OT:RR:CTF:VS H024979 YAG
Mr. George R. Tuttle
Law Office of George R. Tuttle, P.C.
One Embarcadero Center, Suite 730
San Francisco, California 94111-4044
RE: Dutiability of royalty payments
Dear Mr. Tuttle:
This is in reference to your letter, dated March 11, 2008, on behalf of your client, the Licensee, concerning the dutiability of certain royalty and license fees paid by Licensee to Licensor, pursuant to the License Agreement, executed on September 10, 2007.
FACTS:
Licensee entered into a License Agreement with the Licensor, a U.S. corporation, to manufacture, design, advertise, promote, distribute, and sell wearing apparel, golf clubs, and golf-related accessories, including bags, balls, umbrellas, etc., bearing various trade names, marks, and designs managed by the Licensor. Licensor is the exclusive licensing agent for the owners of the marks and designs subject to this ruling. You state that the Licensee is not related to the Licensor. Licensee will source merchandise from various vendors and will pay a royalty fee to Licensor for the use of patents and trademarks in accordance with the terms discussed below. Further you state that none of the parties to this transaction, such as manufacturers in China, vendors, Licensee, and Licensor, are related to each other. Additionally, you state that the Licensor’s patents, identified in Appendix E to the License Agreement, are mostly design patents and request an advance ruling with respect to the design patents only. We considered your request; however, please note that this ruling applies to the License Agreement as a whole, thus, covering all trademarks and patents specified in the License Agreement.
The parties entered into a License Agreement on September 10, 2007. A copy of the License Agreement between the Licensee and Licensor was submitted with the ruling request. Under the License Agreement, the Licensor grants the Licensee, the exclusive right to utilize the trademarks and patents described in Appendices B, E, and F to the Agreement in connection with the manufacture, design, advertisement, promotion, distribution, and sale of the licensed articles in the United States, its territories and possessions. The term “licensed materials” means all products containing the trademarks, including but not limited to “core licensed articles” described in Appendix B to the Agreement. The royalty is paid in consideration of the license, which includes both the trademarks and patents.
The trademarks in respect of which the royalties are paid are listed in Appendices B and F to the Agreement. They consist of some seventy-seven marks, the bulk of which are registered with the U.S. Patent and Trademark Office (“USPTO”). The remainder are either pending registration with the USPTO or is claimed by the Licensor. Certain of the pending registrations have since been abandoned or cancelled.
The patents in respect of which the royalties are paid are listed in Appendix E to the Agreement. They consist of some thirty-one patents owned by the Licensor, all of which, with the exception of three utility patents registered with the USPTO, are design patents. The three utility patents concern inventions related to functional aspects of golf club design. The information submitted indicates that the work related to the utility patents was undertaken in the United States. The design patents are covered by USPTO and foreign registrations. However, the design work was undertaken in the United States, and the United States registrations were first in time.
The License Agreement also grants the Licensee the non-exclusive right to manufacture the licensed articles anywhere in the world, provided that licensed articles may only be advertised, promoted, distributed, and/or sold by Licensee in the United States, its territories, and possessions. There is no reference in the agreement with respect to who exactly will manufacture the goods. Section 3(e) of the License Agreement addresses the fact that Licensee has the right to sublicense the marks to the third-party factories selected by it for the limited purposes of manufacturing licensed articles. Section 3 specifically discusses the use of marks and Licensor’s quality control provisions. Pursuant to this section, Licensor may require Licensee to cease the manufacture of licensed articles if it determines that the style, nature, or quality of such articles are not consistent with the image and relative positioning of the marks. Nonetheless, under the agreement Licensee is permitted to complete its work in progress and sell the merchandise. Section 3(b) also gives the Licensor the right to do on-sight inspections, in order to ensure compliance with the License Agreement and preserve the quality of the marks. Licensor can inspect the licensed articles (including the manner of mark use in connection with licensed articles), facilities associated with the production of licensed articles, and the associated logistics, manufacturing, and distribution processes at such facilities. However, Licensor can only inspect third party facilities subject to the approval of the third parties.
In consideration for the rights set forth in the License Agreement, Licensee agreed to pay licensor the greater of: (a) a minimum annual royalty ranging from $3 million in the 1st year to $5 million in the 5th year or (2) an earned royalty fee. The latter royalty fees are calculated based on the total number of units imported multiplied by the FOB price, charged by manufacturer. Thus, the Licensee effectively pays the royalty fee on each and every importation. A minimum annual royalty fee is to be paid in quarterly installments. However, even though an earned royalty fee is to be accrued and earned on each and every importation, it is to be calculated and paid at the end of the contract year, to the extent that it exceeds the minimum royalty fee already paid. Additionally, pursuant to Section 13(a), Licensee must purchase at least $20,000,000 of licensed articles at FOB cost. If Licensee fails to do so, Licensor may terminate the License Agreement within sixty (60) days after the end of any Contract Year.
Moreover, upon our requests, sample purchase orders, entry documents, packing lists, and patent registrations were also submitted for consideration. You also submitted a 2007 Import Vendor Agreement between Vendor/Seller and the Licensee. Further, we considered the terms and conditions of the Licensee’s Vendor Relationship Guide, referenced and incorporated in the 2007 Import Vendor Agreement, even though you failed to submit this document for our review. Pursuant to Paragraph 12 of the Chapter 8 (Vendor Agreement) of the Licensee’s Vendor Relationship Guide, all merchandise designs, patents, trade names and trademarks which are supplied by Licensee or which are distinctive of the Licensee’s private label or licensed label merchandise (“Special Features”) are considered the property of the Licensee and must be used by Vendor only for the Licensee. This is the only reference to licensed designs, patents, trade names and trademarks in the Licensee’s Vendor Relationship Guide.
Finally, you submitted a Declaration, executed by the Licensee’s Vice President of Product Development on October 17, 2008, stating that Licensee does not sublicense the use of marks to any vendors or manufacturers. The Licensee’s Declaration also stated that although the Licensee has other agreements with its vendors for the manufacture of goods, it does not have a provision either in the manufacturing agreement of any other agreement regarding the use of the marks licensed by Licensor. ISSUE: Whether the royalty payments under consideration constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D). 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 basis of appraisement under the TAA is transaction value, defined in Section 1401a(b)(1), as the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus amounts for enumerated statutory additions to the extent not otherwise included in the price actually paid or payable. The additions include "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). For purposes of this ruling, we assume that transaction value is the proper method of appraisement for the imported merchandise.
As a general matter, we note that royalty payments may be included in transaction value as part of the price actually paid or payable or as an addition thereto. See, e.g., General Notice, “Dutiability of Royalty Payments,” Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993); H.R. Rep. No. 317, 96th Cong., 1st. Sess., at 80 (1979). In the particular circumstances of this case, however, inasmuch as the royalty is not paid to the seller or a party related to the seller and no subsequent proceeds accrue directly or indirectly to the seller, our analysis is confined to whether the royalty payments are included in transaction value as an addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D).
With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action to the TAA provides, in pertinent part, that:
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 they were 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 the 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 ("SAA"), H.R. Doc. No. 153, 96 Cong., 1st Sess. (1979), reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (1981), at 48-49.
In the General Notice, “Dutiability of Royalty Payments,” Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), CBP articulated three factors or questions that assist in determining whether the royalty payments in question are related to the imported merchandise and are a condition of sale such that they are included in transaction value as an addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1). As set forth in the notice, the questions are:
Was the imported merchandise manufactured under patent?
Was the royalty involved in the production or sale of the imported merchandise?
Could the importer buy the product without paying the fee?
The General Notice indicates that affirmative answers or responses to the first and second questions, and a negative response to the third, point towards dutiability.
When analyzing the factors identified in the above-cited general notice, CBP has taken into account certain considerations, which flow from the language set forth in the SAA. These include, but are not limited to, the following:
the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise generally will be dutiable);
to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated third party);
whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require the buyer’s purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other, or termination of the purchase agreement due to the failure to pay the royalties); and,
payment of the royalties on each and every importation.
See, e.g., Headquarters Ruling Letter ("HRL") 547148, dated September 12, 2002.
In order to obtain a ruling with respect to the dutiability of royalty or license fees, copies of any royalty agreements relating to the payment of the royalty or license fees in question and any purchase or supply agreements relating to the sale of the imported merchandise for exportation to the United States must be submitted to CBP with the request. If there are no such written agreements, this must be indicated in the ruling request. See General Notice, "Notice to Require Submission of Royalty and Purchase Supply Agreements in Ruling Requests Regarding Dutiability of Royalty or License Fees," Vol. 29, No. 36, Cust. B. & Dec. at 10 (September 6, 1995). See also 19 C.F.R. §177.2(b). In the instant case, as discussed above, you submitted a license agreement, a vendor agreement, and a vendor manual.
In this case, based on the information provided, the responses to each of the three above-listed questions are as follows:
Was the Imported merchandise manufactured under patent?
The SAA provides that royalties paid for patents covering processes to manufacture the imported merchandise will generally be dutiable, and royalty fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise will not be dutiable. Statement of Administrative Action, H.R. Doc. No. 153, reprinted in Customs Valuation under the Trade Agreements Act of 1979 (1981), supra, at 48.
In this case, the royalty at issue is paid in consideration for the right to use the Licensor’s trademarks and patents in connection with the manufacture, design, advertisement, promotion, distribution, and sale of licensed articles in the licensed territory. Since we determined that this ruling should address all of the rights covered by the License Agreement, the answer to question one is that the merchandise is manufactured under both trademarks and patents.
With respect to patents, the patents in question are owned by the Licensor, a U.S. corporation that is unrelated to the seller. They cover the design of golf clubs and golf club heads, or, in the case of the three utility patents, the process whereby such goods are manufactured. As previously stated, the design and development work that underlies the patented inventions and designs was undertaken in the U.S. Thus, U.S. design and development work is not an assist and is not included in transaction value. 19 U.S.C. §1410a(h)(1)(A)(iv).
Furthermore, even though the royalty is paid for the right to use the patents, it is not paid to the seller of the merchandise, nor does any portion thereof accrue directly or indirectly to the seller. Rather, it is paid by the U.S. Licensee to the U.S. Licensor. Accordingly, while some merchandise is manufactured under patent, it is not manufactured under a patent that is: (1) owned by the seller or a party related to the seller; and (2) that consists of non-U.S. design or development.
Was the royalty involved in the production or sale of the imported merchandise?
The second question expands the analysis of the first question. See General Notice, “Dutiability of Royalty Payments,” supra, at 10. Licensee is paying a royalty to an unrelated third party for the right to use certain trademarks and patents in connection with the importation of its merchandise. Royalty payments are not made to the seller of the imported merchandise or to a party related to the seller. There is nothing in the License Agreement that obligates or requires the Licensee to purchase merchandise from a particular manufacturer or seller. In fact, the opposite is true. Licensee has the right to sublicense the marks to the third-party factories selected by it for the limited purposes of manufacturing licensed articles, and it has the non-exclusive right to manufacture the merchandise anywhere in the world. Hence, in this case, Licensee supplies all merchandise designs, patents, trade names and trademarks to vendors, which use it to manufacture the merchandise. Licensee is free to procure vendors and manufacturers of its own choosing, without obtaining any approvals from the licensor. There is no evidence that the licensed fee is linked to individual sales agreements or purchase orders. See HRL W563382, dated May 25, 2006 (we held that the royalty payments were not involved in the production or sale of the imported merchandise, because Kmart/Licensee was paying the royalty to an unrelated third party and there was nothing in the agreement or the record to show Kmart’s obligation to purchase merchandise from particular manufacturers or sellers). The License Agreement is a contract between the Licensor and the Licensee – not between the Licensee/Buyer and the seller – that sets forth the rights and obligations governing the Licensee’s use of the Licensor’s intellectual property. The royalty is the fee that the Licensee pays for these rights. In this case, the royalty is paid to the seller for rights arising under a separate contractual arrangement, and there is no indication that it is tied in any manner to the sale for exportation of the imported merchandise.
Since there is no evidence in the record before us to show that the subject royalty payments are involved in the production of the imported merchandise, it is our position that the royalty is not involved in the production or sale of the imported merchandise.
Could the importer buy the product without paying the fee?
The answer to the third question goes to the heart of whether a payment is considered a condition of sale. See General Notice, “Dutiability of Royalty Payments,” supra, at 11. Royalty payments and license fees are a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise. If the payments are optional and not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell in a designated area, they do not constitute additions to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D). See HRL 546675, dated June 23, 1999.
You state that the Licensee pays royalty fees on each and every importation. However, you cite HRL 546675, dated June 23, 1999, HRL 548552, dated August 19, 2004, and HRL W563382, dated May 25, 2006, for the proposition that the royalty fees at issue are not inextricably intertwined with the imported merchandise, and, therefore, are not dutiable. You state that these cases present factual situations similar to the present case, in that all parties are unrelated, the licensed intellectual property relates to trademarks or design patents, the licensor does not control the manufacturer, and there is nothing in the purchase agreement with the manufacturers that would require Licensee to pay the royalty to the Licensor in order to purchase the merchandise. However, you also mention that HRL H004991, dated April 2, 2007 and HRL W548692, dated March 2, 2007 support a finding that there would appear to be a clear, substantial nexus between the imported merchandise and the applicable licensing payments because one would expect that the parties anticipated that the licensed good would be manufactured, imported, and, subsequently, resold based on the understanding or condition that the royalties are paid.
In this case, the Licensee makes royalty payments to an unrelated party in consideration for the rights granted by the Licensor. Further, all parties to this transaction are unrelated. We recognize the fact that the royalty payments made to an unrelated third party is not entirely determinative because the SAA provides that a royalty payment made by a buyer as a condition of the sale of the merchandise for exportation to the United States will be added to the price actually paid or payable. See HRL H004991, dated April 2, 2007. However, as indicated in our numerous rulings, the relationship of the parties, although not entirely determinative, is an important factor to consider in analyzing the transactions.
Further, there is support for the position that a royalty paid to an unrelated third party in respect of U.S. patent rights is not dutiable. In TAA 13 (HRL 542152, dated December 4, 1980), a royalty was paid to a U.S. patent owner, who was not related to the seller of the imported merchandise. Based on the information provided, there was nothing to link the payment of the royalty to the sale between the buyer and seller. Accordingly, we determined that the payment was not dutiable. See also HRL 542818, dated May 27, 1982; HRL 545379, dated July 7, 1995.
Hence, we must analyze whether the royalty payments are actually a condition of the sale of the merchandise for exportation to the United States. Based on the facts presented in this case, we find that the royalty is not a condition of the sale of the imported merchandise.
We find that HRL H004991 and HRL W548692 are distinguishable from the facts in this case. In both cases, the nature of the patents, and the licensing agreements established a clear nexus between the royalties and the production of the merchandise.
This case is different. It involves patents and trademarks. There are no references to royalty payments on the purchase orders, Vendor Agreement, or entry documents. There is also no indication in the Licensing Agreement that royalty payments are necessary in order for the Licensee to manufacture the merchandise. The payment of the royalty is not tied to the purchase of merchandise from a particular seller, and the sale of the merchandise is not tied to the payment of the royalty. Should the Licensee fail to pay the royalty, the Licensor’s remedies flow from the License Agreement rather than from the Vendor Agreement governing the transaction between the buyer and seller for the purchase and sale of the imported merchandise. Consequently, it is our opinion that the agreements and transaction documents in this case demonstrate that the royalty payments to an unrelated third party are separate and distinct from the payments made to the vendors for the merchandise, and that the Licensee is able to purchase such merchandise without paying the fee to the Licensor.
Moreover, pursuant to the Licensee’s Declaration, Licensee does not sublicense the marks to other vendors and/or manufacturers. Additionally, in this case, we recognize that under the quality control provisions Licensor may require Licensee to cease the manufacture of licensed articles if it determines that the style, nature, or quality of such articles are not consistent with the image and relative positioning of the marks. However, pursuant to the License Agreement, Licensee is permitted to complete its work in progress and sell the merchandise. Licensor also has the right to do full on-sight inspections and examination of the merchandise, but can only inspect third party facilities subject to the approval of the third parties. We find that these quality control provisions constitute an integral part of a standard license agreement and do not rise to the level of the excessive control and intervention on the part of a Licensor that may exceed mere quality control considerations. See HRL 547226, dated July 27, 1999 (CBP stated that the mere fact that the License Agreement permits licensor to be involved in the quality control process was not evidence that the license fee was a condition of sale of the imported merchandise). Therefore, the royalty fees or payments made by the Licensee to the Licensor pursuant to the License Agreement are not a condition of sale of the imported merchandise for export to the United States and do not constitute an addition to the price actually paid or payable under 19 U.S.C. §1401a(b)(1)(D).
HOLDING:
Based upon the information provided, we find that the license fees paid by Licensee to a third-party unrelated Licensor pursuant to the above-referenced License Agreement are not a condition of sale of the imported merchandise for export to the United States and do not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D).
A copy of this ruling letter should be attached to the entry documents filed at the time this merchandise is entered. If the documents are filed without a copy, this ruling should be brought to the attention of the CBP officer handling the transaction.
Sincerely,
Monika R. Brenner, Chief
Valuation & Special Programs Branch