Internal Advice Request; Transaction Value; Service Fees; Royalties and License Fees

HQ H302184 December 7, 2021 OT:RR:CTF:VS H302184 RMC CATEGORY: Valuation Field Director Regulatory Audit and Agency Advisory Services U.S. Customs and Border Protection 1100 Raymond Boulevard Newark, NJ 07102 Re: Internal Advice Request; Transaction Value; Service Fees; Royalties and License Fees Dear Field Director: This is in response to your correspondence dated August 2, 2018, requesting internal advice on the dutiability of certain service fees that the importer, [ ] (“the Importer”), pays to the related seller, [ ] (“the Parent”), and royalties that the Importer pays to [ ] (“the Related Licensor”). The Importer has asked that certain information submitted in connection with this internal advice request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 C.F.R. § 177.2(b)(7), the request for confidentiality is approved. The information contained within brackets and all attachments to this 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 Importer is a wholly-owned subsidiary of the Parent, a foreign entity that develops, produces, and sells flavors and fragrances. According to the information provided, the Importer manufactures thousands of products from raw materials such as vanilla, citrus products, or plant and flower materials. Its customers include companies in the perfume, cosmetics, and food industries, as well as manufacturers of household products. The imported merchandise primarily consists of raw materials such as fruit, vegetable, or other plant extracts and concentrates; essential oils; special aroma molecules; and aroma chemicals that the Importer purchased from the Parent. The merchandise was appraised based on the transaction value in the sale between the Parent and the Importer. As explained in further detail below, the Importer subsequently used the imported merchandise (along with other imported materials and domestically sourced ingredients) to manufacture products for resale in the United States. This internal advice request arose during an audit by U.S. Customs and Border Protection’s (“CBP”) Regulatory Audit and Agency Advisory Services (“RAAS”). During its review of the Importer’s transactions, RAAS discovered that the Importer made additional payments to the Parent for service fees and to the Related Licensor for royalty fees, and that neither of these payments was included in the declared value of the imported merchandise. RAAS questioned whether these additional payments should be included in the price actually paid or payable for the merchandise or added as an addition to the price actually paid or payable. In response to RAAS’s request for information, the Importer noted that there is no sales contract, sales agreement, or distribution agreement between itself and the Parent, and that the sales are based solely on purchase orders. However, the Importer provided complete copies of the applicable license agreement and service agreement. The facts relating to the service fee payments royalty payments, as well as excerpts from the relevant agreements, are set forth below. Service Fees Pursuant to Cost Sharing Agreement According to the information provided, the Importer makes additional payments pursuant to a service agreement with the Parent dated August 14, 2008. Relevant sections of the service agreement are as follows: Services. During the term of this Agreement the Parent shall provide to the Importer, or otherwise make available to the Importer Services to assist the Importer in the proper and efficient conduct and control of its business and in its leading function. In Particular (but without prejudice to the generality of the foregoing statements) the Parent shall provide, subject to the availability of its personnel, Services as listed and more precisely described in Appendix A. Service Fee. In consideration of the Services provided or made available by the Parent to the Importer under this Agreement, the Importer shall pay the Parent a fee for its Services (hereinafter called “the Service Fee”), which shall be levied by reference to the total cost borne by the Parent from executing its duties hereunder (hereinafter called “the Service Costs”) plus a mark-up of 10% . . . Term In December 2007, the Parties agreed verbally that this Agreement becomes effective on January 1, 2008, and shall remain in force for an indefinite period of time. Appendix A – Scope of General Administration and Support Services The Parent shall support the Importer in its leading role providing comprehensive and superordinated services relating to the following: Business Development and Marketing The provision of business development and marketing support services on behalf of the Importer to facilitate and promote the growth of sales in the Region through: Marketing techniques and strategies; Public relations; Pricing and product development; Bids and contract negotiations; Customer relations; and Other marketing related matters. Finance and Legal The provision of finance and legal support services on behalf of the Importer to facilitate the co-ordination of accurate and up-to-date financial reporting data, tax and legal liaison and currency management through: Accounting and financial reporting support; Budgeting and controlling support; Financing and hedging support; External audit support; Internal audit support; Tax and legal support. Human Resource The provision of human source services on behalf of the Importer to facilitate the recruitment and management of key personnel in the Region, including: Sourcing of key personnel for the operations in the Region; Other HR compliance issues relating to personnel in the Region. Product Management The provision of product management services on behalf of the Importer to facilitate cost effective purchasing and cost savings for the Importer through: Pricing and product development; Negotiations with key suppliers for the operations in the Region; Bids and contract negotiations; Other product management related matters. Royalties The Importer states that it uses a number of licensed manufacturing processes to produce finished products in the United States. The licensed processes include liquid compounding, spray dry technology, and reaction flavors. In addition, the Importer uses licensed technology in its production facilities to carry out distillation and other chemical extraction processes. As described in further detail below, the license agreement covers, among other technologies, the “information in respect to the manufacturing techniques and applications engineering of the molecules” that the Importer needs to manufacture the finished products in the United States. In exchange for these rights, the Importer pays the Related Licensor a royalty payment of 3% of the Importer’s net U.S. sales price of products manufactured in the United States using the know-how provided for in the license agreement. The license agreement dated March 28, 2014, contains the following relevant terms: THIS AGREEMENT is dated 3/28/2014 and is entered into BETWEEN [ ] (“the Related IP Holding Company”] acting on behalf of the partnership in the process of the Related Licensor . . in the following the “LICENSOR” and the Importer . . . in the following of LICENSEE. 1.3 – “CONTRACT PRODUCTS” means the products to be developed, produced, sold and advertised by the LICENSEE listed in the applicable (latest) version of Schedule III – which is subject to changes according to Section 15. 1.5 – “KNOW-HOW” shall mean all know-how as specified in the applicable (latest) version of Schedule I which is subject to changes according to Section 15. All KNOW-HOW licensed herein derives its economic benefit and value by being not generally known or reasonably ascertainable. 2.1 – LICENSOR hereby grants LICENSEE a non-exclusive, non-perpetual, revocable, chargeable, non-transferable, non-sublicensable right to use the KNOW-HOW for the development, production sale and advertising of the CONTRACT PRODUCTS in the TERRITORY in accordance with the AGREEMENT. 9.1 – LICENSEE shall pay to LICENSOR royalty, which is three (3) percent of the LICENSEES’ NET SALES PRICE OF CONTRACT PRODUCTS, sold to THIRD PARTIES and [ ] (“the Corporate Group”). Royalties shall be payable only on the sale of CONTRACT PRODUCTS. 9.3 – Royalties due to LICENSOR shall be due and payable on a quarterly basis, payable not later than thirty (30) days after quarter-end. . . . 9.6 – The PARTIES acknowledge that the royalty payments required under this Section are not required until LICENSEE has sold the relevant CONTRACT PRODUCTS recognizing the sale in its accounts applying IFRS (International Financial Reporting Standards). SCHEDULE 1 – KNOW-HOW – The KNOW-HOW related to the development, production and use of molecules comprising all technical and scientific information and experiences resulting from the basic research activities of the Parent. The KNOW-HOW includes all secret information in respect to the manufacturing techniques and applications engineering of the molecules. . . . SCHEDULE II – TERRITORY – The term TERRITORY covers the territory of the following country: USA. SCHEDULE III – CONTRACT PRODUCTS – The term CONTRACT PRODUCTS covers any and all products currently developed, produced, sold, and distributed by the Corporate Group under the use of the KNOW-HOW. All products are listed in the current SAP system of the Importer for all the Corporate Group which have access to SAP. . . Based on its review of the information that the Importer provided, RAAS concluded that both the service fee payments and the royalty payments were dutiable. The Importer maintains that both payments are unrelated to the imported merchandise and thus non-dutiable. ISSUES: Whether the service fee payments that the Importer makes to the Parent are included in the transaction value of the imported merchandise as part of the price actually paid or payable, or whether they constitute additions to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1). Whether the royalty payments that the Importer makes to the Related Licensor constitute additions to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1). LAW AND ANALYSIS: Merchandise imported into the United States is appraised for customs purposes 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. See 19 U.S.C. § 1401a(b)(1). When transaction value cannot be applied, the appraised value is determined based on the other valuation methods in the order specified in 19 U.S.C. § 1401a(a). Transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain “test values.” See 19 U.S.C. § 1401a(b)(2)(B). Here, although the buyer and the seller are related, the request for internal advice focused solely on the dutiability of royalty payments and service payments. Accordingly, we assume for the purposes of this decision that transaction value is the appropriate method of appraisement. Service Fees Part of the Price Actually Paid or Payable 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). Here, the Importer makes the service fee payments directly to the Parent, which is the seller of the imported merchandise. In determining whether the service fee payments at issue here are part of the price actually paid or payable, the question is therefore whether the payments are part of the “total payment . . . for imported merchandise.” Regarding the scope of the term “total payment,” in Luigi Bormioli Corp., Inc. v. United States, 304 F.3d 1362, 1367 (Fed. Cir. 2002), the Court of Appeals for the Federal Circuit explained that: We have interpreted the term “total payment” in the “price actually paid or payable” definition to be “all-inclusive.” Generra Sportswear Co. v. United States, 905 F.2d 377, 379 (Fed. Cir. 1990). Therefore, we have held that the “price actually paid or payable” includes payments made by the buyer to the seller in exchange for merchandise even if the payment “represents something other than the per se value of the goods.” Id. at 379-80 (holding that quota payments were properly included in the “price actually paid or payable”).  This interpretation is consistent with the broad definition of “price actually paid or payable” adopted by the GATT. Although the total payment is “all inclusive,” it does not encompass payments that are totally unrelated to the imported merchandise. In Chrysler Corp. v. United States, 17 C.I.T. 1049 (1993), the importer challenged Customs’ decision to add “shortfall” and “special application fees” to the value of imported automobile engines. The contract between the importer and the seller specified that the fees were payable if the importer failed to meet purchasing requirements. The Court found that the obligation to pay both fees arose from the plaintiff’s failure to purchase engines and noted that “[a]n expense arising from the failure to purchase certain merchandise is not a component of the price paid for the acquisition of other products.” As a result, the expenses were not part of the price actually paid or payable for the imported engines. However, as the Court of Appeals for the Federal Circuit noted in Generra, 905 F.2d 377: Congress did not intend for the Customs Service 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, are for the merchandise or for something else. As we said in Moss Mfg. Co. v. United States, 896 F.2d 535 (Fed. Cir. 1990), the “straightforward approach [of section 1401a(b)] is no doubt intended to enhance the efficiency of Customs’ appraisal procedure; it would be frustrated were we to parse the statutory language in the manner, and require Customs to engage in the formidable fact-finding task, envisioned by [appellant]. Thus, if the importer seeks to exclude payments to the seller from the “total payment . . . for [the] imported goods,” it carries the burden of establishing that the payments are totally unrelated to the imported merchandise. See, e.g., Headquarters Ruling (“HQ”) W563404, dated March 3, 2006. Whether a payment is “for imported merchandise” (and thus included in the price actually paid or payable) or totally unrelated to the imported merchandise (and thus excluded from the price actually paid or payable) depends on the nexus between the payment and the imported goods. See VWP of Am. v. United States, 25 C.I.T. 1056, 1062 (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. See, e.g., Headquarters Ruling (“HQ”) H242894, dated December 4, 2013. CBP has generally held that service fees that are entirely separate from the amounts paid for the imported merchandise are not part of the price actually paid or payable. For example, in HQ 545998, dated November 13, 1996, CBP held that a “co-promotion” fee that the importer paid to a related licensor was not part of the “total payment . . . for imported merchandise.” In that case, the importer purchased an active pharmaceutical ingredient from an unrelated company in Belgium. Upon importation, the importer combined the product with other ingredients of U.S. origin to produce Zyrtec. Among the five agreements that the buyer entered into was a “co-promotion” agreement which permitted the related licensor to assist the importer in marketing Zyrtec in the United States by making sales presentations to licensed prescribers of medications. In exchange for its marketing and promotion efforts in the U.S., the licensor earned a “co-promotion” fee in accordance with a formula in the contract. CBP agreed with the importer’s argument that the co-promotion fees were not payments associated with the sale for exportation of the imported merchandise. The evidence indicated that the co-promotion fees resulted from specific undertakings of the licensor in promoting the sale of the product in the United States and that the amount the licensor received under the agreement directly related to those specific undertakings. As a result, the price actually paid or payable was “entirely separate from any amounts that the importer/buyer pays to the licensor as a result of the latter’s participation in marketing events.” Thus, even though the payments were made to a party related to the seller, they were not part of the price actually paid or payable for the imported merchandise. Similarly, in H239496, dated March 13, 2015, CBP held that an “administrative fee” that the importer paid to the related seller was not part of the price actually paid or payable for imported jewelry. The administrative fee, which was calculated as percentage of net sales, was designed to compensate the seller for marketing, sales support, administration, information technology, finance, legal, human resources, and logistics arrangements. CBP agreed with the importer that the administrative fee was not part of the price actually paid or payable because the fee was not connected to the imported merchandise, but was paid for specific undertakings of the seller in the United States. See also HQ 543512, dated April 9, 1985 (holding that fees paid by the buyer to the related seller for accounting, financing, planning, management, marketing, and clerical services “were not tied to the sale of exportation of any specific merchandise” and thus were not “for” the imported merchandise). Here, the services agreement provides that the Parent will provide business development and marketing, finance and legal, human resources, and product management services to the Importer at cost plus a 10% markup. Accordingly, the amount that the importer pays for the services does not appear to be tied to the sale for exportation of the merchandise. The services agreement provided does not mention products to be purchased and imported or create any obligation for the Importer to purchase products from the Parent. Accordingly, the service fee is designed to compensate the Parent for providing specific undertakings on behalf of the Importer. As a result, although the “price actually paid or payable” includes all payment to or for the benefit of the seller, whether direct or indirect, the service fees were not paid “for imported merchandise,” 19 U.S.C. § 1401a(b)(4)(A), and are not part of the price actually paid or payable. Statutory Addition as Proceeds under 19 U.S.C. § 1401a(b)(1)(E) Although we have determined that the service fees are not dutiable as part of the price actually paid or payable for the imported merchandise, we must also determine whether they must be added to the price actually paid or pa