OT:RR:CTF:VS H168397 YAG
Mr. Robert J. Leo
Meeks, Sheppard, Leo & Pillsbury
355 Lexington Avenue, Suite 1400
New York, New York 10017
RE: Dutiability of royalty payments; third party unrelated licensor; patents
Dear Mr. Leo:
This is in reference to your correspondence, dated December 10, 2010, on behalf of your client, the Licensee, who is also the importer, concerning the dutiability of certain royalty and license fees paid by Licensee to a third party patent holder (“Licensor”), pursuant to a License Agreement, executed on September 24, 2010. Furthermore, you filed a supplemental submission on June 21, 2011 and participated in a teleconference with CBP officials on May 20, 2011.
FACTS:
Licensee plans to buy and import inflatable mattresses from an unrelated Vendor in China. On September 24, 2010, Licensee entered into a License Agreement with the Licensor, a United States patent-holder, to use his intellectual property to make, have made, use, offer to sell, and sell inflatable mattresses. A copy of the License Agreement between the Licensee and Licensor was submitted with the ruling request. You state that the Licensor is not related to either the Licensee or the Vendor.
In accordance with the terms of the License Agreement (and three subsequent amendments to the License Agreement, dated March 31, 2009 and September 24, 2010) discussed below, Licensor granted Licensee the sole and exclusive right to make, have made, use, offer to sell, or sell any licensed products (or licensed components for incorporation into a licensed product) and to grant sublicenses to third parties in the United States and in any foreign country for such purposes. The term “licensed product” is defined in the License Agreement as the product that comes within the scope of or is covered by one or more of the subsisting patent claims of any United States licensed patent or licensed patent application, regardless of where such product is manufactured or sold. Additionally, the definition of the “licensed product” also covers the products which are sold in a country other than the United States and includes products covered by one or more of the subsisting patent claims or any licensed patent or licensed patent application within that country. Further, the term “licensed component” is defined as a pump, a valve, or other component of a licensed product that is separately covered by a subsisting patent claim. The patents for which the royalties are paid are listed in Schedules A-B to the License Agreement, dated August 10, 2000, and Appendices A-B of the Third Amendment to the License Agreement, dated September 24, 2010. They consist of 19 U.S. patents, as well as 18 U.S. patent applications, all of which are registered with the U.S. Patent and Trademark Office (“USPTO”). There are also numerous foreign patents and applications covered by the License Agreement, registered in various countries around the world. The patents cover collapsible air beds, pneumatic support systems, switchable inflation devices, valves for inflatable objects, pumps, and others.
In consideration for the rights set forth in the License Agreement and its three amendments, Licensee agrees to pay the Licensor a minimum aggregate annual royalty fee, and the earned royalties calculated on the basis of the Licensee’s revenue from net sales in the United States of the finished inflatable mattresses. Both types of royalties are to be paid in quarterly installments. If the earned royalties due and owing to Licensor for that quarter, plus any royalties (both earned royalties and any minimum annual royalties) that were paid for all previous quarters for that year fall below a certain amount, the royalty payments for that quarter include the earned royalties due and a minimum royalty payment equal to the difference between the minimum aggregate annual royalty and the earned royalties due to the Licensor for that quarter. Both the License Agreement and its First Amendment, dated March 31, 2009, assigned to the Licensee, specify that if the earned royalties, paid by the Licensee in two consecutive years and applicable to the licensed products, are less than the aggregate annual minimum royalty, the Licensor shall have the right to terminate the License Agreement in whole or in part. Further, the First Amendment to the License Agreement states that the failure of the Licensee to pay the aggregate minimum royalty shall be deemed to be a breach with respect to all the licensed products and licensed patents. Pursuant to Paragraph 4.02 of the License Agreement, if the Licensee terminates the agreement, the minimum aggregate annual royalty is still due to the Licensor until the expiration date of the last U.S. patent or termination of the License Agreement by either party, except as provided in Paragraph 4.02.
The License Agreement also contains certain provisions, which permit the Licensee to manufacture or have manufactured, and/or sell the licensed products in case of the termination of the License Agreement for a period of 180 days following the date of the termination in order to satisfy permitted orders (orders made in the ordinary course of business and not in anticipation of termination) for quantities and other terms and conditions consistent with past practice, and delivered no later than 180 days from the date the order is accepted. Paragraph 4.07 of the License Agreement obligates Licensee to pay Licensor the earned royalties on any sales of terminated products. Pursuant to Paragraph 3.04 of the License Agreement, Licensee’s obligation to pay any minimum annual royalty terminates with the termination of all licenses under the Licensor’s patents or patent applications.
In accordance with Paragraph 8 of the Third Amendment to the License Agreement, Licensee agrees to consult with Licensor regarding the implementation of the Licensor’s technology into Licensee’s product lines; however, the documents submitted do not specify what these consultations will entail. Additionally, Section 10.08 of the License Agreement specifies cooperation between the parties to the agreement and states that the Licensor will cooperate with the Licensee in designing, purchasing, and/or manufacturing tooling for a valve and pump covered by the Schedule B patents and patent applications. The License Agreement also grants the Licensor the right to review and approve the specifications for any such tooling and licensed components; however, Licensor cannot unreasonably withhold approval of these specifications. Paragraph 10.08(a) of the License Agreement affirms that Licensor’s focus shall be in assuring that the licensed components meet reasonable performance criteria established by Licensor. Section 10.08(b) of the License Agreement also specifies that if Licensor so desires, Licensor can participate in the design and marketing of licensed products, providing input and review in formulating any business, marketing, or strategic plans related to licensed products. Nevertheless, the License Agreement indicates that Licensee will have the sole right to make any decisions with respect to the design or marketing of licensed products. No further cooperation or quality control provisions are present in the License Agreement or its amendments.
Additionally, pursuant to our request, on April 19, 2011, you provided for our review the Manufacturing Agreement, together with its First Amendment, dated October 13, 2004 between the Vendor and the initial Licensee. You also submitted a Certificate of Merger, dated February 25, 2011, certifying the merger between the initial Licensee and the Licensee (who is the importer in the present case) and who assumed the rights under the License Agreement effective March 1, 2011. Therefore, the Manufacturing Agreement became the Licensee’s contract upon the merger with the initial Licensee under the License Agreement.
Moreover, the termination clause in the Manufacturing Agreement states that in the event of termination of the agreement by Licensee, Vendor agrees not to manufacture any products using Licensee’s licensed, patented, or trademarked technology, as long as the licenses, patents, or trademarks are in force or in effect. The Manufacturing Agreement also specifies that Licensee will retain final approval over product development, production planning, and quality control. Further, you state that it is proposed that the Licensee’s Vendor would make the appropriate tooling for the valves and pumps; however, Licensor would not control which manufacturer to use for the tooling or the finished mattress. You state that the Licensor would not have any contact or agreement with the Vendor for this project, and he would not have any authority over the Licensee’s choice of manufacturers. Finally, you state that at the time of the ruling request, the parties contemplated having a termination clause which would have permitted the Licensee to buy additional inflatable mattresses from the Vendor and import them into the United States for a certain period; however, the royalty fee (apart from the minimum) to the Licensor would not have to be paid if the mattresses were not sold in the United States. These provisions are not specified in the current Manufacturing Agreement, and no information was presented that the parties will amend Manufacturing Agreement; therefore, we limit our review to the documents provided to our office.
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).
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:
(i) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise generally will be dutiable);
(ii) 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);
(iii) 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,
(iv) 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, dated September 6, 1995. See also 19 C.F.R. §177.2(b). In the instant case, as discussed above, Licensee provided to CBP its licensing agreement, along with the 1st, 2nd, and 3rd amended agreements. On April 19, 2011, Licensee submitted the Manufacturing Agreement, together with its First Amendment, dated October 13, 2004 between the Vendor and the initial Licensee. Additionally, Licensee also submitted a Certificate of Merger, dated February 25, 2011, certifying the merger between the initial Licensee and the company (importer) that assumed the rights under the License Agreement effective March 1, 2011.
Therefore, 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 your submission of December 10, 2010, you acknowledge that the answer to the first question, i.e., was the imported merchandise manufactured under patent, is yes. In this case, the royalty at issue is paid in consideration for the right to make, have made, use, offer to sell, or sell any licensed products or components in the licensed
territory. The License Agreement also addresses the payment of royalties for the patents of the valve and pump in the mattress and mattress systems containing such valves and pumps. Therefore, the imported merchandise is manufactured under patents, insofar as the patented technologies are utilized in the manufacturing process.
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. In your submission, you argue that the royalty is not involved in the production or sale of the imported merchandise because Licensee is paying a royalty to Licensor, an unrelated third party for the right to use certain patents. The patents are not owned by the Vendor. Moreover, the Licensee, and not the Licensor, will provide the patent information at issue to the Vendor. You state that the royalty payments are not made to the Vendor of the imported merchandise or to a party related to the Vendor. Also, there is nothing in the License Agreement or its amendments that obligates or requires Licensee to purchase merchandise from a particular manufacturer or seller. You state that Licensor provides drawings and data for the manufacturing process and agrees to cooperate in the designing, manufacturing, and purchasing necessary tooling. Licensor is also able to give input into the manufacturing process, but cannot unreasonably withhold approval. Further, you state that the License Agreement with the Licensor will be a contract between the Licensor and the Licensee, not between the Licensee and the Vendor, and will set forth the obligations and rights regarding the Licensee’s use of the patents and the payment for them.
We note that the payment of royalties to a third party for the right to make the imported merchandise does not necessarily mean that the royalties are not dutiable as part of the transaction value. See HRL H004991, dated April 2, 2007; HRL W548692, dated March 2, 2007; and HRL H024980, dated July 22, 2008. HRL H004991, W548692, and H024980, each involved situations similar to the one at issue here in that royalty payments were made to unrelated third party licensors and not to the actual manufacturer or seller of the imported merchandise. In each case, the royalty payments were in consideration for the right to use patents to, among other things, make or have made, import and sell certain products. In HRL W548692, we stated that the language included in the SAA provides that royalties and license fees for patents covering processes to manufacture imported merchandise generally will be dutiable. We also noted that the relevant portions of both the TAA and SAA, which refer to royalties required to be paid as a condition of sale, do not state to whom, or for whose benefit, in particular, the payment is made. Although a reference to the seller is included in the definition of the price actually paid or payable, it is conspicuously absent from the instant provision. We opined that this, along with the language included in the SAA, indicate that royalties for patents covering manufacturing processes generally are
dutiable. Thus, in regard to patents, the framers of the TAA recognized that royalties paid to unrelated third parties could constitute a condition of the sale and, hence, be dutiable. See HRL W548692, dated March 2, 2007. So, in considering royalties paid for the use of a patent covering manufacturing processes, it is of little to no relevance to whom the payments are made; what is relevant is whether the royalty is involved in the production or sale of the imported merchandise. See H024980, dated July 22, 2008.
In this case, the License Agreement grants the Licensee an exclusive right to make any licensed products or license components for incorporation into a licensed product. According to the Manufacturing Agreement, the Vendor cannot manufacture any products using Licensee’s licensed, patented, or trademarked technology in the event of the termination of the Manufacturing Agreement. Thus, without the license to make the patented products (and components), Licensee would be unable to have the patented products made by the Vendor. In other words, the technology for which the royalty is paid, is incorporated into the imported merchandise and without the License Agreement and the applicable royalty payment, the imported merchandise could not be produced by the Licensee. Therefore, the exercise of the right conferred by the patent triggers the payment of the royalties in this instance, and the royalty is clearly involved in the production 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 paid on each and every importation and are inextricably intertwined with the imported merchandise. Where 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.
In support of your position, you cite to HRL H024979, dated May 6, 2009. In HRL H024979, Licensee entered into a License Agreement with 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 was the exclusive licensing agent for the owners of the marks and designs. Licensee was not related to the Licensor. Licensee sourced the merchandise from various vendors and paid a royalty fee to Licensor for the use of patents and trademarks in accordance with the terms of the License Agreement, provided to CBP. None of the parties to this transaction, such as manufacturers in China, vendors, Licensee, and Licensor, were related to each other. The requestor also submitted a Declaration, executed by the Licensee’s Vice President of Product Development on October 17, 2008, stating that Licensee did not sublicense the use of marks to any vendors or manufacturers. The Licensee’s Declaration also stated that although the Licensee had other agreements with its vendors for the manufacture of goods, it did not have a provision either in the manufacturing agreement or any other agreement regarding the use of the marks licensed by Licensor. Based upon the information provided, CBP determined that the license fees paid by Licensee to a third-party unrelated Licensor pursuant to the License Agreement for trademarks and patents was not a condition of sale of the imported merchandise for export to the United States and did not constitute an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. §1401a(b)(1)(D).
Initially, the facts in this matter appear to be similar to the facts discussed in HRL H024979. However, there are some key distinctions. In HRL H024979, there was no indication in the licensing agreement that the royalty payments were necessary in order for licensee to manufacture the merchandise. The royalty payments were also different in that the amount was calculated on the minimum annual amount or on the earned royalty whichever was greater. In addition, the inspection provisions in HRL H024979 were not as substantial as in this case.
As mentioned in your submission, there is some support for the position that a royalty paid to an unrelated third party in respect of United States patent rights is not dutiable. In TAA 13 (HRL 542152, dated December 4, 1980), a royalty was paid to a United States patent owner, who was not related to the seller of the imported merchandise. In HRL 542818, dated May 27, 1982, royalty payments were also made to a U.S. patent holder, who was an unrelated third party, and the licensor, seller, and importer were all unrelated to each other. This ruling, in relying on HRL 542152, held that the payments were not “a condition of the sale of the imported merchandise for exportation to the United States but rather (for the most part) for the right to obtain and use the U.S. patent, and for other related rights. To this extent, such royalty payments were not dutiable.” See also HRL 545379, dated July 7, 1995. However, in HRL 548560, dated September 3, 2004, we distinguished these rulings because these rulings did not deal with the specific issue of whether the merchandise was manufactured under patent (as articulated in the above-mentioned general notice concerning the dutiability of royalty payments. See General Notice, “Dutiability of Royalty Payments,” at 9, supra.) See also W563354, dated October 27, 2010. In the particular case, the License Agreement specifically grants the Licensee the right to make the merchandise under patent. Without the License Agreement the Vendor would not have the right to manufacture the merchandise and without such right, the merchandise could not be manufactured, purchased and imported. Therefore, even though the Licensee is not related to the Vendor or Licensor, we find that this case is distinguishable from HRL 542152 and HRL 542818, inasmuch as it involves the royalty payments for the right to make the merchandise under the patent.
Additionally, in this situation, contrary to your argument, we are of the opinion that there is a clear and substantial nexus between the imported merchandise and the royalty payments for the use of patents in producing the imported merchandise. The License Agreement in question provides for two royalty payments: a minimum aggregate annual royalty fee and the earned royalties calculated on the basis of the Licensee’s revenue from net sales in the United States of the finished inflatable mattress. Pursuant to the provisions of the License Agreement, referenced in the FACTS section of this ruling, some type of the royalty fee, either minimum annual royalty, earned royalty, or the difference between the two has to be paid in order for the Licensee to manufacture, import, or sell the merchandise in the United States. The License Agreement also provides different causes for termination of the License Agreement, including for the failure by the Licensee to make royalty payments as provided for in the Licensing Agreement. Licensee has the right to manufacture or have manufactured, and/or sell terminated products for a period of 180 days following the date of the termination of the License Agreement in order to satisfy permitted orders. However, under the License Agreement, Licensee is still obligated to pay Licensor the earned royalties on any sales of the manufactured products, in case of the terminated agreement. Therefore, the royalty payments are not optional by the terms of the License Agreement and are inextricably intertwined with the imported merchandise.
Further, the sale of mattresses, incorporating the patented technology, would generate both the earned royalty and the aggregate minimum annual royalty (with the minimum royalty paid regardless of whether there are earned royalties), which are linked under the License Agreement. Hence, if the earned royalties, calculated on the basis of the net sales of the manufactured merchandise are less than the aggregate annual minimum royalty for two consecutive years, the Licensor can terminate the agreement, thereby, terminating the manufacture of the licensed products and components. Also, the failure of the Licensee to pay the aggregate minimum royalty is deemed to be a breach with respect to all the licensed products and licensed patents. If the Licensee terminates the agreement, the minimum aggregate annual royalty is still due to the Licensor until the expiration date of the last U.S. patent or termination of the License Agreement by either party, except for the termination by the Licensee. These provisions indicate to us that the royalty payments are necessary in order for the Licensee to utilize the patents and manufacture the licensed products. This conclusion is further supported by the termination provision in the Manufacturing Agreement which states that the Vendor cannot manufacture any products using Licensee’s licensed, patented, or trademarked technology, as long as the licenses, patents, or trademarks are in force or in effect.
Finally, while there are limited consultation and cooperation provisions in the License Agreement (focusing on Licensor’s ability to assure that the licensed components meet reasonable performance criteria established by Licensor), we are of the view that in this particular case, the mere existence of such limited quality control provisions is not by itself determinative of whether the importer may buy the products without paying the fee. Accordingly, based on the information provided, we find that the royalty fees or payments made by the Licensee to the Licensor pursuant to the License Agreement are a condition of sale of the imported merchandise for export to the United States and 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, the royalty fees paid by the Licensee to the Licensor pursuant to the License Agreement are a condition of sale of the imported merchandise for export to the United States and constitute an addition to the price actually paid or payable 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