Fees for Exclusive Distribution Rights; Related Parties; Royalty Payments; Proceeds

HQ H242894 December 4, 2013 OT:RR:CTF:VS H242894 RSD CATEGORY: VALUATION Trade Compliance [ ] P.O. Box 685001 RE: Fees for Exclusive Distribution Rights; Related Parties; Royalty Payments; Proceeds Dear Mr. Davis: This is in response to your letter dated June 4, 2013, on behalf of the automotive company you represent concerning the dutability of proposed fees paid pursuant to an exclusive distribution agreement between a related seller and buyer. You have requested that certain information submitted in connection with your company, including the company’s name, be treated as confidential. Inasmuch as the request conforms to the requirements of 19 CFR §177.2(b)(7), the company's request for confidentiality is approved. The information contained within brackets and all attachments to the ruling request, forwarded to our office, will not be released to the public and will be withheld from published versions of this decision. FACTS: The requester is a leading producer of automobiles and automotive parts and services, whose worldwide headquarters is based in a foreign nation. The automotive company has many subsidiaries throughout the world, including a wholly-owned U.S. subsidiary that imports products into the United States from related overseas based affiliated companies. In addition to importing products from related foreign companies, the U.S. affiliate manufactures products in the United States. In addition to manufacturing vehicles, the U.S. affiliate also distributes the vehicles it manufactures as well as vehicles produced by other foreign divisions of the automotive company. The company’s vehicles are branded with the company’s name or under the name of its luxury division. As the company’s branded vehicles may be manufactured at any given time by one or more of the company’s manufacturing affiliates, including the U.S. affiliate, vehicle production locations and the specific company sellers can and do change on a regular basis. In addition, the U.S. affiliate is the U.S. distributor of aftermarket service parts and accessories for the automotive company’s branded vehicles (aftermarket services parts and accessories are collectively referred to as “parts”). Parts may be produced by the U.S. company or purchased from other affiliated companies or from unrelated parties and may be imported or procured domestically. The U.S. affiliate is the importer of record for all imported vehicles that it distributes, as well as many of the imported parts. The U.S. affiliate imports through 29 U.S. ports of entry, although vehicle imports are limited to six ports of entry, with the largest import activity by value coming through the Port of Los Angeles. The automotive company has announced plans to expand its global manufacturing capabilities in several different countries, including China, Brazil, Russia South Korea, India, as well as in North America. This change in manufacturing will allow the company to rapidly switch model production, between manufacturing locations in response to increasing dynamic economic supply chain marketing and distribution variables. In June of 2011, the company launched a comprehensive, globally structured mid-term (2011-2016) business plan. This corporate initiative represents the automotive company’s goals for brand and sales development with a focus on enhancing the overall customer experience. To facilitate its business plan, the company has developed a business plan with six basic goals, which are to increase brand power, sales power, enhance quality, zero emission leadership, business expansion, and cost leadership. To enable and implement aspects of this business plan, the automotive company is contemplating entering into a new “Exclusive Distribution Agreement” with each of its distribution subsidiaries including its U.S. subsidiary. Under the contemplated agreement, the distribution subsidiaries would pay to the automotive company a “Territorial Exclusivity Fee” in exchange for the exclusive right to distribute the automotive company’s branded products and the exclusive right to use its developed intellectual property for the purposes of distribution, building consumer brand awareness and creating product demand, with a right to the company’s affiliated dealers to use the same in a defined territory. The rights set forth in the agreement would be granted for a multi-year period and the Territorial Exclusivity Fee would be determined at the beginning of the period and be paid in annual installments over the course of the agreement. An independent accounting firm will establish an arm’s length value for the rights granted in the Exclusivity Agreement. Using a global formula, the accounting firm will also develop the level of fees that each of the automotive company’s distributional entities, including the U.S unit, will pay for the rights granted. From an accounting perspective, the exclusivity fee will be booked as a marketing or selling expense. Neither the agreement nor the fee will be referenced in any purchase agreement with any of the company’s suppliers, related or unrelated. It is stated in the Exclusivity Agreement that in no circumstance shall the Territorial Exclusivity Fee be determined with reference to or associated with the volume of products purchased by the distributor. The agreement also states that in the event the distributor fails to pay the Territorial Exclusivity Fee, the company’s sole and exclusive remedy shall be to terminate the exclusive rights granted pursuant to the agreement. In deciding the amount of exclusivity fee, the accounting firm determined that the Comparable Uncontrolled Price (“CUP”) method should be used to set the amount of the exclusivity fee. According to the accounting firm, the CUP method can be based on either “internal comparables” or “external comparables”. Internal comparables reflect transactions between the tested party and an unrelated party, while external comparables refer to uncontrolled transactions that take place between two or more unrelated parties. Based on the understanding that the automotive company does not have any internal CUPs at this stage to determine an arm’s length distribution fee, an external CUP approach was used. The CUP method based on external third party transactions was selected as the best method, since there are publicly available third party agreements that could serve as the comparables for the distribution fee arrangements between the automotive company and its related U.S. distributor. The accounting firm conducted an external agreement search to identify comparable agreements envisaging the granting of exclusive distribution and demand creation rights. Based on the comparable search, five agreements were found to be broadly comparable to that of the proposed arrangement between the U.S. distributor and the automotive company. The agreements identified in the search mostly concerned the granting of exclusive distribution rights and demand creation rights. ISSUE: Whether the proposed exclusivity fees that the U.S. distributor will pay to a related seller for the exclusive right to distribute the seller’s branded products in the United States are dutiable as part of the price paid or payable? Whether the exclusivity fees are dutiable as an addition to transaction value as a royalty or as proceeds? 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 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. The term "price actually paid or payable" is defined in 19 U.S.C. § 1401a(b)(4)(A) as: [t]he total payment (whether direct or indirect, and exclusive of any costs, charges, 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.  Dutiable as Price Actually Paid or Payable Normally, all payments made by a buyer to a seller, or a party related to a seller, are part of the price actually paid or payable. See Headquarters Ruling Letter ("HQ") 545663, dated July 14, 1995. This position is based on the meaning of the term "price actually paid or payable" as addressed in Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990). In Generra, the court considered whether quota charges paid to the seller on behalf of the buyer were part of the price actually paid or payable for the imported goods. In reversing the decision of the lower court, the appellate court held that the term "total payment" is all-inclusive and that "as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods." Id. at 379. The court also explained that Congress did not intend for Customs to engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, were for the merchandise or something else. Id. Similarly, the fact that a particular charge is not among the listed exclusions in the customs value statute does not mean that such payments must be included in the transaction value. The Court of International Trade (CIT) considered this situation in Tikal Distrib. Corp. v. United States, 93 F.Supp. 2d 1269 (Ct. Int’l Trade 2000), when it addressed the treatment of payments for exclusivity rights. The CIT noted, “[simply] because the particular additional payments are not expressly excluded, it does not automatically follow that such payments are part of the price actually paid or payable for the imported goods, and thus includible in transaction value.” Id. at 1271 (upholding Customs’ determination that payments for exclusivity rights should be included in the transaction value). However, in Chrysler Corp. v. United States, 17 Ct. Int’l Trade 1049 (1993), the court analyzed Generra and determined that although tooling expenses incurred for the production of the merchandise were part of the price actually paid or payable for the imported merchandise, certain shortfall and special application fees which the buyer paid to the seller were not a component of the price actually paid or payable. With regard to the latter fees, the court found that the evidence established that the fees were independent and unrelated costs assessed because the buyer, Chrysler, failed to purchase other products from the seller. Id. at 1056. As such, the fees were not a component of the price of the imported engines. Id. Therefore, Chrysler was able to show that the shortfall charges were completely unrelated to the imported merchandise. To determine whether a particular payment should be included in the transaction value of the merchandise, Customs and Border Protection (CBP) analyzes the nexus between the payment and the imported merchandise. See VWP of America v. United States, 163 F.Supp. 2d 645, 652 (Ct. Int’l Trade 2001) (“Whether a particular [payment] provokes liability for customs duties depends upon its relevance to importation.”). In particular, CBP examines the nature of the additional payments, whether the amount of the payments varies according to the value or quantity of merchandise, the timing and frequency of the payments, and whether the payments add value to the imported goods. In the instant case, the payments at issue that the U.S. distributor makes will not be considered part of the price actually paid or payable for the imported merchandise bought from the automotive company, if the evidence clearly establishes that, as in Chrysler they are totally unrelated to the imported merchandise. Accordingly, we must determine if the exclusivity fees that the distributor will pay to the overseas automotive company relate to the imported merchandise that the automotive company sells to its U.S. distributor. We first note that pursuant to the Distribution Agreement, the exclusivity fees are to be paid to acquire the rights to distribute and resell merchandise and services in the United States. In addition, the exclusivity fees will also be paid for the right to use certain intellectual property owned by the automotive company. In addition, the exclusivity fee involves a separate payment that the distributor makes to the seller and is distinct from any payments it makes to the automotive company to purchase the imported merchandise. As such, the exclusivity fee is not connected with the purchase of any imported merchandise from the automotive company. This is shown by the fact that the amount of the exclusivity fee is not dependent on how much merchandise the distributor actually buys from the automotive company. In fact, the Exclusivity Agreement states that in no circumstance shall the Territorial Exclusivity Fee be determined with reference to or associated with the volume of products purchased by the distributor. We note that the distributor will owe the same exclusivity fee to the automotive company even if it does not purchase any merchandise from the automotive company. In addition, payment of the exclusivity fee is not linked to any specific import transaction. Thus, the distributor will owe the same exclusivity fee, even though a substantial portion of the merchandise may be sourced from the United States and not involve any importations. Moreover, since the exclusivity fees are fixed based on an external CUP analysis done by an independent accounting firm, the volume and the value of the imported merchandise are not included in calculating the amount of the exclusivity fees at issue. See, e.g., HQ 546478 dated February 11, 1998; but see also, HQ 545194 dated September 13, 1995 (license fees held to be part of the price actually paid or payable where payments were made to the sellers or parties related to the sellers, the sellers' invoices specifically indicated that the importer was to pay the fee and the only agreements provided merely indicated that the fees were to be paid to one of the sellers). In addition, the agreement further indicates that in the event the distributor fails to pay the Territorial Exclusivity Fee, the automotive company’s sole and exclusive remedy shall be the termination of the exclusive distribution and intellectual rights granted pursuant to the agreement. In other words, there is no remedy against the products imported into the United States, and the automotive company cannot withhold the shipment of merchandise for the failure to pay the exclusivity fees. Thus, based on the information submitted, we find that as in the Chrysler case, the proposed exclusivity fees at issue are not related to the imported merchandise, and they are not an element of the price actually paid or payable. Dutiable as a Royalty Payment Although we have determined that the proposed exclusivity fee payments would not be part of the price actually paid or payable of the imported merchandise, we still must consider whether such payments would constitute a dutiable addition to the price actually paid or payable 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 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 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. 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 (Sep