Royalty payments; proceeds; condition of sale

HQ W545419 November 30, 1995 VAL RR:IT:VA 545419 CRS CATEGORY: Valuation Mr. Mark K. Neville, Jr. International Trade Counsellors 51 Marion Road Westport, CT 06880 RE: Royalty payments; proceeds; condition of sale Dear Mr. Neville: This is in reply to your letter, dated August 27, 1993, on behalf of [XXXXXXX Corporation] concerning the dutiability of certain royalty payments made to its [XXXXX] parent, [XXXXXXXXXXXXXX]. An additional submission was made under cover of a letter dated May 24, 1994. Pursuant to your request for confidentiality, those portions of the text that are bracketed will be deleted from any published version of this ruling. We regret the delay in responding. FACTS: [XXXXX Corporation] (the "licensee") buys parts and components from [XXXXX XXXXX] (the "licensor") and imports these articles into the United States. The licensee and licensor are, respectively, the buyer and seller of the imported merchandise. In the U.S., the imported parts and components are used along with domestic parts to manufacture the licensor's type [XXXXXXXXXX] photomultiplier tubes (the "licensed products"). Pursuant to an agreement dated December 1, 1985, the licensor granted the licensee the right to manufacture and sell the licensed products, and agreed to provide the licensee with technical assistance and "know-how" in connection with their manufacture. In consideration for these rights, the licensee agreed to pay the licensor a fee in an amount equal to a percentage of the net sales price of the licensed products. As the result of an addendum to the original agreement, the amount of the royalty was reduced to [XXXXXX] percent of the net sales price of the licensed products. The licensed products manufactured by the licensee are then sold to the licensor and to third parties. In the case of sales to the licensor, the net sales price is discounted and the royalty is computed on the basis of the ex-discount amount. In the case of sales to third parties, the licensee pays the licensor the full amount of the royalty. The licensee also purchases a number of finished products from the licensor. However, no royalty is paid in respect of these purchases which you state represent approximately [XXXXXXX] percent of the licensee’s total imports. You have also advised that the royalty payment is not connected with any patent rights. In addition, you state that purchase orders for the imported components do not refer to the royalty payment or the obligation to pay a royalty. ISSUE: The issue presented is whether the payments made by the licensee to the licensor are royalties or proceeds such that they constitute an addition to the price actually paid or payable for the imported components. 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; 19 U.S.C. § 1401a). The preferred method of appraisement is transaction value, defined as the price actually paid or payable for the merchandise when sold for exportation to the United States. The term "price actually paid or payable" is defined as "the total payment...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). However, 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." 19 U.S.C. § 1401a(b)(2)(B). Here, the licensee/buyer is a subsidiary of the licensor/seller such that the parties are related within the meaning of section 402(g)(1)(F) of the TAA; but since no information regarding the acceptability of transaction value was submitted with your ruling request we are unable to determine if transaction value is the appropriate basis of appraisement. Nevertheless, if it is determined at the time of importation that transaction value is applicable, the following constitutes our position in respect of the royalty payments at issue. Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable including: any royalty or license fee related to the 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; and the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller. 19 U.S.C. § 1401a(b)(1)(D)-(E). You contend that payments at issue should not be added to the price actually paid or payable of the imported components under either the royalties or proceeds provisions of the TAA. In regard to the dutiability of royalties, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in pertinent part: 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 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.... 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.... [A]n 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, 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. Furthermore, as to whether a royalty payment is a condition of sale, Customs has identified three questions that are particularly relevant in determining dutiability. General Notice, "Dutiability of Royalty Payments," 27:6 Cust. B. & Dec 1 (February 10, 1993). The questions are as follows: (1) was the imported merchandise manufactured under patent? (2) was the royalty involved in the production or sale of the imported merchandise? and (3) could the importer buy the product without paying the fee? 27:6 Cust. B. & Dec. at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability. The notice also stated that royalties may be dutiable under 402(b)(1)(E) of the TAA, as well as under section 402(b)(1)(D). In the instant case, the imported merchandise is not manufactured under patent. Moreover, the payments at issue are not made in respect of a process to manufacture. Rather, the agreement provides that payments are to be made as compensation for the licensor’s technical assistance and "know-how," and for the right to manufacture the licensed products in the U.S. Thus, the first two questions are answered in the negative. The third question posed by the notice is whether the importer could buy the merchandise without paying the fee. The answer to this question is central to the issue of dutiability, i.e., whether the payment is a condition of sale. 27:6 Cust. B. & Dec. at 11. Payments that must be made for each imported item are a condition of sale. Royalty payments are also a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise; but if the payment is optional and not inextricably intertwined with the imported merchandise, or is paid solely for the exclusive right to manufacture and sell in a designated area, it is not dutiable. 27:6 Cust. B. & Dec. at 9-11. Furthermore, as the SAA makes clear, 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 sale. In Headquarters Ruling Letter (HRL) 545361, dated July 20, 1995, we held that royalty payments were a condition of sale when they were paid to the seller of the imported merchandise, or to a third party licensor related to the seller. The imported merchandise was not further processed in the U.S. Here, the royalties are paid by the buyer to the licensor, the seller of the imported components. This fact suggests that the payments at issue may be dutiable. However, in HRL 545307, dated February 3, 1995, the buyer imported a base chemical and used it as the active ingredient in the manufacture of a finished pharmaceutical product. Pursuant to the terms of the license agreement, the buyer agreed to pay a royalty based on the selling price of the finished product for the right to use the seller’s scientific and technical information in connection with the manufacture of the finished product. On the basis of the information presented, we determined that the buyer could purchase the active ingredient without paying the fee. Since there was nothing to indicate that the royalties were an explicit condition of sale, the payments did not constitute an addition to the price actually paid or payable. See also HRL 545114, dated September 30, 1993. Nevertheless, in HRL 544991, dated September 13, 1995, royalty payments were paid in consideration of licensed technology and technical assistance provided by the seller/licensor to the importer/buyer. As in HRL 545307 the imported merchandise (parts) was used to manufacture a finished product (machines) and the royalties were based on the selling price of the finished product. However, an agreement between the seller/licensor and the import/buyer effectively linked the payment of the royalties to the purchase of the imported parts. Consequently, it was determined that as the importer could not buy the imported merchandise without paying the fee, the royalties were a condition of sale and, therefore, dutiable. See also HRL 545380, dated March 30, 1995; HRL 544978, dated April 27, 1995 (royalty payments based on a percentage of the sales of a finished product made from imported merchandise were a condition of sale where the sales contracts and licensing agreements were linked); HRL 544800, dated May 17, 1994 (royalties paid on resale of imported pharmaceutical product was dutiable as part of the price actually paid or payable, as a royalty, or as a proceed of a subsequent resale, disposal or use); and HRL 545784, dated June 6, 1995 (royalty payments based on the sale of products manufactured using an imported machine were a condition of sale where the payment of the royalties and the sale of the machine to the importer were inextricably intertwined). In the instant case, the royalties are paid on a percentage of the net sales price of the licensed products, made in part from the imported components. There is nothing in the license agreement to link the payment of the royalties to the purchase of the imported components. In particular, you have stated that the purchase orders do not refer to, and are not linked with, the royalty payments. Accordingly, it is our position that the payments are not a condition of sale of the imported parts and, thus, not an addition to the price actually paid or payable of the imported merchandise under section 402(b)(1)(D) of the TAA. Please note, however, that our answer would be different if it were determined that royalty payment and the sale of the imported merchandise were linked. Payments that are not dutiable under section 402(b)(1)(D) of the TAA may still be dutiable pursuant to section 402(b)(1)(E). 27:6 Cust. B. & Dec. at 12-13. Under section 402(b)(1)(E), the proceeds of a subsequent resale, disposal, or use that accrue, directly or indirectly, to the seller, are an addition to the price actually paid or payable for the imported merchandise. 19 U.S.C. § 1401a(b)(1). In the instant case, the imported merchandise is used to manufacture a finished product, i.e., the photomultiplier tubes, and the royalty payments are based on the net sales price of the tubes. Since the payments at issue are based partially on the imported merchandise and partially on other factors it would be inappropriate to make an addition to the price actually paid or payable. Accordingly, based on the information furnished, the payments at issue do not constitute an addition to the price actually paid or payable under section 402(b)(1)(E) of the TAA. See also, Headquarters Ruling Letter (HRL) 544656 dated June 19, 1991, C.S.D. 92-12; HRL 545114 dated September 30, 1993; HRL 545307 dated February 3, 1995. HOLDING: Based on the information submitted, the royalty payments at issue do not constitute additions to the price actually paid or payable of the imported components under sections 402(b)(1)(D) or 402(b)(1)(E) of the TAA. Sincerely, Acting Director International Trade Compliance Division