VAL-2 OT:RR:CTF:VS H024566 CMR
Cummins Inc.
500 Jackson Street
Mail Code 60211
Columbus, IN 47210
Attn: Ms. Sandra L. Tumbarello
RE: Dutiability of Royalty Payments
Dear Ms. Tumbarello:
This is in response to your request of March 10, 2008, on behalf of your company, Cummins Inc., for a ruling determination on the dutiability of royalty payments paid pursuant to a Technical Licensing Agreement. The Technical Licensing Agreement was made between [XXXXX] (hereinafter [XXXX]) and Holset Engineering Co. Ltd.
You have requested confidential treatment of the name of the licensor and of any reference to specific dollar values in the requested ruling. We are granting your request and will redact the information bracketed herein before making the ruling available to the general public.
FACTS:
In 1973, Cummins Engine Company acquired Holset Engineering Co. Ltd. from Hanson Trust which had purchased the company earlier in 1973. In 1996, Holset Engineering Co. Ltd. and [XXXX] signed a technical assistance and license agreement regarding the manufacture of “turbochargers and parts thereof” (hereinafter turbochargers). Cummins Inc. is the parent company of Holset Engineering Co. Ltd. which changed its name in 2006 to Cummins Turbo Technologies (CTT) to align itself more closely with its parent company.
CTT in Charleston, South Carolina, is the importer of record for any purchased [XXXX] products or parts entered into the United States and falling under the licensing agreement. The agreement, a copy of which was submitted, requires two lump-sum payments (which are not at issue in this ruling) and a royalty payment in return for licenses, technical information and technical service granted, furnished and rendered to CTT by [XXXX]. The agreement provides for a non-exclusive license to permit CTT and its subsidiaries to manufacture turbochargers developed and designed by [XXXX] by assembling parts purchased from [XXXX] (KD Packs) and parts manufactured or procured by CTT. The agreement also provides an exclusive license to sell the turbochargers to Cummins Engine Company and its subsidiaries and licensees worldwide, and a non-exclusive license to sell the turbochargers to other customers worldwide as agreed to between the parties. The agreement also provides for the provision of certain technical information by [XXXX] including information regarding design, specifications, and manufacturing. Finally, it also provides for the provision of technical assistance by [XXXX] to CTT.
The royalty is calculated as a percentage of the net invoiced value of the finished turbochargers (manufactured in the United States) sold or otherwise disposed of by CTT produced pursuant to the licensing agreement. “Net invoiced value”, according to the agreement, is the price invoiced by CTT to its customers for sales or other disposition of turbochargers, less costs for packing, transportation, ocean freight, import duty and shipping insurance and the F.O.B. port price of any component parts for incorporation into the turbochargers or parts thereof purchased from [XXXX] by CTT and incorporated into the finished products. The agreement further requires that the “net invoiced value” for sales or other dispositions made by CTT to itself or any related parties, i.e., parties owned, controlled, or directed by CTT or which own, control or direct CTT, be computed on an amount not less than that which such sales would be made to arms-length purchasers. Further, any subsidies which might reduce the net invoice value amount are to be added back in prior to calculating the percentage owed by CTT to [XXXX], unless otherwise agreed to by the parties. The royalties which are based on a percentage of the net invoiced value are to be computed and paid on a semi-annual basis.
You have indicated that royalty payments based on the methodology described in the licensing agreement, i.e., the percentage of net invoiced value, was used from 1996 through June 2003, and from 2007 forward. A flat rate method of calculating royalty payments was utilized from July 2003 through 2006. The flat rate method of calculating royalty payments was achieved by averaging all the figures involved, i.e. price, cost of imported parts (including all costs to be deducted under the net invoiced value definition in the agreement), and calculating an average royalty amount which was then multiplied by the number of turbochargers sold by CTT.
You state that Cummins and CTT believe that the royalty payments are not additions to the price actually paid or payable as payment is not guaranteed and is not a condition of sale for the imported products. You also believe that the payments are not dutiable as proceeds of subsequent sales. The parts imported from [XXXX] are combined with other U.S. produced parts to create the finished product. It is the sale of the finished product that forms the basis for the royalty payment. Whether the royalty payment is calculated based on the methodology described in the agreement or the flat rate method, the cost of the imported products used in the finished product is deducted from the sales price of the finished product prior to the calculation of the royalty.
You have requested a ruling on the dutiability of the royalty payments as described in the licensing agreement and the dutiability of the royalty payments based on the flat rate methodology utilized from July 2003 through 2006.
ISSUE:
Are the royalty payments paid by CTT to [XXXX] under the licensing agreement included in transaction value as part of the price actually paid or payable or as an addition under 19 U.S.C. § 1401a(b)(1)(D) when the royalty is based on a percentage of the net invoiced value of final products into which imported parts are incorporated or when the royalty is based on an average royalty amount (flat rate) per final product?
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; and the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller." 19 U.S.C. § 1401a(b)(1)(D) and (E). These additions apply only if they are not already included in the price actually paid or payable. For purposes of this decision, we assume that transaction value is the appropriate method of appraisement.
With regard to royalties, 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. (Statute) 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 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. (Regulation)
Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., Pt II, at 443 – 444 (1979). [Bold added.]
Based on Generra Sportswear Co. V. United States, 905 F.2d 377 (Fed. Cir. 1990), CBP presumes that all payments made by a buyer to a seller are part of the price actually paid or payable for the imported merchandise. However, the presumption is rebuttable and if it is evident that the royalty payments are not related to the sale of the imported merchandise for exportation to the United States, then the royalty payments will not be considered part of the price actually paid or payable. E.g., Chrysler Corp. v. United States, 17 Ct. Int’l Trade 1049, 1055-1056 (1993) (holding that certain shortfall and special application fees were not part of the price actually paid or payable). In this particular case, it is clear that the royalty payments are not part of the price actually paid or payable for the imported merchandise, i.e., the KD packs. Rather, the royalty is paid for the right to manufacture and sell a finished product in the U.S. using the licensor’s patents and technical information.
However, royalty payments may also be included in transaction value as an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA. 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? Affirmative responses to factors one and two and a negative response to factor three would indicate that the payments were a condition of sale and, therefore, dutiable as royalty payments.
With regard to the first question of the dutiability test, the answer is yes. The merchandise imported in the KD Packs is manufactured under [XXXX] patent. However, the answer to the second question is no. The royalty payment is not involved in the production or sale of the imported merchandise. As is evident from a close reading of the licensing agreement, the royalty payment is for the use of various patents in the production of merchandise in the United States which incorporates the imported merchandise, but it is not for the imported merchandise itself. Additionally, the royalty includes the right to sell the U.S. produced product which falls under an [XXXX] patent. The cost of the imported merchandise (and all expenses related to the importation of the merchandise) is subtracted from the final figure which forms the basis for determining the royalty payment. The payment is for the right to manufacture and sell turbochargers, under [XXXX] patents, in the United States. See HQ 544656, dated June 19, 1991, wherein royalty payments were found to be “for technical information and know-how related [to] using the [imported] components in the process [of] assembling and manufacturing machines after the components are imported” and not related to the imported merchandise, nor a condition of its sale. See also C.S.D. 93-26 (HQ 545114), dated September 30, 1993, and HQ 545307, dated February 3, 1995.
In HQ 546478, dated February 11, 1998, it was determined that royalties relating to marketing-related intellectual property rights associated with the distribution of product in a territory and based only on the percentage of the importer’s mark-up (excluding the value of the imported product) were not part of the transaction value of the imported merchandise. The sublicense agreement in HQ 546478 contained only a brief reference to the importer’s purchase of the imported merchandise. Similarly in this case, the value of the imported merchandise is excluded from the basis for determining the royalty payment, the payment is not required for the importation of the merchandise, and the licensing agreement contains only brief references to the imported merchandise. In HQ 546478, our decision included the assumption that there were no supply agreements or other contracts between the parties which linked the royalty payments with the purchase of the imported merchandise. In this case, we have been informed that there are no other agreements with regard to the imported merchandise. HQ 546478 supports our view that the royalty payments at issue here are not related to the production or sale of that imported merchandise.
Finally, the importer can buy the imported merchandise without paying the royalty as it is not the importation of the merchandise that triggers the obligation to pay the royalty, it is the successful production of a turbocharger (or parts thereof) and sale of that product produced in the United States that triggers the obligation to pay a royalty.
As the royalty payments to [XXXX] (the seller of the imported merchandise) are triggered by a sale (or other disposal) of merchandise containing the imported merchandise, we need to examine whether the royalty payments are dutiable under 19 U.S.C. § 1401a(b)(1)(E). This provision of the statute provides for the addition to the price actually paid or payable of “the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller." It is the sale of the merchandise produced in the United States which triggers the royalty payments and that merchandise contains the imported merchandise. However, as stated above, the value of the imported merchandise is deducted from the value which forms the basis for calculating the royalty so that the royalty is not based upon a resale, disposal or use of the imported merchandise. Thus, the royalty payments are not dutiable as proceeds under 19 U.S.C. § 1401a(b)(1)(E). See HQ 544656, dated June 19, 1991; and, HQ 545114, dated September 30, 1993.
HOLDING:
Based on the above analysis, the royalty payments at issue are not included in transaction value as part of the price actually paid or payable for the imported merchandise, nor do they constitute an addition thereto under section 402(b)(1)(D) or (E) of the TAA.
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 and Special Programs Branch