VAL R:C:V 545784 LR
District Director
U.S. Customs Service
Seattle, Washington
RE: I.A. 39/94; royalties; proceeds; sufficient information; interest
Dear Sir:
This is in response to your request for Internal Advice 39/94,
dated June 2, 1994, regarding the dutiability of royalties paid by
Nichimo USA ("importer") to Nichimo Co., Ltd. Of Japan ("seller") for
manufacturing know-how associated with the purchase and use of an
imported Net Making Machine. Your request was forwarded to us by the
Chief, NIS Machinery Branch, New York Seaport on September 14, 1994. On
September 22, 1994, your office notified the importer of your request
for internal advice and indicated that any written comments submitted
within 30 days would be considered. No written comments from the
importer were received. We regret the delay in responding.
FACTS:
You state that the importer is a wholly owned subsidiary of the
seller. By purchase agreement dated January 1992 ("Supply Agreement"),
the importer agreed to purchase and the seller agreed to sell a used
Ultra Net Making Machine ("Machine") and accessories. You state that
the Machine, which manufactures knotless fish netting ("Product"), is
unique. You further indicate that the Machine is internationally
patented but that the importer stated that it was impossible to furnish
a copy of this patent as it is located in Japan.
The Supply Agreement provides that the importer will pay the
seller the purchase price in five yearly installments including ten
percent interest. The amount of interest is separately identified. The
Supply Agreement further provides that the seller retains ownership
until all payments have been finalized and that the importer cannot
resell the Machine even if ownership is transferred to the importer,
because the Machine includes the production know-how which is owned by
the seller. A copy of the Supply Agreement was submitted.
A separate Royalty Agreement dated May 1, 1992 ("Royalty
Agreement"), between the importer and the seller provides that the
parties shall agree on the royalty of manufacturing know-how owned by
the seller concerning the Machine as follows: 1) the importer shall pay
to the seller as royalty 5% of the domestic sales price in U.S.A. on all
Products manufactured by the Partnership and 2) the payment of the
royalty shall be continually made as long as the partnership for
manufacturing the Product continued and existed. A copy of the Royalty
Agreement was provided.
You indicate that the Machine was imported on May 1, 1992 and is
leased to Superior Netting Products, Inc., a joint venture between the
importer and another company ("the Partnership"). The entry has not
been liquidated.
You ask us to address: 1) whether the royalty payments are
dutiable and if so, for how long; and 2) whether the interest charges on
the Machine paid after the date of importation are dutiable.
Your opinion is that the royalty payments are part of transaction
value because they are a condition of sale of the imported machine.
While the New York Seaport generally concurs with your analysis
regarding this issue, that office is of the opinion that transaction
value does not exist because the royalty is not quantifiable. Although
the importer has not submitted any written comments, you advise that its
position is that the royalty is for the value of a technician furnished
to the importer to set up the machine and train personnel and that these
expenses for the technician are paid as a separate cost by the importer.
ISSUES:
1. Whether the 5% royalties paid by the importer to the seller based on
sales of Products manufactured using the imported Machine should be
added to the price actually paid or payable and if so, for how long.
2. Whether the portion of the price representing interest is dutiable.
LAW AND ANALYSIS:
As you are aware, 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 United States (section 402(b)(1)(D)) and the
proceeds of any subsequent resale, disposal or use of the imported
merchandise that accrue to the seller (section 402(b)(1)(E)).
The "price actually paid or payable" is defined in section
402(b)(4)(A) of the TAA as the "total payment (whether direct or
indirect, and exclusive of any costs, charges, or expenses incurred for
transportation, insurance, and related services incident to the
international shipment of the merchandise...) made, or to be made, for
the imported merchandise by the buyer to, or for the benefit of, the
seller." The price actually paid or payable for imported merchandise
shall be increased by the amounts attributable to the enumerated
additions only to the extent that each such amount is not otherwise
included within the price actually paid or payable; and is based on
sufficient information. Section 402(b)(1) TAA.
The transaction value between a related buyer and seller is
acceptable if an examination of the circumstances of the sale of the
imported merchandise indicates that the relationship between such buyer
and seller did not influence the price actually paid or payable or if
the transaction value of the imported merchandise closely approximates
certain "test values". For purposes of this ruling we assume that
transaction value is acceptable.
ADDITIONS TO PRICE ACTUALLY PAID OR PAYABLE
Additions under 402(b)(1)(D)
Since the subject royalties are not included in the price actually
paid or payable, we must analyze whether they should be added thereto
under section 402(b)(1)(D) TAA. Under this provision, an addition is
made for 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." Thus, in order to be dutiable under this provision, the
royalty must be related to the imported merchandise and the payment of
such royalty must be a condition of the sale of the imported
merchandise. The following three questions are relevant in determining
whether these conditions are satisfied: 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. An affirmative answer to questions 1
and 2 and a negative answer to question 3 points to dutiability. See
General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B.
& Dec. at 1 (February 10, 1993) ("Hasbro II ruling").
In this case, the answer to the first question is "yes"; the
Machine was manufactured under patent. Royalties and license fees for
patents covering processes to manufacture the imported merchandise will
generally be dutiable. See Statement of Administrative Action (SAA),
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(1981) The answer to the second question is "yes"; the
royalty was involved in the sale of the imported Machine. As indicated
above, the Supply Agreement specifically states that the importer shall
not resell the Machine because it includes the production know-how which
is owned by the seller. Thus, in order to purchase and use this
patented machine, the importer must pay the seller the royalties in
question. The sale of the Machine to the importer is inextricably
intertwined with the payment of the royalties. Finally, the answer to
the third question is "no"; the importer could not buy the Machine
without paying the royalty. Again, we refer to the language in the
Supply Agreement that the Machine includes production know-how owned by
the seller and that the importer is precluded from selling the Machine.
Based on this language and the Royalty Agreement, we conclude that the
importer could not buy the machine without paying the royalty.
Also, we note that as in Hasbro II, the royalties are paid by the
buyer to the seller. In determining that the royalties could have been
considered to be dutiable under section 402(b)(1)(D), Customs referred
to the language in the SAA regarding royalties paid by the buyer to the
seller:
. . . 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 the sale
of the imported merchandise for exportation to the United States
(emphasis added).
Hasbro II at page 12.
In this case, the importer/buyer has not established that the
royalty payment is distinct from the price actually paid or payable for
the machine and that it was not a condition of importation. As
discussed above, we believe that the facts indicate otherwise.
Finally, in Hasbro II, Customs determined that the method of
calculating the royalty, e.g. on the resale price of the goods, is not
relevant to determining the dutiability of the royalty payment. Thus,
in this case, the fact that royalty is based on a percentage of the
sales price of the Products manufactured with the Machine, is not
relevant.
Based on the above considerations, we find that the royalty
payments relate to the imported Machine and that such payments are a
condition of sale of the imported merchandise. Therefore, provided the
amount of the royalties is based on sufficient information, the
royalties are to be added to the price actually paid or payable for the
Machine under section 402(b)(1)(D).
Additions under 402(b)(1)(E)
Alternatively, as discussed below, the royalties in question are
dutiable under section 402(a)(1)(E) TAA, as proceeds of any subsequent
resale, disposal or use of the imported merchandise that accrue to the
seller are dutiable. (Emphasis added). With regard proceeds, the SAA,
supra, reprinted in Department of the Treasury, Customs Valuation under
the Trade Agreements Act of 1979 at 49, provides that:
[a]dditions for the value of any part of the proceeds of any
subsequent resale, disposal or use of the imported merchandise
that accrues directly or indirectly to the seller, do not extend
to the flow of dividends or other payments from the buyer to the
seller that do not directly relate to the imported merchandise.
Whether an addition will be made must be determined on a case-by-case basis depending on the facts of each individual transaction.
In Hasbro II, supra at 13, Customs referred to the definition of
proceeds in analyzing whether certain payments were proceeds within the
meaning of section 402(b)(1)(E). The decision states:
Proceeds are defined as "issues or income; yield; receipts;
produce; money or articles of other thing of value arising or
obtained by the sale of property; the sum, amount, or value of
property sold or converted into money or into other property.
Notice, p. 13 cited Black's Law dictionary, 6th ed., 1990 at p.
1204. Another definition of proceeds is "what is produced by or
derived from something (as a sale investment, levy, business) by
way of total revenue: the total amount brought in ***." Webster's
Third New International Dictionary 1986.
In applying this definition in the context of 402(b)(1)(E) the
income produced from the subsequent resale, disposal, or use of
the imported merchandise that accrues directly, or indirectly, to
the seller is added to the price actually paid or payable for the
imported goods.
In Hasbro II, the payments at issue accrued to the seller upon the
resale of the imported merchandise. Specifically, the seller received
7% of income from the subsequent resale of the imported merchandise.
Customs ruled that such payments constituted proceeds of the subsequent
resale of the imported merchandise and were to be added to the price
actually paid or payable for the imported merchandise. See also HRL
544800, May 17, 1994 (regarding proceeds of a subsequent resale). In
other rulings, Customs considered whether royalty payments accrued to
the seller upon the resale of the imported merchandise where the royalty
was based on the sale of a finished product which incorporated the
imported product. See HRL 545307, February 3, 1995; C.S.D. 93-26 (HRL
545114, September 30, 1993); C.S.D. 92-12 (HRL 544656, June 19, 1991).
The present case is different from the above rulings because the
Machine is not the subject of a subsequent resale. The issue here is
whether proceeds accruing to the seller from the use of the imported
merchandise are dutiable. Although we have not previously considered
this question we believe that under appropriate circumstances they are.
As the statutory language makes clear, it is not necessary for the
proceeds to accrue from the resale of the imported product; the proceeds
may also accrue from the use of the imported product. We believe that
the present case falls squarely within the language of 402(b)(1)(E). As
indicated above, the imported Machine contains the production know-how
for which the royalties are paid. The importer pays the seller
royalties for the right to purchase and use the imported Machine. The
royalties are paid to the seller each time the Machine is used to
produce the Product and such Product is sold. We conclude that the
royalty is income which accrues to the seller upon the subsequent use of
the imported Machine. The royalty may be added to the price actually
paid or payable under 402(b)(1)(E) provided there is sufficient
information to determine the amount.
Thus, the instant case involves the type of situation described by
Congress where "certain elements called royalties' may fall within the
scope of the language under either new section 402(b)(1)(D) or
402(b)(1)(E) or both. See, Hasbro II at 13, quoting from H.R. Rep. No
317, 96th Cong., 1st Sess. (1979) at 80 and S. Rep. No. 249, 96th Cong.,
1st Sess., at 120 (1979).
Sufficiency of Information
The next issue to be addressed is whether there is sufficient
information to determine the amount of the royalties/proceeds. This
issue arises because the royalties are not due until the Products
manufactured using the imported Machine are sold in the U.S.
Section 402(b) TAA provides that the price actually paid or
payable for imported merchandise shall be increased by the amounts
attributable to the enumerated items only to the extent that such amount
is based on sufficient information. If sufficient information is not
available, for any reason, ... the transaction value of the imported
merchandise concerned shall be treated, for purposes of this section, as
one that cannot be determined. The term "sufficient information" is
defined as "information that establishes the accuracy of such amount,
difference, or adjustment."
In HRL 545504, May 4, 1995, involving proceeds under section
402(b)(1)(E), counsel argued that there was a lack of sufficient
information to establish transaction value because the proceeds cannot
be quantified in a reasonable period of time. In that case, the buyer
was required to account for sales on a quarterly basis, with an
accounting and payment due 30 days after the end of a quarter. Customs
rejected counsel's argument noting the following:
The TAA is designed to accommodate situations in which a purchase
price is established, but not paid, at the time merchandise is
imported into the United States. For purposes of the transaction
value provision, a bona fide sale may be found to exist even
though actual payment has not been made for goods at the time of
importation, provided that the purchase agreement includes fixed
terms which make the purchase price either determined or
determinable at that time.
Two situations in which a buyer and a seller have potentially
agreed to a price without full payment being made prior to or at
the time of importation involve royalties and proceeds of
subsequent resale, disposal or use of the imported merchandise.
In both of these instances, Customs must determine whether
payments - which inure to the benefit of a foreign seller after
importation has occurred -- should be added to the "price actually
paid or payable" for purposes of calculating the duty owed. Such
amounts should be added provided there is sufficient information
upon which to determine the amounts therefor.
. . . we do not find that such a payment arrangement indicates,
prima facie, that the proceeds cannot be quantified in a
reasonable period of time and, hence, that there is a lack of
sufficient information. It is our position that the term
"subsequent resale," by its very nature, implies that proceeds may
not be paid, or even quantifiable, for some time after importation
of the merchandise. Furthermore, we do not believe the payment
structure agreed to by the parties is uncommon in such
transaction. To hold otherwise could render transaction value
unacceptable in numerous cases in which proceeds subsequently
accrue to the seller. Cf. HRL 542701, TAA No. 47, issued April
28, 1982, and HRL 542746, issued March 30, 1982.
In this case, even though the amount of the royalty/proceeds
addition is not known at the time of importation, we believe that there
is sufficient information to determine the amount of the addition. The
royalty agreement clearly specifies how the royalties are to be
calculated. As such, there is information that establishes the accuracy
of such amount. Additions should be made for the royalties/proceeds
paid by the importer to the seller up to the time the entry is
liquidated. You should request an accounting from the importer
regarding royalties paid to the seller in order to determine the proper
amount of the addition. If such an accounting is not provided and you
cannot otherwise determine the amount of the royalties/proceeds, the
Machine cannot be appraised based on transaction value.
DUTIABILITY OF INTEREST PAYMENTS
The Supply Agreement provides that the importer will pay the
seller the purchase price in five yearly installments including ten
percent interest. The interest charges are identified separately in the
Supply Agreement. In T.D. 85-111, July 17, 1985, Customs indicated that
interest payments, whether or not included in the price actually paid or
payable for imported merchandise, should be not considered part of
dutiable value provided the following criteria are satisfied:
1. the interest charges are identified separately from the price
actually paid or payable;
2. the financing arrangement in question is made in writing;
3. when required by Customs, the buyer can demonstrate that the
goods undergoing appraisement are actually sold at the price
declared as the price actually paid or payable, and the claimed
rate of interest does not exceed the level for such transaction
prevailing in the country where, and at the time, when the
financing was provided.
On July 17, 1989, Customs published a Statement of Clarification
regarding T.D. 85-111 (54 FR 29973) in which we stated that for the
purposes of T.D. 85-111, the term "interest encompasses only bona fide
interest charges, not simply the notion of interest arising out of
delayed payment." Customs added that "bona fide interest charges are
those payments that are carried on the importer's books as interest
expenses in conformance with generally accepted accounting principles."
This clarification became effective October 16, 1989. See also, C.S.D.
91-10 which applied the statement of Clarification for T.D. 85-111.
In this case, the interest charges on the imported machine are
excluded from the price actually paid or payable provided the conditions
set forth above are met.
HOLDING:
The royalty payments made by the importer to the seller should be
added to the price actually paid or payable for the imported machines
either as royalties under section 402(b)(1)(D) or proceeds of a
subsequent use under section 402(b)(1)(E). Additions should be made for
royalty payments made by the importer to the seller up to the time of
liquidation. Interest charges are excluded from the price actually paid
or payable if the conditions set forth in T.D. 85-111 and the Statement
of Clarification are met.
Sincerely,
John Durant, Director
Commercial Rulings Division