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

HQ W545777 September 1, 1995 VAL 545777 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 (**********************), (“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, (*********************) (“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 (********************) (“Licensor”), a German patent holder. The Licensor/ Parent Company Agreement, which included all of the Parent Company’s subsidiaries, granted to the Parent Company the right to manufacture, sell, or otherwise dispose of VCRs, camcorders, and other consumer products that incorporated or used the Licensor’s proprietary video programming system (“Technology”). The Licensor/ Parent Company Agreement also granted the Parent Company a release from any claim arising out of an alleged violation of the Licensor’s patents prior to April 1990. In return, the Parent Company agreed to pay a non-refundable down payment and a continuing royalty for each of the licensed products manufactured, sold, or otherwise disposed of by the Parent Company. The royalty amount differed according to the geographic region of the manufacture, sale, or disposal of the merchandise. In the subsequent Parent Company/ Importer Agreement, the Importer assumed the obligations previously imposed on the Parent Company under the Licensor/ Parent Company Agreement, on merchandise the Importer purchased from (*************************) (“Manufacturer”) of Korea and sold in the U.S. In return, the Importer agreed to remit to the Parent Company the continuing royalty payment for the licensed products produced by the Manufacturer and sold by the Importer in the U.S. Subsequently, the Parent Company makes these payments to the Licensor pursuant to the Licensor/ Parent Company Agreement. You submit that at all times the Importer’s obligation to pay the royalty under the Parent Company/ Importer Agreement is triggered when merchandise purchased from the Manufacturer is sold by the Importer in the U.S. Additionally, 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. 1401 a. 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 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 (SAR), 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. 11, 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 factors 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 subsidiaries with the right to have the patented technologies used by the Manufacturer in the manufacture of VCRs and camcorders imported by the Importer. As indicated above, the 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. 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 state to whom, or for whose benefit, in particular, 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 instant provision. In our opinion, this, along with the language included in the SAÄ, 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 or camcorders 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 provides that “such Contract Products shall be covered by the Agreement and subject to royalty payments” and that the Importer will pay the amount of the “royalties for the Contract Products manufactured [by the foreign Manufacturer] and purchased and sold in U.S.A.” Parent Company/ Importer Agreement at 1, 2. Additionally, the Licensor/ Parent Company Agreement states that the Licensor granted the Parent Company a “license under the Contract Patents to manufacture and sell or otherwise dispose of Contract Products manufactured by the [Parent Company]” and refers to the payment of a royalty for each “Contract Product manufactured or sold or otherwise disposed of for consumption in the Contract Territory US.” Licensor/ Parent Company Agreement at 3, 4. In our opinion this language repeatedly referencing the merchandise as, and royalties for, the [foreign] manufactured Contract 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. 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). Although it is likely that the payments alternatively may be dutiable as assists pursuant to section 402 (b) (1) (C) , since 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) , it is unnecessary for the purposes of this decision to reach a finding in this regard. HOLDING : Based on the facts submitted, the payments made to the Licensor constitute royalties to be included within the transaction value of the imported merchandise. Sincerely, John Durant, Director Commercial Rulings