I.A.- Dutiability of Importer's Royalty Payments to Third Party Licensor

February 22, 1994 HQ W544923 VAL CO:R:C:V W544923 DPS CATEGORY: Valuation Regional Director, USCS Regulatory Audit Division Northeast Region 10 Causeway Street Boston, Massachusetts 02222-1056 RE: I.A.- Dutiability of Importer's Royalty Payments to Third Party Licensor Dear Sir: This is in response to your request for internal advice transmitted via Headquarters’ Office of Regulatory Audit on January 16, 1992. The I.A. request was submitted by counsel for the importer, Schmid Brothers, Inc. (Schmid). It involves the dutiability of a license fee/royalty paid by Schmid to Ars Alpina Handelsanstalt (Alpina or licensor), of Vaduz, Liechtenstein, for the exclusive right to use the ANRI trade name and trademark for sales in the U .S. of various wood-carved statues manufactured and sold by Anri S.p.A. (Anri or seller), of Bozen, Italy. The issue was developed in the course of an audit of Schmid by the Northeast Region's Regulatory Audit Division (RAD). FACTS: Schmid imports a wide variety of merchandise including figurines, music boxes and giftware. Among these articles are wood figurines manufactured by and purchased from Anri, the seller. When these articles bear the ANRI trademark, Schmid is required to pay a royalty of 10 percent of the ex-factory purchase price to licensor, Alpina, pursuant to an agreement dated September 26, 1972, as amended by letter dated August 17, 1989 (Exhibit A to I.A. request). The payment is stated to cover Schmid’s exclusive right to use the ANRI trade name and trademark for sales in the U .S. Schmid’s representatives advise that Anri and Alpina are not and never have been related, and that none of the royalty payment to Alpina inure to the benefit of the manufacturer, Anri. Schmid contends that the royalty payments are not dutiable because the payments are made to an unrelated third party, are not related to the imported merchandise and not a condition of sale of the imported articles. Further, Schmid asserts that the royalty arrangement is governed by the 1972 Licensing Agreement between Alpina and Schmid and the 1989 Amendment thereto, and that it confers on Schmid the exclusive right sell merchandise bearing the ANRI trademark in the U.S. and Canada. It is for this valuable right that payment is made to Licensor, Alpina, not for merchandise. RAD, Northeast Region, contends that the subject royalty payments are dutiable as royalties for a number of reasons. First, because the payments to the licensor from the importer are a condition of sale. They rely on several facts to support their position: (1) payments are based on exports from Italy and determined at the time of exportation, not on resales in the U.S. such that the obligation to pay the license fee accrues to Schmid upon exportation, thereby causing the royalty to be “related” to the imported merchandise; (2) without Schmid satisfying its legal obligation to pay the license fee to Alpina upon exportation, Schmid has no right to sell ANRI products in the U.S.; and, (3) Schmid’s accounting records reflect royalty payments to Alpina being charged to the product and reported as inventory under the same accounting treatment as Schmid follows to record the purchase of the wood statues from Anri--as such, RAD asserts that the accounting treatment suggests that the royalty expense is part of the purchase price of the imported articles--in contrast to recording the royalty as a period expense as part of Schmid’s general expenses. Alternatively, RAD suggests that the 10% royalty payments to Alpina are more in line with selling commissions which are dutiable under §402(b) (l)(B) of the TAA . The claim is based on information provided in a letter from the Anri president to Schmid’s counsel explaining the relationship between Anri and Alpina. In 1949, when the Anri-Alpina licensing agreement was initiated, Anri was a small wood carving company in need of international contacts and marketing skills, which Alpina was able to provide, pursuant to a distributorship agreement. Subsequently, the distributorship agreement was extended to include the territory of the United States. The letter also states: “In 1954, Alpina was entitled to support ANRI sales. For this purpose, Alpina obtained the right to use the ANRI trademarks and the rights to register copyrights wherever needed .” RAD asserts that the subject royalties are akin to selling commissions, as payment for services rendered by Alpina that are characteristic of a selling agent. The Distributorship Agreements referred to between Anri and Alpina have not been presented or reviewed in the context of this internal advice proceeding. ISSUE: Whether the subject trademark license fee/royalty, paid to an unrelated third party, calculated as a percentage of the purchase price between buyer and seller of the imported merchandise, is considered dutiable pursuant to Section 402(b)( l)(D) of the Tariff Act of 1930 as amended by the Trade Agreements Act of 1979 (TAA). LAW AN D A NALYSIS: Under the circumstances presented, it appears that transaction value is the proper basis of appraisement. Transaction value is defined in section 402(b)( l) of the TAA as the “price actually paid or payable for the merchandise” plus five enumerated statutory additions. Here, only one of the five statutory additions is at issue. Section 402(b)( l)(D) of the TAA provides for additions to the price actually paid or payable for: (D) 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. In Headquarters Ruling Letter (HRL) 544436, dated February 4, 1991 (C.S.D. 91-6; 25 Cus. Bull. 18), the importer was required to pay 7% of the U.S. resale price to the seller, in addition to the price originally paid to the seller for the imported merchandise. The importer had been paying duties on the additional 7% payments as “royalties” under section 402(b)(l)(D) of the Tariff Act of 1930, as amended by the TAA. In HRL 544436, Customs held that the payments were not dutiable under the royalty provision, section 402(b)(l)(D) of the TAA. Rather, Customs determined that the payments were proceeds of subsequent resale of the merchandise that accrued to the seller, dutiable under section 402(b)( 1)(E) of the TAA. This position represented a departure from previous interpretations of the royalty and proceeds provisions to the extent that it recognized the existence of dutiable proceeds under §402(b)(l)(E) without necessarily having a dutiable royalty under §402(b)(l)(D) of the TAA. On February 10, 1993, Customs published a General Notice in the Customs Bulletin, which incorporated Customs analysis of public comments concerning the change in position and our decision both modifying and affirming the holding in the HRL 544436. The determination in HRL 544436 was upheld in the General Notice and modified to the extent the subject payments were found to be dutiable as either royalties under 402(b)(l)(D) or proceeds under 402(b)(l)(E). The analysis first addressed the question of whether the payment qualified as a dutiable royalty. In addressing this issue, Customs took an historical approach that incorporates the Statement of Administrative Action (SAA), legislative history and case law under the prior statute. The analysis sets forth three questions derived from decisions by the Customs Court construing prior law to determine the dutiability of payments for royalties under export value. Applying these questions to particular import transactions under the current law provides importers and Customs with a uniform approach to determining whether certain payments constitute dutiable royalties, one of the statutory additions to the price actually paid or payable under transaction value.The analysis set forth in the General Notice on royalties is instructive in analyzing the dutiability of the royalties in the instant case. The three questions considered by Customs to be determinative with regard to finding a dutiable royalty in the General Notice were: Is the imported merchandise manufactured under patent? Is the royalty involved in the production or sale of the imported merchandise? Can the importer buy the product without paying the fee? Consistent with the Notice, negative responses to the first and second questions, and an affirmative response to the third, point toward non-dutiability. Here, the imported merchandise is not manufactured under patent or trademark. Rather, the license agreement between Schmid and Alpina gives Schmid the right to use the licensed mark in connection with sales in the U .S. of the imported merchandise. The royalty is not involved in the production and sale by the seller or the purchase of the imported merchandise by the buyer. The royalty is paid for the right to use the ANRI trademark in the U.S. and is separate from the purchase price of the merchandise. Finally, Schmid can purchase and import the merchandise from the manufacturer without paying the royalty to the third party licensor. Counsel indicated that other than the purchase transaction documents, no purchase contract between buyer and seller exists. The existing purchase documents (buyer’s purchase orders and seller’s confirmations), contain no requirement that a royalty payment be made to Licensor. The ANRI trademark is placed on the goods by the Seller prior to importation. However, the right to that trademark in the U.S. and Canada does not belong to the Seller. That right is the property of the Licensor, which has agreed that the buyer (Schmid) may exploit the mark in the territory. There is no prohibition against the buyer purchasing merchandise that does not bear the ANRI trademark. Such purchases would not result in an obligation to pay a royalty to Licensor. Your office argues that since Schmid has the legal obligation to pay the license fee to Alpina for the right to sell ANRI marked products in the U.S., an implied condition of sale exists. However, based on the facts presented here, this obligation to pay for the exclusive right to sell product in the U.S. is distinct from Schmid’s right to purchase the merchandise from ANRI. In addition, the Statement of Administrative Action (SAA) distinguishes payments to third parties for intellectual property rights from payments to importers for merchandise. It States: 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 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. 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. The SAA language makes clear the case-by-case nature of determinations about dutiability of royalty payments for intellectual property rights. Here, the evidence shows separate payments by Schmid to Alpina for the trademark rights. The fact that the royalty amount is based on a percentage of the purchase price and determined at the time the merchandise is exported to the U.S. is not dispositive of the existence of a condition of sale. While it may lend support to the notion that the royalty is in some way “related” to the imported merchandise, the statutory language and SAA require that the payment be a “condition of the sale of the imported merchandise for exportation to the United States.” Pursuant to the SAA language, we conclude that the subject royalty/license fee payment between Schmid and Alpina is not dutiable under §402(b)(l )(D). Schmid’s accounting treatment of the royalty payments reflects the fact that a cost was incurred. There is no dispute that royalty payments were made to third party licensor, Alpina. We find Schmid’s accounting treatment, such that the royalty payments to A1pina are charged to the product and reported as inventory under the same accounting treatment as Schmid follows to record the purchase of the wood statues from Anri, rather than recording the royalty as a period expense as part of Schmid’s general expenses, has no impact on determining the dutiability of the subject royalty/licensing fee. With regard to the assertion by RAD that the royalty payment is akin to a selling commission because Alpina provides “sales support” to Anri, no evidence, other than the letter from Anri to Schmid’s counsel has been provided detailing services rendered by Alpina to Anri. That letter from the Anri president refers to a distributorship agreement between Anri and Alpina, which we assume to be separate and distinct from the 1972 License Agreement between Schmid and Alpina, and the 1989 Amendment letter thereto. Counsel for Schmid has provided written assurances from Anri, that Anri and Alpina are not related parties, and that Schmid’s royalty payments to Alpina are for the right to use the trademark in the territory specified in the agreement. Accordingly, we find no basis to characterize the subject royalty payments as selling commissions absent further information regarding the existence of selling/marketing services performed by Alpina on Anri’s behalf relative to the subject imported merchandise.HOLDING: Based on the foregoing, we hold that payment of the subject license fee/royalty, by importer, Schmid, to third party licensor, Alpina, is not a condition of sale of the imported merchandise from seller, Anri, to buyer/importer, Schmid. Accordingly, the subject license fee/royalty does not constitute a dutiable royalty pursuant to §402(b)(l )(D) of the TAA . Sincerely, John Durant, Director Commercial Rulings Division