Internal Advice; Dutiability of Royalty Payments and License Fees; Parts/Components for Battery Production Lines

HQ H186056 March 26, 2013 VAL-2 OT:RR:CTF:VS H186056 HkP CATEGORY: Valuation Field Director Regulatory Audit Field Office - Chicago Office of International Trade U.S. Customs and Border Protection 610 South Canal Street, 9th Floor Chicago, IL 60607 RE: Internal Advice; Dutiability of Royalty Payments and License Fees; Parts/Components for Battery Production Lines Dear Field Director: This is in response to your memorandum, dated September 16, 2011, requesting Internal Advice on the dutiability of royalty payments made by Spectrum Brands, Inc. (“Spectrum”) pursuant to Technical Collaboration, Sale and Supply Agreements. This issue arose out of a Focused Assessment Pre-Assessment Survey of importations by Spectrum for the fiscal year ending September 30, 2009, conducted by the Regulatory Audit Directorate, Chicago Field Office. FACTS: According to the information submitted, the importer’s (Spectrum’s) predecessor company, Rayovac Corporation (“Rayovac”), a Wisconsin corporation, entered into Technical Collaboration, Sale, and Supply Agreements with Matsushita Battery Industrial Co. Ltd. (“Matsushita”/“MBI”), a Japanese corporation, and Matsushita Electric Industrial Co. Ltd. (“MEI”), a Japanese corporation, in 1991 and 1994 to purchase pilot production lines and their spare parts for the production of certain alkaline batteries in the United States. A 1998 Agreement between the same parties covers the purchase of new and retooling equipment and retooling parts for the battery manufacturing equipment covered by the 1991 and 1994 Agreements. The 1998 Agreement was amended by addendum in 2000 to cover the purchase of additional battery manufacturing equipment. The terms of all three agreements are substantially similar. The prices in all three contracts include charges for equipment, technical documentation, spare parts, and training. At the time of the agreements, MBI and MEI were related parties for purposes of U.S. Customs law, and today along with other companies are collectively known as Panasonic Corporation. Neither Rayovac nor Spectrum is related to MBI, MEI, or the Panasonic Corporation. In addition to providing for the sale of machinery, under the terms of the agreements MBI granted to Rayovac non-exclusive licenses of Intellectual Property other than Patents, and MEI granted to Rayovac non-exclusive licenses of Patents, in each case to make and use zero mercury formula, primary dry batteries in various sizes (“Contract Batteries”, as they are defined in each agreement) in the United States, Canada, and Mexico. MBI and MEI also granted to Rayovac non-exclusive licenses to sell Contract Batteries throughout the world, excluding Japan, for the full term of the agreements. Relevant terms are defined as follows: Equipment: The term equipment shall mean the most advanced equipment for production of LR6, LR14 and LR20 alkaline batteries in operation on the Date hereof at Matsushita’s manufacturing facility in Osaka, Japan or at Matsushita-Ultra Tech Battery Corporation’s (“MUTEC”) facility in Georgia. The Equipment shall consist of the items set forth on Schedule A hereto. Technical Know-How: The term technical know-how shall mean know-how in any form whatsoever other than patents or patent applications or other know-how for which MEI or Matsushita intends to file a patent application, which MEI or Matsushita possess or will possess during the term of the Agreement, and which concerns or will concern the design, testing, manufacture and quality control of Contract Batteries and the processes or equipment for manufacturing Contract Batteries. Patents: The term patents shall mean all patents and patent applications (while pending) which MEI owns or controls or which it will own or control as of the date of delivery of each line of Equipment, in any country excluding Japan, and which are or will be used or useful in the manufacture of the Contract Batteries or in the processes and equipment for manufacture of the Contract Batteries in the Manufacturing Territory. Improvements: The terms Improvements shall mean all improvements, modifications or variations, other than those that are patented or for which a patent application has been or will be filed (but only for the pendency of such an application), in or to the manufacture of Contract Batteries, or relating to the design, construction, or operation thereof, made or acquired by Matsushita or Rayovac by using Technical Know-how or Patents after the Date hereof and prior to the fifth anniversary of that date. Intellectual Property: Intellectual Property shall mean all of the Technical Know-How, Patents and Improvements. Pursuant to these licensing provisions, Rayovac was required to make several types of scheduled royalty payments to MEI for licenses to use MBI’s patents and for the technical know-how needed to manufacture the batteries. The royalty fees fell into three categories of payments: fees payable within 30 days of the signing of each contract; fees tied to the manufacture and sale of batteries payable for the first five years of each contract; and, fees for the life of the patents (20 or 25 years depending on the contract). However, by the time of the audit, the first two types of fees were no longer payable and, therefore, will not be addressed. The fees at issue are in the third category - yearly payments by Rayovac to MEI for Intellectual Property licenses for periods of up to 20 or 25 years, depending on the contract. According to the agreements, the yearly payments were for “each line accepted on 1 July of each year and for each such year thereafter as long as any of the Patents shall be valid and enforceable in the United States and practiced by Rayovac.” The agreements are each effective for the duration of the longest-lived U.S. Patent, after which time Rayovac will have fully paid, nonexclusive perpetual licenses to manufacture, use, and sell Contract Batteries. The 1991 and 1994 Agreements are effective for 20 years and the 1998 Agreement for 25 years. To the extent that the importer was/is still utilizing the patents, the royalty payments for the 1991 Agreement ended in 2011; they will end for the 1994 and 1998 Agreements in 2014 and 2022, respectively. In 2003, the amount of royalty to be paid by Rayovac to MEI was decreased after it defended and settled patent infringement charges made by another battery manufacturer. In addition, MBI made a lump sum payment related to the settlement to Rayovac. In 2005, Rayovac changed its name to Spectrum Brands. In 2008, MBI and MEI were unified under the corporate name Panasonic Corporation. The period covered by the Focused Assessment, FY 2009, was after the names of the parties to the agreements changed. Accordingly, hereafter Rayovac will be referred to as Spectrum and MBI and MEI will individually and collectively be referred to as Panasonic. According to importer’s counsel, during the period covered by the Focused Assessment (FY 2009) Spectrum imported or purchased domestically replacement parts from suppliers other than Panasonic, as well as from Panasonic. Thirty percent of the imported parts were sourced from two suppliers, Panasonic and another company. Goods imported from Panasonic included belts, magnets, cams, plates, guides, reducers, die pulleys, belts, and motors. Goods purchased from the other overseas supplier included seal assemblies, drive shafts, plungers, “O” rings, roll bars, and plates. There are no purchase or supply contracts for these purchases. No full production lines were imported. Therefore, this ruling is only applicable to the imported replacement parts. ISSUE: Whether the royalty payments made by the importer, Spectrum, are dutiable as part of the price actually paid or payable for the imported merchandise, or whether they are additions to the price actually paid or payable. 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." 19 U.S.C. § 1401a(b)(1) (D). These additions apply only if they are not already included in the price actually paid or payable. 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: 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. I. Royalty Payment as part of the Price Actually Paid or Payable The “price actually paid or payable” means the total payment (whether direct or indirect, and exclusive of any charges, costs, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) 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 (Fed. Cir. 1990), and Chrysler Corporation v. United States, 17 Ct. Int’l Trade 1049 (CIT 1993). The issue is whether the royalty payments are included in the price actually paid or payable for the imported spare parts. In this case, the imported spare parts were sourced from two overseas suppliers, Panasonic and another company not related to Panasonic. Accordingly, the royalty payments made by Spectrum to Panasonic did not directly or indirectly benefit the third party seller and, therefore, are not included in the price paid to the third party seller. See 19 U.S.C. § 1401a(b)(4)(A). At issue is whether royalty payments made to Panasonic are included in the price of the imported merchandise purchased from Panasonic. Counsel argues that Spectrum is required by the terms of the agreements to make fixed payments for license fees for as long as any of the patents are valid and enforceable in the United States and practiced by Spectrum. The payments have to be made regardless of how many Contract Batteries are manufactured, whether replacement parts are purchased or from whom they are purchased. By the time of the audit period, Spectrum could have purchased all or none of its parts requirements from Panasonic but was required to pay the same amount of royalty. Counsel argues that these facts show that the royalties are clearly tied to the right to use patents to manufacture batteries but are not tied to the right to buy and import equipment, replacement parts or components. For the reasons stated by counsel, we agree. The agreements establish that the additional payments paid to the seller, Panasonic, are consideration for Spectrum to use Panasonic’s patents and technical know-how. Payment is due to Panasonic only for as long as Spectrum uses Panasonic’s patents to manufacture batteries. Therefore, we find that the royalty payments are not part of the price actually paid or payable for the imported merchandise. In Headquarters Ruling Letter (“HQ”) 545381 (May 4, 1998), the importer manufactured licensed test kits for related company BMC from materials supplied by both foreign and domestic companies. Two of the foreign suppliers, BMC and BMG were related to the importer and each other. BMC and BMG were parties to a license agreement in which BMG was the licensor and BMC the licensee. In consideration of the license granted, BMC agreed to pay as a royalty fee a percentage of net sales of all products manufactured by BMC and sold or otherwise disposed of by BMC. BMC interpreted this clause to include all products manufactured by the importer for BMC. CBP found that the royalty fees paid by the importer to BMC were not related to the imported merchandise because they were for the right to make, use and sell the kits in the U.S. Technical information transferred under the license agreement related to the manufacture, quality control and marketing of the kits in the U.S., not to the manufacture or production of any of the imported components. However, the royalty may still be included in the transaction value as an addition to price actually paid or payable for the imported merchandise. See 19 U.S.C. § 1401a(b) (1)(D). II. Royalty Payment as an Addition to the Price Actually Paid or Payable 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 included in transaction value as an addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1). As set forth in the notice, the questions are: Was the imported merchandise manufactured under patent? Was the royalty involved in the production or sale of the imported merchandise? 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: the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise generally will be dutiable); 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); 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, payment of the royalties on each and every importation. See, e.g., HQ 547148 (Sept. 12, 2002). With regard to the first question of the dutiability test, the answer is no. The merchandise imported by Spectrum from Panasonic and the third party supplier (belts, magnets, cams, plates, guides, reducers, die pulleys, belts, motors, seal assemblies, drive shafts, plungers, “O” rings, roll bars, and plates) are standard machinery parts not manufactured under the patents at issue. The answer to the second question is no, the royalty payment is not involved in the production or sale of the imported merchandise. The royalty provisions in the agreements indicate that the payments are for the right to use various patents in the production of Contract Batteries in the United States, but are not for the imported merchandise itself. The royalties are payable annually and not tied to each importation. Moreover, we note that although the royalty provisions are included in the same agreements that control the sale of production lines previously imported by Spectrum, those production lines are not the imported merchandise in the instant case. Standard machinery parts are imported. Thus, we find that the purchase of the imported merchandise and the payment of the royalties are not inextricably intertwined. In response to the third question, we find that the importer can buy the merchandise without paying the royalty. Spectrum is under no obligation to purchase the imported products from the licensor, Panasonic, and in fact also imports merchandise from a third party supplier. If Spectrum imports nothing, but manufactures batteries in accordance with a Panasonic patent, the obligation to pay the royalty exists. Conversely, if Spectrum imports merchandise but does not rely on a Panasonic patent to manufacture batteries, then Spectrum is not obligated to pay a royalty to Panasonic. Accordingly, we find that the obligation to pay the royalty only arises when Spectrum uses a Panasonic patent to manufacture batteries and is not tied to the purchase of the imported merchandise. 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, Panasonic is both the seller of the replacement parts and the licensor of the patents and know-how to manufacture batteries. However, the obligation to pay the royalty only arises when Spectrum uses a Panasonic patent to manufacture batteries and is not tied to the subsequent resale, disposal, or use of the imported parts. Therefore, we find that the royalties are not considered proceeds, dutiable under 19 U.S.C. § 1401(a)(b)(1)(E). Based on these facts, we find that the royalty payments are not dutiable as additions to the price for the merchandise imported from Panasonic or the third party supplier because the payments are not related to the imported merchandise. HOLDING: The royalty fees paid by Spectrum to Panasonic are not included in the transaction value of the imported merchandise as part of the price actually paid or payable for the merchandise or as an addition thereto under 19 U.S.C. § 1401a (b)(1)(D) or (E). This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, Regulations and Rulings, Office of International Trade, will make the decision available to CBP personnel and the public 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