Dutiability of royalty payments

HQ H294766 May 31, 2018 OT:RR:CTF:VS H294766 JMV CATEGORY: Valuation Mr. Eric W. Hansel Regulatory Compliance Manager 478 Wando Park Blvd. Mt. Pleasant, SC 29407 RE: Dutiability of royalty payments Dear Mr. Hansel: This is in reply to your letter dated February 15, 2018, on behalf of Coravin Inc. (“Coravin”), in which you requested a ruling, pursuant to 19 C.F.R. Part 177, regarding the dutiability of royalty payments paid after importation. Coravin requested confidential treatment for certain information contained in its submission and in the file. Pursuant to 19 C.F.R. § 177.2(b)(7), the identified information has been bracketed in bold and will be redacted in the public version of this ruling. FACTS: Coravin is the importer and distributer of a dual stage regulatory product that is used to dispense and preserve wine known as the Coravin Wine System. This product includes a dual stage regulator component (“the regulator”) that was developed and patented by [XXXXXXXXXXXXX] (“Patent Holder”). The Patent Holder licenses the regulator to Coravin for use in the Coravin Wine System. In the Product Supply Agreement (“License Agreement”) and subsequent Addendum, the Patent Holder provided Coravin with right “to develop, make, have made, use, improve, offer to sell, sell, distribute, import and export the Products within the exclusive market.” The term “Product” is defined in the product supply agreement as the regulator. Exclusive market is defined in the agreement as “all applications and markets in the wine dispensing and preservation business worldwide . . .” In order to maintain the exclusive right to the aforementioned market, Coravin also agreed to purchase a certain minimum cumulative quantity of products by the end of each contract year, referred to as the “Exclusive Minimum Product Order.” Coravin contracts with the manufacturer to produce the Coravin Wine System, which includes the patented regulator. In exchange, Coravin pays a royalty payment for each regulator that it makes (or has made) under the license and is shipped to Coravin’s customers. Coravin pays the manufacturer for production of the Coravin Wine System, then separately pays the Patent Holder the royalty payments for the regulator after importation. Under the License Agreement, Patent Holder agrees to actively assist the manufacturer in establishing its regulator production activities. The License Agreement states: [Patent Holder] shall take all necessary and sufficient steps to establish [Coravin] (or its third party designee) as a manufacturing facility for the products (the “Second Source”). [Patent Holder] will provide the Second Source with the tooling and complete and accurate information and assistance necessary to manufacture the Products in compliance with the then current manufacturing processes and in commercial yields. Without limiting the generality of the foregoing, Supplier will provide on-site technical assistance, and access to all relevant Confidential Information, technology, trade secrets, know how, data and other materials and information then currently used or useful in manufacturing the products. In the case where the Second Source is established and the Agreement has not expired or been terminated, then Customer will have the right to order and purchase from the Second Source and /or [Patent Holder]. An amendment to the License Agreement further provides that the Patent Holder agreed to provide the following activities to assist in establishing [XXXXXXXXXXX] (“Manufacturer”), of Hong Kong, China, as the manufacturer of Products: Meeting with Coravin and Manufacturer (in person or via videoconference) for 2 days work related to tool, design, critical dimensions, overall planning and quality control, Travel to Manufacturer for 2 days work related to first-off tool build, and Travel to Manufacturer for 4 days work related to the pilot run production of regulators, audit and conformance to the Specification. According to the License Agreement, Coravin’s license ceases upon termination of the agreement. The License Agreement permits early termination by either party “in the event of a breach of a material item or obligation of this Agreement by the other party, which breach is not cured within 90 days (30 days in case of non-payment) after written notice of such breach.” Currently, Coravin contracts with Manufacturer to manufacture the Coravin Wine System. In the manufacturing agreement, Coravin agrees to grant Manufacturer a “nonexclusive, nontransferable, royalty-free right and license to practice and use [Coravin’s intellectual property] solely to perform its obligations hereunder for [Coravin’s] benefit.” Coravin states that it purchases the product directly from Manufacturer, without buying or selling agents on FOB (port of lading) terms. Coravin further states that all the parties are unrelated and the transaction between the manufacturer and Coravin is at arm’s length. ISSUE: Whether the royalty payments paid to the Patent Holder are dutiable as either part of the price actually paid or payable or as an addition to the value. 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). For purposes of this ruling, we accept that transaction value is the proper method of appraisement for the imported merchandise. 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) [hereinafter General Notice]; 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 Customs and Border Protection’s (“CBP”) 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 CIT 1049 (1993). With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action to 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 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. In the 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 affirmative answers or responses to the first and second questions, and a negative response to the third, point toward 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 (“HQ”) 547148, dated September 12, 2002. In order to obtain a ruling with respect to the dutiability of royalty or license fees, copies of any royalty agreements relating to the payment of the royalty or license fees in question and any purchase or supply agreements relating to the sale of the imported merchandise for exportation to the United States must be submitted to CBP with the request. If there are no such written agreements, this must be indicated in the ruling request. See General Notice, “Notice to Require Submission of Royalty and Purchase Supply Agreements in Ruling Requests Regarding Dutiability of Royalty or License Fees,” Vol. 29, No. 36, Cust. B. & Dec. at 10, dated September 6, 1995. See also 19 C.F.R. §177.2(b). Coravin provided to CBP its licensing agreement with the Patent Holder and the subsequent Addendum. Coravin also submitted the Manufacturing Agreement. In this case, the royalty payments relate to a patent. Coravin is paying the Patent Holder for the rights to use the patented product, the regulator, as a component within the Coravin Wine System. Therefore, question one, whether the merchandise was manufactured under a patent, is answered in the affirmative. The second question is whether the royalty is involved in the production or sale of the imported merchandise. Here, the merchandise is purchased from a manufacturer, chosen by the importer and unrelated to the Patent Holder. However, we note that the payment of royalties to a third party for the right to make imported merchandise does not necessarily mean that the royalties are not dutiable as part of the transaction value. See HQ H004991, dated April 2, 2007; HQ W548692, dated March 2, 2007; and HQ H024980, dated July 22, 2008. Three cases, HQ H004991, HQ W548692, and HQ H024980, all involved situations similar to the one at issue here in that royalty payments were made to unrelated third party licensors and not to the actual manufacturer or seller of the imported merchandise. In each case, the royalty payments were in consideration for the right to use patents to, among other things, make or have made, import and sell certain products. In HQ W548692, CBP stated that the language included in the SAA provides that royalties and license fees for patents covering processes to manufacture imported merchandise generally will be dutiable. CBP also noted that the relevant portions of both the TAA and SAA, which refer to royalties required to be paid as a condition of sale, do not state to whom, or for whose benefit the payment is made. Although a reference to the seller is included in the definition of the price actually paid or payable, it is conspicuously absent from the relevant TAA provision. CBP opined that this, along with the language included in the SAA, indicate that royalties for patents covering manufacturing processes generally are dutiable. Thus, in regard to patents, the framers of the TAA recognized that royalties paid to unrelated third parties could constitute a condition of the sale and, hence, be dutiable. So, in considering royalties paid for the use of a patent covering manufacturing processes, it is of little to no relevance to whom the payments are made; what is relevant is whether the royalty is involved in the production or sale of the imported merchandise. See H024980, dated July 22, 2008. In this case, the license agreement grants Coravin an exclusive right to, among other things, make or have made, develop, improve, import and sell the patented regulator within the exclusive market. Coravin uses its license to incorporate the regulator into its own product, the Coravin Wine System. Additionally, the license agreement explicitly states that upon termination of the agreement, the license shall cease. Thus, without the license to have the patented component made, Coravin would be unable to have the Coravin Wine System made by the Manufacturer. In other words, the technology for which the royalty is paid, is incorporated into the imported merchandise and without the license agreement and the applicable royalty payment, the imported merchandise could not be produced by Coravin. Thus, the exercise of the right conferred by the patent triggers the payment of the royalties in this instance. The royalty is clearly involved in the production of the imported merchandise, and therefore, the answer to the second question is yes. 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. As mentioned in your submission, there is some support for the position that a royalty paid to an unrelated third party patent holder is not dutiable. However, that is not always the case. This case is similar to the situation in HQ H233376, dated September 19, 2016. There, the importer paid an unrelated manufacturer to produce merchandise for importation into the United States. The importer separately paid the U.S. licensor, the owner of a utility patent, royalty fees that became due and payable upon sale of the merchandise after importation. CBP found that even though the royalties were paid to an unrelated third party, without the license agreement, the vendor would not have the right to manufacture the merchandise and without such right, the merchandise could not be manufactured, purchased and imported. CBP based this finding on the fact that the importer had to obtain the patent information to provide the manufacturer with the ability to produce the imported merchandise. It was in the manufacturing agreement that the importer would supply the manufacturer with the technology and equipment necessary to enable the manufacturer to produce the merchandise at issue. Without entering into the agreement and committing to the payment of the royalties, the importer would not have the requisite technology to allow the manufacturer to produce the imported merchandise. Thus, there was a clear nexus between the imported merchandise, the patented technology, and the royalty payments. Similarly, in HQ H168397, the license agreement provided different causes for termination of the agreement, including the non-payment of royalties. Additionally, even though the royalties were based on sales to third parties after importation, a minimum royalty was required regardless of whether there were earned royalties. Therefore, if the earned royalties, based on sales, were less than the aggregate annual minimum for two consecutive years, the licensor had the right to terminate the agreement. Additionally, the failure to pay the aggregate minimum royalty was deemed to be a breach of the license agreement. These provisions indicated to CBP that the royalty payments were necessary for the licensee to utilize the patents and manufacture the licensed products. Therefore, the royalty payments were not optional by the terms of the agreement and CBP found that the royalty payments were inextricably linked to the imported merchandise. Here the license agreement also requires Coravin to purchase a minimum cumulative quantity of products by the end of each contract year in order to maintain the exclusive right to the aforementioned market. If Coravin does not pay the royalties owed, or does not purchase the minimum cumulative quantity, Patent Holder has the option of terminating the License Agreement, and Coravin’s license to the regulator. Therefore, the royalty payments are necessary by the terms of the License Agreement for Coravin to have the imported merchandise produced. Further, the Patent Holder agrees to provide the manufacturer with tooling, technology and information necessary to manufacture the dual stage regulator. Patent Holder also agrees to travel to China to assist Manufacturer in establishing its manufacturing activities. Therefore, as in H233376, without entering into the agreement and committing to the payment of the royalties, the importer would not have the requisite technology to allow the manufacturer to produce the imported merchandise. We, therefore, find that there is a clear nexus between the imported merchandise, the patented technology, and the royalty payments. The royalty payments are not optional by the terms of the agreement and the third question should be answered in the negative. Accordingly, based on the information provided, we find that the royalty fees or payments made by Coravin to the Patent Holder pursuant to the Purchase and Supply Agreement are a condition of sale of the imported merchandise for export to the United States and constitute a dutiable addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D). HOLDING: Based upon the information provided, the royalty at issue is a dutiable addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D). Please note that 19 C.F.R. § 177.9(b)(1) provides that “[e]ach ruling letter is issued on the assumption that all of the information furnished in connection with the ruling request and incorporated in the ruling letter, either directly, by reference, or by implication, is accurate and complete in every material respect. The application of a ruling letter by a CBP field office to the transaction to which it is purported to relate is subject to the verification of the facts incorporated in the ruling letter, a comparison of the transaction described therein to the actual transaction, and the satisfaction of any conditions on which the ruling was based.” A copy of this ruling letter should be attached to the entry documents filed at the time this merchandise is entered. If the documents have been filed without a copy, this ruling should be brought to the attention of the CBP officer handling the transaction Sincerely, Monika R. Brenner, Chief Valuation and Special Programs Branch