VAL RR:IT:VA 546782 CRS
Louis S. Shoichet, Esq.
Tompkins & Davidson, LLP
One Astor Plaza
1515 Broadway, 43rd Floor
New York, NY 10036-8901
RE: Royalty payments; license fees; related parties
Dear Mr. Shoichet:
This is in reply to your letter of June 18, 1997, under cover of which you requested a ruling on behalf of your client, [**************], on the dutiability of certain royalty payments. An additional submission was made under cover of a letter dated September 15, 1999, following a meeting at Customs Headquarters on July 14, 1999. We regret the delay in responding.
In accordance with section 177.2(b)(7), Customs Regulations (19 C.F.R. § 177.2(b)(7)), you have requested that the names of the parties to this transaction be treated as confidential. Pursuant to your request, we will excise the bracketed confidential information from public versions of this decision. We also note that a prior disclosure was filed with the port of New York, JFK Area, on February 24, 1997, but that no action has been taken in this regard.
FACTS:
Your client [*********] (hereinafter, the “importer”) is a wholly owned subsidiary of [**** ************ (hereinafter, the “seller”), a German corporation, from which it purchases and imports women’s apparel and accessories. The imported merchandise bears the [**************] trademark. Entries of the imported merchandise are primarily filed through the port of JFK.
Under the terms of a license agreement (hereinafter, the “license agreement”) with a French licensor, [*******************] (hereinafter, the “licensor”), the importer obtained the exclusive right to use the [********] trademark (hereinafter, the “trademark”) in connection with the manufacture, distribution and marketing of ladies ready-to-wear apparel and accessories in the United States and Canada. In return for these rights, the importer agreed to pay the licensor a semi-annual royalty equal to four percent of the net sales of the trademarked products in the U.S. and Canada. The license agreement was subsequently amended to provide for quarterly payment of the royalty.
The licensor is a French partnership in which the ownership interest is split equally (50-50) between [****************] (hereinafter “Group”) and [****************] (hereinafter “GmbH”). Group is comprised of [***************((****] (hereinafter “F1”), and members of the family of [**************] (hereinafter “F2”). GmbH is a German corporation in which Frau [********] is the majority shareholder. [**********] (hereinafter “Madame”) of Licensor Group, and Frau of GmbH are co-managing directors of the licensor. You have advised that under the by-laws, Madame and Frau are each entitled to one vote and that business decisions must be jointly approved by each side prior to adoption.
You state that the license agreement does not refer to, nor provide for, the sale of the imported merchandise, nor does it require that the importer purchase merchandise from the seller. In addition, you have advised that the purchase agreements between the importer and the seller are not subject to the terms and conditions of the license agreement. Pursuant to article 5 of the license agreement, the importer is entitled to grant sub-licenses to firms in the [*****] (hereinafter “Seller”) Group, i.e., any firms whose stock is held at least fifty percent by [************] (hereinafter, “Frau”) and her children.
In addition, the agreement provides that the licensor also will supply certain general styling information and conceptual designs to the importer. This information consists of sketches and, on request, paper patterns. The importer is also permitted under the agreement to attend two fashion shows annually in which the F2 couture collection is displayed to the media, and to work with F2 designers for a half day. The sketches are not used in the production of the imported merchandise, nor do they contain technical production information. The imported merchandise is designed by the seller and manufactured from patterns produced exclusively by the seller. The sketches and patterns are provided solely to assist the importer in the development of its U.S. product specifications. The actual designs and patterns used in the production of the imported merchandise are supplied by the seller and the cost of these items is included in its sales price.
In affidavits dated August 28, 1999, Frau and the former Managing Director of the seller, stated that sales by the seller to the importer were undertaken without regard to the payment of the royalty and that sales between the seller and the importer were not connected or linked to the license agreement between the importer and the licensor. Frau stated that no portion of the royalty payments from the importer were ever rebated to her directly or as a separate or quantifiable element of any dividend.
ISSUES:
The issues presented are: whether the royalty payments made by the importer to the licensor are included in the transaction value of the imported merchandise bearing the licensor’s trademark; and whether certain technical information provided by the licensor to the importer constitutes an assist.
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 (19 U.S.C. § 1401a; TAA). The primary method of appraisement under the TAA is transaction value, defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States, plus amounts equal to” certain statutorily enumerated additions to the price actually paid or payable including the value, apportioned, as appropriate, of any assist. 19 U.S.C. § 1401a(b)(1). The additions include: any royalty or license fee 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; 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).
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). In the instant case, the importer and the seller of the imported merchandise are related pursuant to 19 U.S.C. § 1401a(g)(1)(F). Insufficient information regarding the acceptability of transaction value has been submitted; however, absent any information to the contrary, we have assumed for purposes of this ruling that transaction value is the appropriate method of appraisement.
The term “price actually paid or payable is defined as “the total payment (whether direct or indirect...) 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). Customs presumes that all payments made by the buyer to the seller, or a party related to the seller, are part of the price actually paid or payable. Generra Sportswear Co. v. United States, 905 F.2d 377, 380 (Ct. Int’l Trade 1990) (holding that so long as quota payments were made to the seller in exchange for merchandise sold for export to the U.S., they “properly may be included in transaction value, even if [they represent] something other than the per se value of the goods”); see also, Moss Manufacturing Co., Inc. v. United States, 714 F.Supp. 1223 (Ct. Int’l Trade 1989), aff’d., 896 F.2d 535, 539 (CAFC 1990) (stating, in finding that commissions payments remitted by the buyer to the seller for later payment to a related party were included in transaction value, that the straightforward approach of transaction value is “no doubt intended to enhance the efficiency of Customs’ appraisal procedure; it would be frustrated were to parse the statutory language...and require Customs to engage in formidable fact-finding). However, this presumption may be rebutted by evidence which clearly establishes that the payments are completely unrelated to the imported merchandise. Chrysler Corporation v. United States, 17 Ct. Int’l Trade 1049 (1993).
In the instant case, the royalty payments were made by the importer/buyer to the licensor. The licensor is a French partnership in which the ownership interest is split equally (50-50) between Group and GmbH. GmbH and the licensor are related pursuant to 19 U.S.C. § 1401a(g)(1)(F) which defines “related persons” as including “any person directly or indirectly owning, controlling, or holding with power to vote, 5 percent or more of the outstanding voting stock or shares of any organization and such organization.” In addition, Frau is a co-managing director of the licensor.
Frau is also the majority shareholder in the seller and in GmbH, the seller’s parent company. Thus, Frau is related to both the seller and GmbH under 19 U.S.C. § 1401a(g)(1)(F). As previously noted, the seller and the importer are related, the latter being the seller’s wholly owned subsidiary. Section 402(g)(1)(G) of the TAA provides that two or more persons directly or indirectly controlling, controlled by, or under common control with, any person” are related. The determination of what constitutes "control" is made on a case by case basis within the context of the administrative review procedures available to the importing public the Customs Regulations. General Notice, 58 Fed. Reg. 5445, January 21, 1993; 27:4 Cust. B. & Dec. 4, entitled, "Transfer Pricing; Related Party Transactions" (hereinafter, the “Transfer Pricing Notice”); see also, Headquarters Ruling Letter (HRL) 545481 dated September 14, 1994; HRL 545435 dated March 2, 1994.
Accordingly, we find that the licensor and the importer are related persons under the TAA in that they are directly or indirectly controlled by, or under common control with, Frau. Frau is the majority shareholder in GmbH, the seller’s parent, and a partner and fifty percent shareholder in the licensor. As such, we find that for purposes of section 402 of the TAA, Frau is legally or operationally in a position to exercise restraint or direction over both the licensor and the importer.
Since the payments at issue were made by the importer/buyer to a third party related to the seller, we find that they are included in transaction value as part of the price actually paid or payable. Under Generra, it is Customs’ position that payments made to the seller or parties related to the seller are presumed to be part of the price actually paid or payable for the imported merchandise unless, in accordance with Chrysler, there is evidence which clearly establishes that the payments are completely unrelated to the imported merchandise. In this instance, the information submitted does not clearly establish that the payments were “independent and unrelated costs” as in Chrysler. 17 Ct. Int’l Trade at 1062. To the contrary, the license agreement indicates that the royalty payments were indeed related to the imported merchandise purchased from the seller. The license agreement provides that the licensor is entitled to certain information including the quality and appearance of items under production and before delivery to customers. License and Service Agreement, Art. 9. While article 9 is intended in part to assist the licensor in maintaining the trademark image and to ensure the licensor’s quality and distinctive and sporting style, it also gives the licensor leverage over the production of the trademark merchandise.
Moreover, the licensor is involved in the production of the imported merchandise to the degree that it provides general styling information and conceptual designs, in the form of sketches and paper patterns, to the importer. For example, Appendix 1 to the license agreement provides, at paragraph 2, that the licensor shall initially prepare 400 sketches each season for the ready-to-wear collection. Subsequently, the licensor prepares 160 sketches and supplies “written explanation about details such as buttons, embroideries, special effects, etc. as well as suggestions with respect to materials, printed materials and colors [and], on request, paper patterns and ecru semi-cotton cuts of sixty models.” In addition, the importer is entitled to transmit a total of 100 sketches from the seller that can be distributed within the framework of the seller’s collection. License and Service Agreement, App. 1, para. 2. These provisions of the license agreement closely associate the licensor with the overall design and production of the imported merchandise. The information submitted does not support a finding that the payments made by the importer were “independent and unrelated costs” as in Chrysler. Accordingly, it is our position that the royalty payments at issue - made by the importer/buyer to the seller - are properly part of the price actually paid or payable for the imported merchandise in accordance with Generra.
As noted above, royalties may also be included in transaction value as an addition to the price actually paid or payable. In regard to the dutiability of royalty payments, 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, 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 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....As a further example, 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.
Statement of Administrative Action (SAA), 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.
In reviewing the legislative history of the TAA Customs has identified three questions that are relevant in determining the dutiability of royalty payments under section 402(b)(1) of the TAA. 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? Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability. Id. At 9-11. The method of calculating the royalty, e.g., on the resale price of the goods, is not relevant in determining the issue of dutiability. Id. at 12. The notice reaffirmed that royalty payments may be dutiable as part of the price actually paid or payable, under the "royalties" provision pursuant to section 402(b)(1)(D) of the TAA, or as proceeds under 402(b)(1)(E) of the TAA.
The imported merchandise is not manufactured under patent. However, as discussed above, we find that the royalty was involved in the production and sale of the imported merchandise. The license agreement provides that the licensor is entitled to certain information related to the imported merchandise including the quality and appearance of items under production and before delivery to customers. License and Service Agreement, Art. 9. The licensor is involved in the production of the imported merchandise in that it provides general styling information and conceptual designs, in the form of sketches and paper patterns, to the importer. As noted above, the licensor provides sketches to the importer and written explanations about details such as buttons and embroideries, as well as suggestions with respect to materials, printed materials and colors [and], on request, paper patterns and ecru semi-cotton cuts of sixty models.” In addition, the importer is entitled to transmit sketches from the seller that can be distributed within the framework of the seller’s collection. License and Service Agreement, App. 1, para. 2. These provisions of the license agreement closely associate the licensor with the overall design and production of the imported merchandise.
In addition, we find that the importer could not buy the imported merchandise without paying the fee. This goes to the heart of whether a payment is considered to be a condition of sale. General Notice, 27:6 Cust. B. & Dec. at 11. The license agreement provides that the royalty is to be based on a percentage of the importer’s net sales of the licensed merchandise. The licensed merchandise was purchased by the importer from the seller. The method of calculating the royalty, e.g., on the resale price of the goods, it not relevant to determining the dutiability of royalties; payments that must be made for each imported item are dutiable. Id. at 11-12; see also, Imperial Products, Inc. v. United States, 425 F. Supp. 852, 77 Cust Ct. 66 (1976), aff’d, 570 F.2d 337, 65 CCPA 38 (1978). In the instant case, the agreement supports a finding of dutiability in that under the terms of the agreement the royalty was paid - as a percentage of net sales - by the importer to its related licensor, on each and every item of imported merchandise that the importer purchased from its related seller.
Accordingly, it is our position, based on the information submitted, that the royalty payments at issue are related to the imported merchandise and a condition of sale such that they are included in transaction value as an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA. As noted in the SAA, 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. The payments at issue were made by the importer to a party related to the seller. The importer is also related both to the seller and the licensor who themselves are related. Moreover, the information submitted indicates that the royalty was paid on each and every item of imported merchandise and was a condition of sale. Consequently, it is our position that the royalty payments are also included in transaction value as an addition to the price actually paid or payable. Given that the royalty payments are an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA, it is unnecessary to address the question of whether they also constitute an addition under the subsequent proceeds provision set forth in section 402(b)(1)(E) of the TAA.
You have also asked whether certain technical information provided by the licensor to the importer constitutes an assist. Section 402(b)(1)(B) of the TAA provides for the addition to the price actually paid or payable of the value, apportioned, as appropriate, of any assist. The term “assist” refers to certain enumerated goods or services “supplied directly or indirectly, and free of charge or at a reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise.” Assists include “engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise.” 19 U.S.C. § 1401(a)(h)(1).
Pursuant to the terms of the license agreement, the licensor furnishes sketches, together with written explanations relative to various clothing details, and, on request, paper patterns, free of charge to the importer, for the importer’s ready-to-wear collection. The licensor also undertook to make its chief designer available to the importer four times a year for a period of several days. License and Service Agreement, App., para. 2. The work in question is undertaken outside the U.S., was “supplied directly or indirectly” within the meaning of section 402(h)(1)(A) of the TAA, and conveys general styling information to the importer and the seller. The only remaining issue to be resolved in this case is whether the services supplied by the licensor are necessary for the production of the imported merchandise.
In HRL 546054 dated October 23, 1996, it was determined that certain services including the review of technical development issues, the confirmation of specifications, the evaluation of samples, and the coordination of service part lists, constituted development within the meaning of section 402(h)(1)(A)(iv) of the TAA. In that regard we noted:
Such services, we find, are an integral, necessary part of the production process. Moreover, we note that in Texas Apparel Co. v. United States, 12 CIT 1002, 698 F.Supp. 932 (1988) aff’d 883 F.2d 66 (1989), the court deferred to Customs’s interpretation of section 402(h)(1)(A)(ii) distinguishing air-conditioning and power generators from sewing machines, finding the latter to have been used directly in the production of the imported merchandise and, hence, to constitute assists. Likewise, in the instant matter, Customs must draw a distinction in the context of section 402(h)(1)(A)(iv) between services which are distinctly supervisory and managerial in nature and those where the services performed are necessary for the production of the imported merchandise.
HRL 546054 at 5.
In HRL 542152, dated December 4, 1980 (TAA No. 13, Department of the Treasury, Customs Valuation Rulings under the Trade Agreements Act of 1979, 25 (December 1984)), the importer provided a cash advance and paid royalties to a Canadian company for a drawing and crude working model. The design and working model were then provided free of charge to the importer’s subsidiary in Hong Kong and used in the fabrication of the imported merchandise. It was determined that the drawing and crude working model were necessary for the production process. The value of the assist consisted of both the cash advance and the royalty payments. In HRL 544621, dated April 22, 1991, colorways produced outside the U.S., that instructed the manufacturer how to color textile designs, were found to be necessary for the production of the imported merchandise and therefore constituted assists within the meaning of section 402(h)(1)(A)(iv) of the TAA. In HRL 544088, dated March 25, 1988, a buyer entered into an agreement with an unrelated foreign company pursuant to which the latter provided engineering, development, artwork, plans and sketches, and certain non-tangible design consulting services in resect of the design and development of the imported merchandise. The services in question were determined to be necessary to the production of the imported merchandise such that they constituted assists under section 402(h)(1)(A)(iv) of the TAA.
In the instant case, sketches and other styling information were furnished by the licensor. The services furnished conveyed general styling information and was used by both the importer/buyer and the seller to this end. As in HRL 546054, we here distinguish between services which are completely unrelated to the production process and those where the services performed are necessary for the production of the imported merchandise. Customs has found that design work ranges from such items as crude working models to colorways. Here, the various intercompany design activities undertaken pursuant to the license agreement was used in designing the apparel for the ready-to-wear collection which the importer ultimately purchased from the seller. Accordingly, in the circumstances of this related party transaction, and based on the information submitted, we find that the technical information was used in the production of the imported merchandise such that constitutes an assist under section 402(b)(1)(B) of the TAA.
HOLDING:
In conformity with the foregoing, the royalty payments at issue are included in transaction value either as part of the price actually paid or payable, or as an addition thereto under section 402(b)(1)(D) of the TAA. The technical information supplied by the licensor to the importer constitutes an assist within the meaning of section 402(h)(1)(A)(iv) of the TAA.
Sincerely,
Thomas L. Lobred
Chief, Value Branch