RR:IT:VA 548489 GG
Brett Ian Harris, Esq.
McKenna Long & Aldridge LLP
1900 K Street, NW
Washington, DC 20006
RE: Dutiability of Royalty Payment; 19 U.S.C. 1401a(b)(1)(D); Patented Process; Agency
Dear Mr. Harris:
This is in response to your ruling request dated February 16, 2004, which was made on behalf of your client, “LICENSEE.” The issue is the dutiability of certain royalties paid by LICENSEE. Our ruling also takes into account information obtained from our telephonic discussion with you and representatives of LICENSEE on July 23, 2004, and from two e-mails from you dated June 2 and August 3, 2004. We grant your request to protect the identity of the parties involved in the public version of this ruling.
FACTS:
LICENSEE is a corporation with operations in nearly 60 countries. It has recently started to produce and market a product called the PRODUCT X, a battery-powered air-freshener that utilizes electronic technology to atomize 100% perfume oil. The unit consists of a pump, a domed orifice plate through which the fragrance is pumped, and a piezoelectric ceramic unit that is soldered to the orifice plate and causes the pump to vibrate at a high frequency when voltage is applied. In addition, the product contains electronic components including a computer chip, a charge capacitor, a 5-position switch and a circuit board. All of these components are housed in a plastic dispenser shell. The central issue in this ruling is whether the royalties in question relate to the imported dispensers and are required to be paid by the buyer as a condition of their sale for exportation to the United States.
LICENSEE has licensed the atomization technology used in the PRODUCT X from two different companies, LICENSOR A and LICENSOR B. Under the LICENSOR A license agreement, LICENSEE has obtained the exclusive right to use the licensed technology in “Air Care” and “Insect Control” products in exchange for the payment of a royalty. Specifically, Article 2.1 A. of the license agreement provides in pertinent part that –
. . . LICENSOR A hereby grants to LICENSEE the exclusive (even as to LICENSOR A) license under the LICENSOR A Technology to make, have made, use, sell, offer for sale and import Licensed Products for use in the Field in the Territory during the term of this Agreement.
Article 2.1 B. provides that “LICENSEE may grant sublicenses under its rights granted under Paragraph A to its Affiliates without LICENSOR A’s prior consent”. “Affiliates” are defined in Schedule 1.1 E. of the agreement as:
. . . any Person, relative of a Person, any trust in which a Person is a trustee or beneficiary, any partnership, corporation, or business entity that directly or indirectly controls, is controlled by, or is under common control with a Party. The term “control” as used in this Paragraph includes direct or indirect ownership of at least forty percent (40%) of the voting shares of a corporation, or at least forty percent (40%) of the beneficial ownership of any other Person.
The agreement also allows LICENSEE, without LICENSOR A’s prior consent, to grant sublicenses to contract manufacturers “to manufacture and sell Licensed Products to LICENSEE and its Affiliates only” (Article 2.1 C.). Article 7.1 allows LICENSEE to assign its rights and interests under the agreement to its affiliates without obtaining the licensor’s consent; in the same manner it also allows LICENSEE to designate its affiliates to perform its obligations under the agreement.
The royalty rate applicable to the licensed products is 2% of net sales, which are defined as gross sales of licensed products sold by LICENSEE within the United States to retailers, less certain allowances for discounts, returns, freight, taxes and off-invoice promotions granted to LICENSEE’s customers. In the event LICENSEE does not have commercial sales of the licensed products in any given quarter, the company is obligated to pay LICENSOR A a minimum quarterly royalty payment of $125,000. Royalties owed to LICENSOR A are payable on a quarterly basis within 60 days after the end of the calendar quarter in which they accrue.
LICENSEE’s license agreement with LICENSOR B provides LICENSEE with essentially the same rights as those granted to it in the LICENSOR A agreement, albeit under the LICENSOR B technology and on a non-exclusive basis. In exchange, LICENSEE has agreed to pay LICENSOR B a royalty ranging from 3% to1% of net sales of the licensed products within the United States, depending upon the sales volume. As under the LICENSOR A agreement, “net sales” are defined as gross revenues resulting from LICENSEE’s sales of licensed products to its customers, less certain allowances for discounts, returns, freight, taxes and off-invoice promotions granted by LICENSEE to those parties. Royalties due LICENSOR B are payable each quarter within 60 days after the end of the quarter in which they accrue.
Although LICENSOR A and LICENSOR B have developed the atomization technology used in the PRODUCT X, neither company is involved in manufacturing these products for LICENSEE. Instead, LICENSEE has sublicensed the actual manufacturing to other companies. In a typical transaction, the Chinese supplier – a factory named MANUFACTURER – purchases the pump, the domed orifice plate, and the piezoelectric ceramic unit from JAPANESE SUPPLIER, a Japanese company. (JAPANESE SUPPLIER in turn has sourced the orifice plate from DUTCH SUPPLIER) MANUFACTURER combines these components with the necessary electronics in a plastic shell and sells this completed dispenser unit to IMPORTER, a U.S. company that specializes in the packaging of retail products. IMPORTER is the importer of record. IMPORTER purchases filled bottles of perfume oil from LICENSEE and packages the fragrance with the dispensers into “primary” or “starter” PRODUCT X packages suitable for retail sale, which are then sold to LICENSEE on a landed, duty-paid basis.
With regard to the licensed technology, LICENSEE in its August 3, 2004, e-mail explains as follows:
The LICENSOR A and LICENSOR B U.S. patents which are covered by LICENSEE’s license agreements with these companies together claim particular methods for aerosolizing a liquid (i.e., dispensing liquid in the form of airborne droplets) and claims relating to certain apparatus and apparatus components intended to achieve that purpose. Specifically, the apparatus covered by these patents includes the domed orifice plate (as well as the particular shape of the holes in that orifice place) and the piezoceramic vibration unit. With regard to the merchandise imported by LICENSEE which is the subject of this binding ruling request, these items are manufactured by DUTCH SUPPLIER and JAPANESE SUPPLIER, respectively.
LICENSEE has entered into a Master Agreement with MANUFACTURER and a Contract Manufacturing Agreement with IMPORTER. Both documents specify the terms under which the two suppliers (MANUFACTURER and IMPORTER) will manufacture product for LICENSEE and LICENSEE will in turn purchase the finished product from the suppliers. Of note are the following extracts from certain sections of these agreements:
LICENSEE-MANUFACTURER Master Agreement
1.1 Supply Commitment. Subject to the terms and conditions set forth in this Master Agreement, Supplier shall manufacture and sell to LICENSEE, and LICENSEE shall purchase from Supplier certain products. . .
1.6 Designated Purchasers.
(A) LICENSEE may request that Supplier sell Product directly to a third party manufacturer (the “Third Party Manufacturer”). And under these circumstances the Third Party Manufacturer shall purchase Product subject to the terms and conditions of this Master Agreement. . .
(C) LICENSEE guarantees the performance of such Third Party Manufacturers including payment within terms.
4.1 Property of LICENSEE. Neither this Agreement nor either party’s disclosure of Confidential Information shall be deemed by implication or otherwise to vest in the other party any rights in any patents, trade secrets, trademarks, trade names, designs, copyrights, or other property of the party; provided, however, that each party is granted a limited license to use such intellectual property to the extent required to perform this Agreement.
5.3 Exclusivity. Unless otherwise agreed upon, Supplier shall not, either during the term of this Master Agreement, and for a period of three years thereafter, manufacture or sell to any party other than LICENSEE and its affiliates any air freshener, insect control, home storage or home cleaning devices . . .
LICENSEE-IMPORTER Contract Manufacturing Agreement
1.1 Supply Commitment. Subject to the terms and conditions of this Agreement, Supplier shall manufacture and sell to LICENSEE and LICENSEE shall purchase from Supplier the products listed in the Price Schedule (“the Product(s)”).
14.1 Independent Contractor. The parties are independent contractors. This Agreement does not create an employer-employee, principal-agent, or any similar relationship between the parties.
LICENSEE’s counsel reports that none of the parties named in this ruling request are related to one another, including LICENSOR A or LICENSOR B. U.S. Customs and Border Protection (“CBP), in an e-mail to counsel on May 27, 2004, asked LICENSEE to explain IMPORTER’s authority to import the dispensers, given the fact that the license agreements limit that right to LICENSEE or to LICENSEE’s related affiliates to whom LICENSEE has granted sublicenses of its rights under the agreements. See, Articles 2.1 A. and B. of the license agreements. CBP also inquired into LICENSEE’s authority to direct MANUFACTURER to sell product to unaffiliated third party manufacturers such as IMPORTER, given the fact that Article 2.1 C. of the license agreements requires third party manufacturers such as MANUFACTURER to sell product to LICENSEE or to its affiliates absent prior licensor consent. Counsel’s response is as follows:
As noted in our binding ruling request dated January 9, 2004, LICENSEE does not act as importer of record for merchandise incorporating the LICENSOR B and LICENSOR A atomization technology. Rather, IMPORTER imports the goods at the specific direction of LICENSEE directly from unrelated foreign vendors such as MANUFACTURER. Because IMPORTER acts in these transactions only at the specific direction of LICENSEE (in essence taking LICENSEE’s place in the purchase transactions with regard to the foreign vendors), LICENSEE has consistently interpreted its contracts with LICENSOR B and LICENSOR A to permit the sales of licensed technology directly to IMPORTER and other U.S. contract manufacturers acting in its stead.
LICENSEE has also submitted copies of representative transaction documents. These include purchase orders, invoices, packing lists, wire transfers, bills of materials, packing lists, and entry documents.
ISSUE:
Whether the subject royalty payments constitute an addition to the price actually paid or payable for the imported merchandise as either royalties or proceeds of subsequent resale.
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) codified at 19 U.S.C. § 1401a. The preferred 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 certain enumerated additions, including “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.” (19 U.S.C. § 1401a(b)(1)(D)). These additions apply only if they are not already included in 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 relevant 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 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 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 were they paid. For example, if the buyer pays a third party for the right to use, in the United States, a trademark or copyright relating to the imported merchandise, and such payment was not a condition of the sale of the merchandise for exportation to the United States, such payment will not be added to the price actually paid or payable. However, if such payment was made by the buyer as a condition of sale of the merchandise for exportation to the United States, an addition will be made. 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, 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.
CBP has established a three-part test for determining the dutiability of royalty payments. This test appears in the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) (“Hasbro II ruling”). The test consists of the following questions: 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 question 1 and 2 and a negative answer to question 3 points to dutiability. Question 3 goes to the heart of whether the payment is considered to be a condition of sale. In the situation under review, the first two questions can clearly be answered in the affirmative. The imported dispensers are manufactured under patent, and the royalty payments made by LICENSEE in part cover LICENSEE’s exercise of its license “to make or to designate another party to make the licensed product.”
On first impression, question 3 would appear to be easily answered. IMPORTER, the importer, is under no obligation to make a royalty payment upon ordering dispensers from MANUFACTURER. Rather, LICENSEE is the party that ultimately makes the payments to LICENSOR A and LICENSOR B. So it would appear that IMPORTER may indeed buy the product without paying the fee. However, such an analysis would be too facile given the totality of the circumstances surrounding these particular transactions.
As noted earlier, when questioned about MANUFACTURER’s sale of dispensers to a company that is identified as not being an LICENSEE affiliate, and about IMPORTER being the importer, counsel for LICENSEE indicated that LICENSEE interprets its license agreements with LICENSOR A and LICENSOR B “to permit the sales of licensed technology directly to IMPORTER and other U.S. contract manufacturers acting in its stead.” Since such an interpretation would seem to directly contradict Articles 2.1 A. and 2.1 C. of the license agreements, which restrict the importation of licensed product to LICENSEE (or to its affiliates, if LICENSEE has sublicensed its rights to an affiliate under Article 2.1 B.), and require third party manufacturers to sell licensed product to LICENSEE or its affiliates, the only logical interpretation of counsel’s explanation is that either IMPORTER is an affiliate of LICENSEE, as that term is defined in Schedule 1.1 E. of the agreements, or that IMPORTER is LICENSEE’s agent. Counsel for LICENSEE denies any relationship between the involved parties. Consequently, by process of elimination, the conclusion must be drawn that IMPORTER’s role is that of a de facto agent for LICENSEE.
The primary consideration in determining whether an agency relationship exists is the right of the principal to control the agent’s conduct with matters entrusted to him. J.C. Penney Purchasing Corp. v. United States, 80 Cust.Ct. 84, C.D. 4741, 451 F. Supp. 973 (1978). Counsel for LICENSEE, in stating that IMPORTER “imports the goods at the specific direction of LICENSEE” and is “in essence taking LICENSEE’s place in the purchase transactions with regard to the foreign vendors,” confirms that LICENSEE exerts the requisite degree of control over IMPORTER to create an agency relationship. By allowing IMPORTER to act “in its stead” in the purchase of the dispensers, the real buyer in these transactions is LICENSEE, not IMPORTER. Since LICENSEE is the purchaser, question 3 may now be framed as “could LICENSEE buy the product without paying the fee?”
LICENSEE addresses this question on several fronts. Counsel first notes that the royalty payments were not paid by LICENSEE to the seller of the merchandise, MANUFACTURER, but rather to an unrelated third party (LICENSOR A or LICENSOR B). Counsel cites to HQ 545381, dated May 4,1998, wherein CBP stated that –
It is more likely that the royalty will be dutiable when the licensor and the seller are one and the same and the royalty is paid directly to the seller. Under these circumstances, payment of the royalty is more likely to be a condition of the sale for exportation of the imported merchandise than when the royalty is paid to an unrelated third party.
However, the fact that the payments are made to an unrelated third party is not entirely determinative. This is because the SAA provides that a royalty payment made by a buyer as a condition of sale of the merchandise for exportation to the United States will be added to the price actually paid or payable. CBP has generally interpreted this to mean that royalties will be dutiable even if paid to third parties if they constitute a condition of sale for exportation. See HQ 546513, dated February 11, 1998; and HQ 545777, dated September 1, 1995.
LICENSEE contends that the royalty payments are not a condition of sale of the merchandise for exportation to the United States but rather a condition of LICENSEE’s subsequent sale of the merchandise within the United States. In support of this position counsel for LICENSEE makes the following points:
The license agreements condition royalty payments upon the sale of the merchandise by LICENSEE to its retailer customers in the United States, and not upon the purchase of the merchandise from MANUFACTURER or any other foreign seller.
LICENSEE must pay royalties to LICENSOR A and LICENSOR B upon the sale of licensed products within the United States even if the licensed products are manufactured domestically.
The royalties are calculated and payable to the licensors on a quarterly basis, and are not linked in any way to invoices for imported licensed product issued by MANUFACTURER.
Royalties will not be owed if imported licensed product is never sold in the United States or if it is sold to a foreign customer, proving that LICENSEE’s obligation to pay royalties is independent of the importation of the merchandise.
LICENSEE’s termination of the license agreements would be unknown to IMPORTER, which would still be obligated to pay MANUFACTURER for any PRODUCT X it had purchased and imported from China.
LICENSEE contends that all of these factors demonstrate that the purchase of the imported dispensers and the payment of the royalties are not inextricably intertwined. Counsel cites to HQ 547557, dated February 13, 2001, in support of its position.
The Hasbro II ruling dispensed with Counsel’s first point, i.e., that the conditioning of the royalty payments upon the domestic resale of the licensed products renders the payments nondutiable. Specifically, CBP stated 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.” Vol. 27, No. 6 Cust. B. & Dec. at 12. See also HQ 545777, supra, and HQ 545710, dated October 30, 1998.
CBP has also previously examined and discounted LICENSEE’s next argument, which is that the royalty payments are not subject to duty because the payments would be due even if the licensed products were manufactured in the United States. CBP in HQ 548055, dated March 14, 2002, determined that a company’s payment of royalties “as to both domestically produced and imported [product] does not vitiate the claim that the payment of royalties is closely related to the sale of the imported product.”
Turning next to the contention that the royalty payments are not dutiable because they are calculated and payable on a quarterly basis, and are not linked in any way to the invoices issued by MANUFACTURER, CBP can again direct attention to rulings in which such factors were found to have no effect on dutiability. For example, royalties based on periodic payments were deemed to be additions to the price actually paid or payable in HQ 547148, dated September 12, 2002; HQ 545710, supra; and HQ 546038, dated July 19, 1996. Regarding the absence of a link between the royalty payments and the MANUFACTURER invoices, as has already been discussed, royalties paid to unrelated third parties may be dutiable if they constitute a condition of sale for exportation. In such situations, it is understandable that amounts due for royalties will not be reflected on the seller’s invoices to the buyer. Thus, the lack of a link is not in and of itself a disqualifying factor in determining dutiability.
The ruling to which counsel cites in support of its position, HQ 547557, is, in our opinion, of limited relevance to LICENSEE’s situation. This is because HQ 547557 involved the payment of royalty and license fees pursuant to a trademark license agreement. The SAA notes a distinction between royalty and license fees paid for patents covering processes to manufacture imported merchandise, and royalty and license fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise. It states that the former will generally be dutiable, whereas the latter will generally be considered as selling expenses of the buyer and therefore will not be dutiable. Given this crucial distinction between LICENSEE and HQ 547557, the latter is not controlling here.
The question remaining to be answered is whether LICENSEE could buy the product without paying the fee. It is clear, upon examination of the license agreements, that the dispensers will be manufactured, imported and subsequently resold only on the understanding or condition that the royalties are paid. In particular, we note the previously cited Article 2.1 A. of the license agreements, which grants LICENSEE the license under the licensed patents to make, have made, use, sell, offer for sale and import licensed product. As compensation for the exercise of this right, LICENSEE is required by Article 3 to pay a royalty to the respective licensor upon resale of the licensed product in the United States. It is abundantly clear that none of the described activities could occur if LICENSEE were not obligated to pay a royalty. LICENSEE would thus be unable to purchase the manufactured licensed product from MANUFACTURER in the absence of the license agreements and their underlying contingencies, including the requirement to make royalty payments.
CBP has had occasion to review similar scenarios, and has found the royalty payments to be a condition of the sale of the imported merchandise. For example, in HQ 545777, dated September 1, 1995, a Japanese parent company granted its subsidiary importer certain rights it had acquired from a German patent holder/licensor. Under this arrangement, an unrelated manufacturer was selected to make the patented products, which the manufacturer then sold to the importer. Upon resale of the patented products in the United States, the importer made royalty payments to the parent company, which in turn remitted the payments to the German patent holder/licensor. In examining whether the royalty payments were dutiable, CBP focused on the language of the agreements between the German licensor and the parent company, and between the parent company and the importer subsidiary. CBP concluded that the “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.” CBP held the royalty payments to be dutiable. The same result would attain here. See also HQ 545710, supra; HQ 546159, July 18, 1997; and HQ 545998, November 13, 1996.
Based on the above considerations, we find that the royalties at issue relate to the imported merchandise and that LICENSEE is required to pay them as a condition of the sale for exportation to the United States of the imported licensed dispensers. Accordingly, we find that they are additions to the price actually paid or payable as royalties under 19 U.S.C. § 1401a(b)(1)(D).
HOLDING:
Based on the information provided, the subject royalty payments constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D).
Sincerely,
Virginia L. Brown
Chief,
Value Branch