Dutiability of royalty payments for VCRs and camcorders incorporating patented technology; Section 402(b)(1)(D) of the TAA

HQ W545776 September 1, 1995 VAL R:C: V 545776 LPF CATEGORY: Valuation Sandra Liss Friedman, Esq. Barnes, Richardson & Colburn 475 Park Avenue South New York, NY 10016 RE: Dutiability of royalty payments for VCRs and camcorders incorporating patented technology; Section 402(b)(1)(D) of the TAA Dear Ms. Friedman:

This is in response to your letter of September 12, 1994, submitted on behalf of [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("Importer"), requesting a ruling concerning the dutiability of royalty payments made in connection with the use of patented technology. We have excised, in the public version of this decision, the information as indicated in our letter of August 29, 1995. FACTS: The agreement at issue was entered into between the Importer and its Japanese parent company, [xxxxxxxxxxxxxxxxxxxx] (“Parent Company”). In this agreement (“Parent Company/Importer Agreement”), the Parent Company granted the Importer certain rights that the former had acquired in an earlier agreement (“Licensor/Parent Company Agreement”) from [xxxxxxxxxxxxxxx] (“Licensor”), a U.S. patent holder. The Licensor/Parent Company Agreement, which included all of the Parent Company's affiliates and subsidiaries, granted to the Parent Company the right to make, have made, use, lease, sell, or otherwise dispose of VCRs, camcorders, and other consumer products that incorporated or used the Licensor's proprietary VCR programming algorithm known as the VCR Plus+ System ("Plus Technology"). The Licensor/Parent Company Agreement also granted the Parent Company a license to all patents, copyrights, and other rights related to the Plus Technology. In return, the Parent Company agreed to pay a continuing royalty for each of the licensed products sold, leased, or otherwise disposed of by the Parent Company. The royalty amount is a set dollar amount, which varies according to the volume of the sale, lease, or other disposal of the VCRs. In addition, the Licensor and the Parent Company entered into a Rider to their agreement wherein the Licensor extended its license to include the Cable Box Control Technology ("CBC Technology"), which included the design specifications for implementing the CBC Technology in VCRs incorporating the Plus Technology. In return, the Parent Company agreed to pay a one-time royalty and a continuing royalty payment per unit of the shipped licensed products that incorporated the CBC Technology. Thereafter, the Licensor and the Parent Company entered into the Indemnity Rider to the CBC Technology Rider, wherein the Licensor agreed to hold harmless the Parent Company against any lawsuit brought against it as a result of the Parent Company's inclusion of the CBC Technology in the VCRs it sold. In exchange, the Parent Company agreed to pay an additional payment per unit of the products shipped to the U.S. that incorporated the CBC Technology. In the subsequent Parent Company/Importer Agreement the Importer assumed the obligations previously imposed on the Parent Company under the Licensor/Parent Company Agreement, the CBC Rider, and the Indemnity Rider in return for the right to have the patented technologies used by [xxxxxxxxxxxxxxxxxxxxxxxxxxxx] ("Manufacturer") of Korea in the manufacture of VCRs imported by the Importer. In return, the Importer agreed to remit to the Parent Company the one time royalty payment and the continuing per unit royalty payment which the Parent Company was obligated to pay the Licensor under the CBC Technology Rider; the per unit continuing royalty based on the sale, lease, or other disposal of the VCRs in accordance with the Parent Company/Importer Agreement and the Licensor/Parent Company Agreement; and the indemnity payment per unit as set out in the Indemnity Rider. Thereafter the Parent Company makes these payments to the Licensor. All payments made to the Parent Company from the Importer will be preceded by a quarterly debit note from the former to the latter. You submit that at all times the Importer’s obligation to pay the royalty or indemnity under the Parent Company/Importer Agreement is triggered when the VCR is sold, leased, or otherwise disposed of by the Importer. Finally, you have verified that the entire royalty is paid by the Importer and received by the Licensor and that the manufacturer is unrelated to any of the parties involved. Based upon the information provided, it is your opinion that the royalty payments made by the Importer to the Licensor are not dutiable as royalties or proceeds. ISSUE: Whether the royalty payments made from the Importer to the Licensor for use of the patented technology are included within the transaction value of the imported merchandise as dutiable royalties. LAW AND ANALYSIS: The preferred method of appraising merchandise imported into the United States is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. 1401a. Section 402(b)(1) of the TAA provides, in pertinent part, that the transaction value of imported merchandise is the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus enumerated statutory additions, including any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to the U.S. (section 402(b)(1)(D)). For purposes of this decision, we have assumed transaction value is the appropriate method of appraisement. Based on the information provided, it appears that the royalty payments are not part of the price actually paid or payable for the merchandise since they are not part of the total payment, directly or indirectly, made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller. See section 402(b)(4)(a). In the present matter where such payments are made to an unrelated third party, and the evidence does not indicate otherwise, such amounts are not part of the price actually paid or payable. Therefore, we must consider whether the payments constitute royalties to be added to the price. With regard to royalties, the Statement of Administrative Action (SAA), adopted by Congress with the passage of the TAA. provides that: [a]dditions 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. Statement of Administrative Action, H.R. Doc. No. 153, Pt. II, 96th Cong., 1st Sess. (1979), reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 at 48-49 (1981). In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), Customs articulated three factors, based on prior court decisions, for determining whether a royalty was dutiable. These factors were whether: 1) the imported merchandise was manufactured under patent; 2) the royalty was involved in the production or sale of the imported merchandise and; 3) the importer could buy the product without paying the fee. Affirmative responses to factor one and two and a negative response to factor three would indicate that the payments were a condition of sale and, therefore, dutiable as royalty payments. In the present matter, first, it is not disputed that the imported merchandise is manufactured under patent, insofar as the patented technologies are utilized in the manufacturing process. Second, we find that the royalty is involved in the production or sale of the imported merchandise. The licensing agreements, the obligations under which are assumed by the Importer, provide the parent company and its affiliates with the right to have the patented technologies used by the Manufacturer in the manufacture of VCRs imported by the Importer. As indicated above, the Plus and CBC Technology, for which the royalties are paid, are incorporated into the imported merchandise. Without the licensing agreements, and the attendant royalty payments, the imported merchandise as such could not have been produced by the Manufacturer. However, with regard to the royalties paid due to the Indemnity Rider, we do agree with counsel that these amounts are not involved in the production or sale of the imported merchandise. Specifically, we note that such payments pertain instead to the Manufacturer's indemnity should a finding of patent infringement arise. In prior decisions, including the General Notice, supra, Customs acknowledged that the "answer to question three goes to the heart of whether a payment is considered to be a condition of sale." Although at times Customs may have indicated that a royalty less likely would constitute a condition of sale and, hence, be dutiable when the royalty was paid to a party other than the seller or a party related to the seller, this factor alone, especially when a patent is involved, does not automatically indicate that a payment is not a condition of sale. In particular, the language included in the SAA provides that royalties and license fees for patents covering processes to manufacture imported merchandise generally will be dutiable. Furthermore, we note 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 provide to whom, or for whose benefit, in particular, the payment is made. Although such a reference to the seller is included in the definition of the price actually paid or payable, it is conspicuously absent from the instant provision. In our opinion, this, along with the language included in the SAA, to wit, that royalties for patents covering manufacturing processes generally are dutiable, indicates that in regard to patents, the framers of the TAA recognized that royalties paid to unrelated third parties could constitute a condition of sale and, hence, be dutiable. In the instant matter, it appears the royalty is to be paid on each imported item that is purchased and resold by the Importer. Although you submit that the payments are not triggered by the importation of the VCRs since they become due only after the Importer sells or otherwise disposes of the merchandise in the U.S., we recognize that the goods only will be manufactured, imported, and subsequently resold based on the understanding or condition that such royalties are paid. Particularly, we note that the language included in the Parent Company/Importer Agreement refers to the merchandise at issue as the "Licensed Products as defined in the License Agreement" and provides that the Importer "desires to cause" the Manufacturer to "manufacture Licensed Products and desires to purchase from Suppliers and resell such Licensed Products." Parent Company/Importer Agreement at 1, 2. The agreement further refers to a one-time royalty to be paid to the Licensor for the CBC Technology which is "necessary for the ... development of Licensed Products incorporating such technology." Id. at 2. Additionally, the Licensor/Parent Company Agreement references a license from the Licensor "permitting access to Technology in connection with the manufacture of its VCRs" and indicates that a "royalty is due and payable at the time of delivery or shipment of the Licensed Product." Licensor/Parent Company Agreement at 1, 2. In our opinion this language repeatedly referencing the merchandise as the "licensed products" shows the clear, substantial nexus existing between the imported merchandise, patented technology, and applicable royalty payments. It is evident that these payments cause the patented technology to be utilized in the processing of the merchandise which is then sold for export to the U.S. Contrary to your position, we believe the one-time royalty payment is further indicia of such a nexus. However, we believe this analysis does not hold true for the royalties paid due to the Indemnity Rider. These payments pertain instead to the Manufacturer's indemnity should a finding of patent infringement arise, a consideration distinct from the manufacture and sale of the imported merchandise. In light of the fact that the SAA recognizes that such decisions will be made case-by-case, we do not find the cases you cite, Headquarters Ruling Letters 545370, issued March 4, 1994, and 542844, issued June 17, 1982, controlling in the present matter. In fact, we are aware that at least one of these decisions does not concern patent rights. For these reasons, it is our position that the importer cannot buy the imported merchandise without paying the fee, and based on this entire analysis, that the royalty payments are a condition of sale of the imported merchandise in accordance with section 402(b)(1)(D). As we have determined that the subject royalty payments are to be added to the price actually paid or payable, pursuant to section 402(b)(1)(D), and since we recognize that the patent process was developed in the U.S., it is unnecessary for purposes of this decision to consider whether the payments alternatively may be dutiable as assists in accordance with section 402(b) (1)(C). HOLDING: Based on the facts submitted, the payments made to the Licensor, except for those made due to the Indemnity Rider, constitute royalties to be included within the transaction value of the imported merchandise. Sincerely, John Durant, Director Commercial Rulings Division