Ellos AB pursuant to the agreements. Redcats USA, the importer, claims that the foreign suppliers are not aware of the trademark licensing agreement between Redcats USA and Redcats SA or the CSA with La Redoute. The importer provided commercial documents for a sample transaction, and there is no mention of either of the agreements or the related fees on any of the documents between Redcats USA and the suppliers. The agreements between Redcats USA and Ellos AB are almost identical to those between Redcats USA and Redcats SA and La Redoute. Just as with Redcats USA’s Trademark License Agreement and CSA with Redcats SA and La Redoute, respectively, the Trademark License Agreement and CSA between Redcats USA and Ellos AB are intended to run concurrently and be coterminous. The term for the agreements between Redcats USA and Ellos AB is 12 months from January 1, 2009, to be automatically renewed for another 12 months unless two months written notice is provided. Although the QRA addressed only the Redcats SA and La Redoute agreements, Redcats USA has asked that this decision address both sets of agreements because they are virtually identical. We agree the agreements are almost identical, and therefore, this decision will address the agreements regarding both the Taillissime mark and the Ellos mark together (collectively, “the marks”). ISSUE: Whether the royalties paid to Redcats SA and Ellos AB under the Trademark License Agreements are dutiable as either part of the price actually paid or payable or as an addition to value. Whether the services fees constitute assists and how they should be calculated. 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 primary method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable, including 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 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)(A)-(E). If, for any reason, sufficient information is not available with respect to the additions to the price actually paid or payable, the transaction value of the imported merchandise is treated as one that cannot be determined. 19 U.S.C. § 1401a(b)(1). Royalties We note that royalty payments may be included in the transaction value as part of the price actually paid or payable or as an addition thereto. See, e.g., General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993); H.R. Rep. No. 317, 96th Cong. 1st sess., at 80 (1979). The term “price actually paid or payable” is defined as “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.” 19 U.S.C. § 1401a(b)(4)(A). It is CBP’s position that payments made by the buyer to a party related to the seller are indirect payments made to, or for the benefit of, the seller. All such payments are included in transaction value unless it is established that they were made in exchange for something other than the imported goods. See Generra Sportswear Company v. United States, 905 F.2d 377(CAFC 1990), and Chrysler Corporation v. United States, 17 CIT 1049 (CIT 1993). In the instant case, the royalty payments by Redcats USA are made in consideration for the use of the marks. The foreign suppliers are unrelated. As the payments are made to Redcats SA and Ellos AB, which are neither sellers of the merchandise nor related to the sellers, we find that they are not included in the price actually paid or payable for the imported merchandise. Despite having concluded that the payments at issue are not part of the price actually paid or payable, it still remains to be determined whether they should be added to the price actually paid or payable as royalties or license fees under 19 U.S.C. § 1401a(b)(1)(D) or as proceeds under 19 U.S.C. § 1041a(b)(1)(E). With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action (“SAA”), which forms part of the legislative history of 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 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 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) [hereinafter General Notice], 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 negative answers or responses to the first and second questions, and a positive response to the third, point toward non-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 will generally 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 (“HQ”) 547148, dated September 12, 2002. In this case, the license fees relate to trademarks and not patents; therefore, the answer to question one, whether the merchandise was manufactured under patent, is answered in the negative. The second question is whether the royalty is involved in the production or sale of the imported merchandise. In the instant case, the royalties are paid to related parties for use of the marks on women’s wearing apparel and accessories in the United States. However, the merchandise is purchased from unrelated foreign suppliers, chosen by the importer or their buying agent. Under the CSAs, the licensor will provide the buying terms and terms of sale for the suppliers used by the licensor, and the importer may request assistance from the licensor to contact and place orders with the licensor’s suppliers. However, using the licensor’s suppliers or taking advantage of the licensor’s assistance in contacting their suppliers is not mandatory. Redcats USA is not contractually obligated by the Trademark License Contracts or the CSAs to use the licensor’s suppliers. The importer claims that the suppliers are not aware of either the license agreements or the CSAs, and there is no indication in the sample commercial documentation provided between Redcats USA and its supplier that the license fees are linked to the sales. See Headquarters Ruling Letter (HRL) H024979, dated May 6, 2009 (citing HRL W563382, dated May 25, 2006). See also HRL 548368, dated December 24, 2003. In HRL H024979, it was held that the royalty payments were not involved in the production of the imported merchandise because the licensor was not related to the seller and there was no evidence that the license fees were linked to the commercial transaction with the seller. In this case, the royalty is not involved in the production or sale of the imported merchandise because the sellers are not related to the licensors and the license fees are not involved in the commercial transactions for the purchase of the merchandise. The third question asks whether the importer could buy the product without paying the fee. This question goes to the heart of whether a payment is considered a condition of sale. See General Notice, “Dutiability of Royalty Payments”. The licensors in this case are given control over the quality of the merchandise bearing the marks through both the Trademark License Contracts and the CSAs. The Trademark License Contracts give the licensors (Redcats SA and Ellos AB) the right to inspect the use of the marks, verify that the use of the marks are of the proper quality and in accordance with the specifications provided by the licensors, and request specimens of the merchandise produced. The Licensor, or a related party in the case of the Taillissime mark, also has other rights related to quality control under the parallel CSAs that must be considered given the relationship of the CSAs to the Trademark License Agreements. Under the CSAs, Redcats USA must obtain the licensor’s approval to deviate from the provided page lay-out, garment quality, or garment type. The Company must also have all advertising and promotions for merchandise bearing the marks approved by the licensor. This is defined to include advertising and promotional materials, the page layouts for the catalogue or website, and standard articles prior to manufacture. However, Customs has held that “quality control clauses are standard in trademark license agreements, and . . . license fees paid to third parties for use in the U.S. of trademarks are generally not dutiable.” HRL 547226, dated July 27, 1999. The Office of Regulatory Audit concluded that because the CSAs provide for assistance in negotiating with suppliers and provide the information necessary for Redcats USA to use the licensors’ suppliers, Redcats USA cannot buy the merchandise without the licensors’ intervention. The CSAs allow for this to occur at the request of Redcats USA, but do not require it. The agreements state in Article I that “[a]s commercial intermediary LA REDOUTE will provide REDCATS USA, at the request of REDCATS USA, with access to the LA REDOUTE suppliers.” Additionally, neither of the agreements requires Redcats USA to use the licensor’s suppliers. As such, Redcats USA would be free to purchase from other suppliers. As discussed above, the royalties paid under the Trademark License Agreements are paid to a party unrelated to the seller of the merchandise, and do not form part of the commercial transaction between the buyer and seller. Accordingly, we find that the importer could buy the product without paying the fee and the royalties are not a condition of sale. 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 actually paid or payable. In this case, the sellers are foreign manufacturers, unrelated to both Redcats USA and the licensors, and the royalties, although based on a percentage of U.S. sales, are paid to the licensors. As the licensors are unrelated to the sellers, the royalties are not considered proceeds dutiable under 19 U.S.C. § 1401(a)(b)(1)(E). Therefore, we find that the royalties at issue are not dutiable. Service Fees In this case, the service fee covers the pages of the catalogue transmitted to Redcats USA by the licensors under the separate CSAs, inclusive of (1) ektachromes, (2) the supplier’s coordinates and buying terms, (3) technical files, and (4) the products sales descriptions for the clients. Additionally, the CSAs cover quality control retained by the licensors over the marked merchandise and the promotional material for the marked merchandise, which has already been discussed above. The service fees are calculated as a percentage of the net turnover (gross sales, exclusive of taxes, minus customer returns) on products sold under the agreements and paid to the licensor, or a party related to the licensor. As discussed above, transaction value, is “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. As with the royalty, because the service fee is paid to the licensor of the mark, and not the seller or a party related to the seller, it cannot be included in the dutiable value as part of the price actually paid or payable. However, the fee might still be dutiable as an addition to value. See 19 U.S.C. § 1401a(b)(1)(A)-(E). As discussed above, 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 actually paid or payable. In this case, the sellers are foreign manufacturers, unrelated to both Redcats USA and the parties providing services under the CSAs, and the CSA payments, although based on a percentage of U.S. sales, are not paid to the sellers. Therefore, as with the royalties, the CSA payments are not considered proceeds dutiable under 19 U.S.C. § 1401(a)(b)(1)(E). Another relevant addition to the price actually paid or payable is for the value, apportioned as appropriate, of any assist. 19 U.S.C. § 1401a(b)(1)(C). 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. § 1401a(h)(1)(A). There are four categories of assists, including "[e]ngineering, 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) [hereinafter category four assist]. The design work undertaken in this case, pursuant to the CSAs, is undertaken outside the U.S. by La Redoute or Ellos. After Redcats USA obtains the designs they rework them for their American customers, and in turn provide them free of charge to the seller of the merchandise. The designs are essential to the production of the clothing contained on the transmitted catalogue pages and purchased from the unrelated sellers by Redcats USA. Therefore, we find that the designs provided under the CSAs are dutiable assists. Redcats USA agrees that this design work is dutiable and has provided a disclosure listing the value of the assist at the cost to La Redoute and Ellos to create the designs. Although Redcats USA performs further work on the designs, this work is not dutiable as part of the assist, as it occurs in the U.S. See 19 U.S.C. § 1401a(h)(1)(A)(iv) and § 1401a(h)(1)(C)(ii). The time spent reviewing the standard articles prior to manufacture, along with other approval activities, as listed as required in Article I of the CSAs, would constitute a category four assist, along with the designs themselves. As this occurs prior to the manufacture of the goods, it is considered development necessary to the production process. It occurs outside the U.S., and is supplied indirectly by the buyer to the seller. In HRL 548368, dated December 24, 2003, a Design and Consulting Agreement, executed with the same party as a concurrent trademark license agreement, provided for assistance and consulting services with regard to the creation of the design and approval of products bearing the licensed trademark, along with approval of promotional material relating to the products. In that case, these services were all considered to be a category four assist because “[t]hese actions all offered significant assistance to the overall production of the garments.” Additionally, they “were supplied indirectly by the buyer ‘and free of charge or at a reduced cost’ because the various design activities undertaken pursuant to the agreement were used in the development of the apparel for the clothing collection that the importer ultimately purchased from the seller.” The relevant provisions of the agreement in HRL 548368 are also present in this case. Therefore, it is not only the time spent producing the design that would constitute the assist. These ancillary actions performed under the CSA are also assists. The Office of Regulatory Audit disagrees with Redcats USA that the value of the assist is the cost to the foreign related parties to produce the designs, and instead believes it should be the entire price paid by Redcats USA under the CSAs. Section 152.102 of the Customs Regulations (19 C.F.R. § 152.102) provides: (3) The following apply in determining the value of assists described in paragraph (a)(1)(iv) of this section [category four assists]: (i) The value of an assist that is available in the public domain is the cost of obtaining copies of the assist. (ii) If the production of an assist occurred in the United States and one or more foreign countries, the value of the assist is the value added outside the United States. (iii) If the assist was purchased or leased by the buyer from an unrelated person, the value of the assist is the cost of the purchase or of the lease. 19 C.F.R. § 152.102(a)(3) (emphasis added). Additionally, section 152.103(d) (19 C.F.R. § 103(d)) also discusses the value of an assist. It provides that “[i]f the assist were produced by the buyer or a person related to the buyer, its value would be the cost of its production.” 19 C.F.R. § 152.103(d)(1)-(2). As the assist in this case was purchased from a related party, section 152.102(a)(3)(iii) prevents the purchase price, in this case, the amount paid under the CSAs, from being used as the value of the assist. In this case, pursuant to § 152.103(d)(1)-(2), the value of the assist should be the cost of production by the related party, which includes not only the cost of creating the designs, but also the cost related to the review process, as discussed above. In HRL 548368, in reliance on the General Notice, the value of the design assist was the value of the “design royalty”: the percent of net sales the importer paid the licensor under the agreement. In the General Notice, Customs described design agreements such as these as a type of royalty that is dutiable as an assist: . . . royalty payments may also be dutiable under the assist provision, section 402(b)(1)(C). For example, an importer can arrange for a product to be designed by a company outside of the U.S. In return for the development and use of the design work, the company requires the importer to pay a fee of 5% of the importer’s selling price of the product. The importer then supplies the design work, free of charge, to a foreign manufacturer who produces the product. In this case an assist, the design work, has been provided. The value of the assist is the 5% royalty payment. General Notice, at 6. The situation at issue is very similar to both HRL 548368 and the General Notice, except that in this case, the buyer (Redcats USA) is acquiring the assist from a related party, and therefore, the cost of acquisition, the price paid under the CSA, is not an appropriate method of valuation. See 19 C.F.R. § 152.102(a)(3). As such, the value of the assist cannot be based on the amount paid by Redcats USA under the CSAs. The design and review services provided under the CSAs are considered an assist under 19 U.S.C. §§ 1401a(b)(1)(C) and 1401a(h)(1)(A)(iv). The value of the assist is the cost of production by the related party, which includes not only the cost of creating the designs, but also the cost related to the review process discussed above. HOLDING: The fees paid under the license agreements at issue are not dutiable, however, the design and review services provided under the CSAs are a dutiable assist valued as discussed above. You are directed to mail this decision to the internal advice applicant, no later than 60 days from the date of this letter. On that date the Office of Regulations and Rulings will make the 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 public methods of distribution. Sincerely, Monika R. Brenner, Chief Valuation and Special Programs Branch