RR:IT:VA 547148 CC
Port Director
U.S. Customs Service
1205 Royal Lane
P.O. Box 619050
DFW Int’l. Airport
Dallas/Fort Worth, TX 75261-0950
RE: Request for Internal Advice; Dutiability of Royalty payments; 19 U.S.C. § 1401a(b)(1)(D)
Dear Sir or Madam:
This is in response to your request for internal advice, dated August 6, 1998, regarding the dutiability of certain royalties a U.S. importer, Fujitsu Network Communications, Inc. (“FNC”) pays to a related foreign manufacturer, Fujitsu Limited (“FJ”). Also, you forwarded a submission made by counsel for FNC dated July 9, 1998. Counsel made a submission, dated September 10, 1998, requesting confidentiality of certain information. A representative of FNC and its counsel met with members of the Value Branch on May 25, 1999. Subsequent to that meeting, counsel made an additional submission dated June 30, 1999. We apologize for the delay in responding to your request.
Counsel has requested confidentiality pursuant to 19 CFR § 177.2(b)(7) concerning this matter. Specifically, counsel requested that certain financial and commercial information, including sales figures and costs, contained in its submissions and in the various agreements submitted, be accorded confidential treatment. We agree with this confidentiality request, and the subject information is bracketed in this ruling and will not be disclosed in copies of this ruling made available to the public.
FACTS:
The importer, FNC, is a wholly owned subsidiary of Fujitsu America, Inc. (“FAI), which in turn is wholly owned by FJ, a foreign manufacturer. The subject royalty payments, which are paid from FNC to FJ, were identified during a Compliance Assessment performed in 1997.
According to counsel, FNC imports two categories of merchandise from FJ. It imports merchandise at the board component level that is used in FNC’s manufacturing operations, and which FNC refers to as “raw materials.” In addition, FNC imports subassemblies that are ready for final assembly without further manufacturing other than assembly or some minor modifications, which FNC refers to as “finished goods.”
The royalties at issue concern imported merchandise at the board component level. These royalties do not cover the imported subassemblies. The royalty payments at issue cover manufacturing “know how” for telecommunications equipment manufactured by FNC using raw materials imported from FJ and raw materials sourced from other U.S. and foreign vendors. According to counsel, FNC is under no obligation to source any quantity of merchandise from FJ, and in fact, sources a substantial and increasing amount form other vendors. You state, however, that from April 1 to September 30, 1997, FNC purchased over 99 percent of its imported merchandise from FJ.
Counsel claims that the payment of the royalty is due upon production of the equipment, not upon the sale of that equipment. In addition, counsel asserts that the benchmark value for calculating the royalty for accrual purposes is not the actual resale price of the merchandise, but, in essence, the resale value at the time of production.
There are three relevant agreements relating to royalty payments and importation of the merchandise. They are the following:
1. Parts and Materials Supply Agreement, dated February 15, 1984, between Fujitsu Limited and Fujitsu America, Inc. (amended to FNC).
2. License Agreement, dated February 15, 1984, between Fujitsu Limited and Fujitsu America, Inc. (amended to FNC).
3. Distributorship Agreement for Telecommunications Equipment, dated February 26, 1990, between Fujitsu Limited and Fujitsu America, Inc. (amended to FNC).
Counsel considers the following provisions under these agreements, and the arguments related thereto, to support a finding that the subject royalty payments are nondutiable:
The Parts and Materials Supply Agreement, Section 1, paragraph 1.1, defines “GOODS” to mean “units, components, assemblies, subassemblies or parts of [FNC’s] products.” Section 9 of that Agreement provides that “[n]othing herein shall be construed as the transfer or grant of license of any trade names, trademarks, patents, designs and/or copyrights which FJ owns or may own in connection with GOODS.” Under the Whereas clauses and Section 2, paragraph 2.1, FJ and FNC agree to sell and purchase “GOODS” in accordance with the agreement. Nothing obligates either party to do so, however. …FNC exercises that ability commonly by sourcing raw materials to a large and increasing degree from other vendors when the raw materials satisfy quality standards and they are competitively priced.
The License Agreement, as amended by Addendum No. 2 of July 3, 1990, Paragraph No. 3, which replaces the license description in paragraph (a) of Article 4 of the License Agreement, grants “[FNC] a non-exclusive and non-transferable license to use information provided by FJ and Licensed Patents of FJ for assemblage, manufacture, use, sale, lease and/or other disposition of Licensed Products in the United States of America.” “Licensed Products” are defined in Article 1, Section 1, as finished equipment, as distinguished from “GOODS.” …
The Distributorship Agreement, in Articles 18 and 21, provides FNC, on a free-of-charge basis, with operation and maintenance manuals and training manuals, and the use of trademark and tradenames for marketing and sale of “FUJITSU PRODUCTS.” “FUJITSU PRODUCTS” are defined in Article 1, Section 1.1 to mean finished telecommunications equipment. Section 1.1 thus states: “ ‘FUJITSU PRODUCTS’ means telecommunications equipment to be sold by FUJITSU to [FNC] under this Agreement which are specified in Exhibit A attached hereto.”
You argue that the royalty payments are dutiable either as royalties under 19 U.S.C. § 1401a(b)(1)(D) or as proceeds of a subsequent resale under 19 U.S.C. § 1401a(b)(1)(E). You argue that the License Agreement and the Parts and Materials Supply Agreement are inextricably intertwined and that FNC cannot purchase FJ parts unless the License Agreement is in effect. As one piece of evidence, you identify the License Agreement and Parts and Materials Supply Agreement as being executed on the same day, February 14, 1984.
In addition, you consider the following provisions under these agreements, and the arguments related thereto, to support a finding that the subject royalty payments are dutiable:
The Parts and Material[s] Supply Agreement refers to Article 9 of the License Agreement, and states that FNC desires to procure products from FJ to assemble or manufacture Licensed Products as defined in the License Agreement. The Parts and Material[s] Supply Agreement (Section 12) states the supply agreement shall terminate on the date of termination of the License Agreement. We believe these conditions strongly indicate that the payment of royalties is closely tied to the purchase of the imported parts.
The License Agreement states that FNC and FJ desire to enable FNC to assemble or manufacture certain Licensed Products. FJ owns and may own rights in and to FJ information and Licensed Patents which FNC desires to acquire. Article 4 grants FNC a non-exclusive and non-transferable License to use FJ Information for assemblage, manufacture, use, sale, lease and/or other disposition of Licensed Products in Canada and the U.S. Article 9 of the License Agreement specifically refers to the purchase of parts for which the detailed terms and conditions shall be agreed upon between parties from time to time in separate agreements.
The License Agreement requires a [xxxxxxxx] royalty payment on the “net selling price,” which is FNC’s revenue on licensed products less direct expenses and the price (FNC’s costs) of units, components, assemblies, subassemblies or parts purchased from FJ. You contend that the actual calculation of royalties is inconsistent with the method delineated in the agreement because estimates are employed. In addition, you state that the actual method employed in calculating royalties does not ensure that the cost of imported goods is excluded from the royalty payment.
In its July 30, 1999, letter, counsel presented detailed information on how the royalties were calculated. Counsel explains that the reason FNC uses the method employed is because “the raw materials parts purchased from FJ are too numerous to track on a part by part basis for purposes of the royalty calculation.” Therefore, counsel states, “FNC relies on an aggregate approach using methods acceptable under generally accepted accounting principles (“GAAP”) to calculate the royalty payable to FJ.”
Our understanding of the royalty calculation is as follows. Royalties are calculated on a monthly basis; however, royalty payments are made on a semi-annual basis. A current manufacturing cost for each licensed product is obtained from the system for the month; this cost would include the cost of all raw materials. For each licensed product, the net revenue is arrived at by grossing-up the current month’s manufacturing cost with the prior month’s gross margin. Therefore, the revenue figure is essentially an estimate. FJ material purchased that is consumed in production of the licensed products is deducted from the estimated revenue. That figure is calculated by determining the ratio of purchases of raw materials from FJ compared to the total purchases of raw materials from all other sources. That ratio is applied against the cost of raw materials withdrawn from inventory for production. After the FJ raw material costs, as well as direct expenses, are deducted from the estimated revenue, a [x xxxxxxx] royalty payment is made on that amount.
ISSUE:
Whether royalty payments made by FNC to FJ are included in the transaction value of the imported merchandise.
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: 19 U.S.C. § 1401a). Section 402(b)(1) of the TAA (19 U.S.C. § 1401a(b)(1)) provides that the preferred method of appraisement is transaction valuation, which is defined as the “price actually paid or payable for 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 sale of the imported merchandise for exportation to the United States (Section 402(b)(1)(D) of the TAA); and the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller (Section 402(b)(1)(E) of the TAA).
FNC and FJ are related parties. When parties are related, section 402(b)(2)(B) of the TAA (19 U.S.C. § 1401a(b)(2)(B)) provides that transaction value is acceptable only if an examination of the circumstances of the sale indicates that the relationship between the buyer and seller did not influence the price actually paid or payable or if the transaction value of the imported merchandise closely approximates the transaction value of identical or similar merchandise in sales to unrelated buyers in the U.S. or the deductive or computed value for identical or similar merchandise. For purposes of this decision, we assume that transaction value is acceptable.
The term “price actually paid or payable” is defined in 19 U.S.C. § 1401a(b)(4)(A) as “the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.” There is a rebuttable presumption that all payments made by a buyer to a seller, or a party related to the seller, are part of the price actually paid or payable for the imported merchandise. See Generra Sportswear Company v. United States, 905 F.2d 377 (Fed. Cir. 1990).
In the present case, the subject payments are paid by the buyer to the licensor, who is also the seller of the imported merchandise. Thus, there is a rebuttable presumption that these payments are part of the price actually paid or payable. This presumption can be rebutted by evidence that clearly establishes that the royalty payments are completely unrelated to the imported merchandise. Although an analysis of the royalty payments could proceed as to whether they constitute part of the price actually paid or payable, it is our belief that the facts better lend themselves to a royalties analysis. Based on the detailed agreements and presented facts concerning the royalty payments, our analysis will proceed as to whether the royalty payments are properly added to the price actually paid or payable as royalties or license fees pursuant to 19 U.S.C. § 1401a(b)(1)(D).
With regard to the dutiability of royalties and license fees, the Statement of Administrative Action (SAA), H.R. Doc. No. 153 96 Cong., 1st Sess., reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981) at 48-49, 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 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.
After reviewing the legislative history of the TAA, Customs has identified three questions that are relevant in determining whether royalty payments are dutiable under section 402(b)(1)(D) of the TAA. General Notice, “Dutiability of Royalty Payments,” 27:6 Cust. B. & Dec 1 (February 10, 1993) (the “Hasbro II ruling” or “General Notice”). The questions are: (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? Id. At 9-11. Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability.
When analyzing the factors identified in the above-noted General Notice, Customs has taken into account certain considerations which flow from the language set forth in the SAA. These include, but are not limited to:
(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 Headquarters Ruling Letter (HRL) 546478, dated February 11, 1998; see also, HRL 546433, dated January 9, 1998, and HRL 544991, dated September 13, 1995 (and cases cited therein).
Although the SAA provides that determinations about the addition of royalty payments to the price actually paid or payable are to be made case-by-case, it is more likely that the royalty will be included in transaction value when the licensor and seller are related 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. See, HRL 545361, dated July 20, 1995, which held that trademark royalties are included in transaction value when paid to the seller/licensor but not when paid to a third party unrelated to the seller.
In this case, the party to whom the royalties are paid is both the seller and the licensor. According to the SAA, any royalty or license fee paid to the seller is part of transaction value unless the importer can establish that it is distinct from the price actually paid or payable for the imported merchandise and that such payment was not a condition of the sale of the imported merchandise for exportation to the United States. In other words, there is a presumption that royalties paid to the seller are included in transaction value unless the importer can show otherwise. See also, HRL 544991, dated September 13, 1995.
Counsel makes the following arguments in support of its position that the royalty payments are not part of transaction value: the royalty covers manufacturing rights and “know how” that are separate from the rights embodied in the raw material imported from FJ, and the Parts and Materials Supply Agreement specifically excludes the transfer of any intellectual property rights relating to the imported merchandise; the Parts and Materials Supply Agreement contains no purchase requirement or minimum purchase requirement; FNC is free to source from other vendors and does so; the royalty is not paid as part of the invoice price for the raw materials imported from FJ; FNC pays the royalty even if it purchases nothing from FJ; if the Parts and Materials Supply Agreement were terminated, FNC would still pay the royalty; the royalty accrues at the time production is completed on products manufactured in the U.S.; and the royalty is not paid as proceeds of a subsequent resale of the imported merchandise.
Additionally, counsel argues a royalty is not dutiable when it is calculated using a formula that excludes the value of imported components, citing the following rulings: TAA #56 (HRL 542900, dated December 9, 1982); C.S.D. 92-12 (HRL 544656, dated June 19, 1991); HRL 546478, dated February 11, 1998; and HRL 544978, dated April 27, 1995. Counsel contends that the royalty is not inextricably intertwined with the imported merchandise due to the termination provision in the Parts and Materials Supply Agreement that references the License Fee Agreement. One reason, counsel argues is that if the Parts and Materials Supply Agreement were terminated and FNC sourced nothing from FJ, FNC would still owe the royalty. Also, counsel states that FNC has no minimum purchase requirement in order to make any link between the two agreements meaningful. Finally, counsel states that when a royalty is paid on finished goods manufactured in the U.S. using domestic components, Customs has relied on the fact the royalty is paid on U.S. manufactured goods to determine that they are not dutiable, even when there are numerous references to a royalty agreement in a purchase agreement. Counsel cites HRL 545035, dated August 23, 1995, and HRL 545072, dated April 1, 1996, in support of this argument.
With respect to the first question under the notice, counsel states, “[w]hile some of the imported merchandise may be manufactured under patent, the royalties are entirely unrelated to any such patents.” We are unable to find anything conclusive in the agreements concerning this issue, nor is there any other information available concerning whether the imported merchandise is manufactured under patent. Consequently, we are unable to determine whether the imported merchandise is manufactured under patent.
The second question indicated in the notice is whether the royalty or license fee is involved in the production or sale of the imported merchandise. We have ruled that where “the license agreement is replete with requirements regarding the sale of the imported merchandise” the royalty is involved in the production or sale of the imported merchandise. HRL 546433, dated January 9, 1998, and HRL 546033, dated March 14, 1996. In addition, we have found in certain rulings that when imported merchandise from the licensor/seller was used to manufacture a finished product, the provisions of the relevant agreements linked the payment of the royalties to the importation of the imported parts. See HRL 544991, dated September 13, 1995, and HRL 545896, dated June 23, 1999.
In this matter the relevant agreements are replete with requirements regarding the sale of the imported merchandise. Article 9 of the License Agreement provides that FNC desires to procure merchandise from FJ to assemble or manufacture Licensed Products. Article 9 further provides that the terms for the purchase of such merchandise will be governed by separate agreements. Additionally, the preamble “whereas” provision in the Parts and Materials Supply Agreement specifically states that “in accordance with Article 9 of the LICENSE AGREEMENT, [FNC] desires to procure units, components, assemblies, subassemblies or parts from FJ to assemble or manufacture certain of Licensed Products as defined in Article 1 Section 1 of LICENSE AGREEMENT….”
In addition, the License Agreement and the Parts and Materials Supply Agreement were both executed on February 15, 1984. Section 12 of the Parts and Materials Supply Agreement provides that it “shall terminate on the date of termination of LICENSE AGREEMENT.” These are important considerations cited above as providing evidence that the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined. Despite counsel’s contention that the Parts and Materials Supply Agreement specifically excludes the transfer of an intellectual property right relating to the imported merchandise, the above provisions of the agreements indicate that the royalty payments to the seller are closely tied to the purchase of the imported products from the seller. Consequently, we find that the royalty is involved in the sale of the imported merchandise.
The third question contained in the notice is whether the importer could buy the product without paying the fees. This question goes to the heart of whether a payment is considered to be a condition of sale. As stated in the SAA and in several rulings, royalty payments made to the foreign seller provides an indication that the royalty is a condition of sale for exportation of the imported merchandise. See, e.g., HRL 545361, dated July 20, 1995, and HRL 546433, dated January 9, 1998. In fact, as stated above, royalty payments made to the seller create a presumption they are included in transaction value. In addition, we have ruled and find controlling in this matter, HRL 544991, dated September 13, 1995, and HRL 545896, dated June 23, 1999, in which we found that the relevant agreements linked the payment of the royalties to the purchase of the imported parts used in manufacturing final products such that payment of the royalty was a condition of sale for exportation of the imported merchandise. In HRL 545896, we stated the following:
In HRL 54499[1], royalty payments were paid in consideration of licensed technology and technical assistance provided by the parent, seller/licensor, to the importer/buyer. The imported merchandise (parts) from the licensor/seller was used to manufacture a finished product (machines) and the royalties were based on the selling price of the finished product. In that case, an agreement between the seller/licensor and the importer/buyer effectively linked the payment of the royalties to the purchase of the imported parts. Consequently, it was determined that as the importer/buyer could not buy the imported merchandise without paying the fee, the royalties were a condition of sale and, therefore, a proper addition to the price actually paid or payable of the imported merchandise under § 402(b)(1)(D) of the TAA.
Therefore, based on the foregoing and on HRL 544991 and HRL 545896, we find that FNC could not buy the imported merchandise without paying the fee and the royalties were a condition of sale.
Concerning counsel’s specific arguments, counsel has stated that when a royalty is paid on finished goods manufactured in the U.S. using domestic components, Customs has relied on the fact the royalty is paid on U.S. manufactured goods to determine that they are not dutiable, even when there are numerous references to a royalty agreement in a purchase agreement. We find this argument inconsistent with HRL 544991, discussed above, in which the royalty was found to be dutiable even when U.S. components were used in part to manufacture the finished merchandise. Concerning counsel’s contention that a royalty is not dutiable when it is calculated using a formula that excludes the value of imported components, it has cited several rulings, including TAA #56 and C.S.D. 92-12. However, in those rulings the purchase of the imported merchandise and the payment of the royalties were not found to be inextricably intertwined due to the provisions in the relevant agreements. In this regard, we find HRL 544991 and HRL 545896 controlling, as stated above. In addition, we do not believe the formula used by FNC to deduct FJ imported materials from the selling price on which royalties are calculated conclusively shows that all FJ imported materials are deducted. Counsel contends that the royalty is not inextricably intertwined with the imported merchandise due to the termination provision in the Parts and Materials Supply Agreement because if it were terminated and FNC sourced nothing from FJ, FNC would still owe the royalty. (As stated above, the Parts and Materials Supply Agreement provides that it shall terminate on the date of termination of the License Agreement.) This argument is inconsistent with one of the considerations which flow from the language of the SAA, cited above, in which an important factor in determining that the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined is the “termination of either (emphasis added) the purchase or license agreement upon termination of the other.” In addition, in HRL 545998, dated November 13, 1996, we found royalties related to the imported merchandise and a condition of sale, in part, because the supply agreement was conditioned upon the continued existence of the license agreement. Finally, counsel states that there is no purchase requirement or minimum purchase requirement and FNC is free to source from other vendors as factors for finding the royalties nondutiable. These factors were present in HRL 544991, discussed above, in which we found the royalties to be dutiable.
Based on the foregoing, FNC, which pays royalties to its related seller, FJ, has failed to rebut the presumption that the royalties paid to the seller are included in transaction value. Consequently, the subject royalties should be included in transaction value.
HOLDING:
Royalty payments made by FNC to FJ are included in the transaction value of the imported merchandise. Having reached this conclusion, it is not necessary to address the issue of whether the payments could alternatively be considered proceeds under 19 U.S.C. § 1401a(b)(1)(E).
You are to mail this decision to the internal advice applicant no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to Customs personnel, and to the public on the Customs Home Page on the World Wide Web at www.customs.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Sincerely,
Virginia L. Brown
Chief, Value Branch