OT:RR:CTF:VS H160935 CMR
Kimberly Wiggins
Acting Field Director
Office of Regulatory Audit
2001 Cross Beam Drive
Charlotte, NC 28217
RE: Request for Internal Advice; Related Parties; Transaction Value; Royalty Fees
Dear Ms. Wiggins:
This is in response to a request for internal advice from your office, dated April 12, 2011, regarding the acceptability of transaction value between related parties in light of discounts ranging from 25 to 57.5% on the price of the goods, and the dutiability of royalty fees paid for the use of a trademark owned by a related party. The questions arose as a result of a Focused Assessment Pre-Assessment Survey, Audit Report #451-10-FA1-P1-22905, which reviewed the importer’s entries for fiscal year 2009.
This office has been in contact with the importer’s counsel, Cassidy Levy Kent (USA) LLP, and has received additional information from counsel regarding how the related parties conduct business, including examples of negotiations. In addition, counsel and his client met with members of this office on December 4, 2014, to discuss this matter.
FACTS:
The importer buys goods from related and unrelated suppliers. It is the exclusive distributor in the United States of certain equipment, machinery and spare parts/components manufactured by its related parties. The importer’s business is the design, development, manufacture and sale of process equipment, technology and know-how for customers in a variety of industries, including dairy, food, chemicals, pharmaceutical, beverage, oil and gas, and cement manufacturing. It uses both imported and domestic sourced equipment, machinery and components, including certain equipment it produces in the United States, to build manufacturing process equipment for customers in the U.S. as well as outside the U.S. In limited cases, approximately 5%, the importer may only use imported machinery and equipment to complete a project, yet each project always requires engineering and commissioning by the importer’s service team. In the majority of cases, approximately 95%, the importer utilizes equipment and machinery from various sources, domestic (including its own U.S. produced equipment) and possibly foreign, to engineer, build, possibly install, and commission a manufacturing process system.
Counsel submits that the related suppliers to the importer operate as individual profit centers. Counsel states:
Each entity is required to establish annual revenue and margin targets against which it is evaluated at year end on its ability to meet or exceed such targets. Therefore, ensuring all sales include appropriate profit margins is critical to the success of the [importer] related suppliers.
A transfer pricing study was submitted to your office. According to the study, the importer does not have any formal intercompany agreements in place with its related party suppliers. Further, it indicates that the importer bears the foreign exchange risk associated with purchases from its related party suppliers as most purchases are conducted in the local currency of the related supplier and not in U.S. dollars.
The transfer pricing study utilized the Comparable Profits Method (CPM) to evaluate whether the importer’s transactions with its related parties would be considered to be at arm’s length. The study identified six (6) comparable companies and used the Net Cost Plus Ratio (NCP) as the basis for comparison, with some adjustments for differences in accounts payable, accounts receivable and inventory. Comparing the capital-adjusted NCP, the importer fell within .1% of the median for comparable companies.
Your office identified related party transactions which included discounts ranging from 3 to 57.5%. The importer maintains that it negotiates and settles prices with its related party suppliers in the same manner it negotiates with unrelated suppliers and that the relationships do not affect pricing. Counsel for the importer submits that “suppliers quote prices on a case-by-case basis according to the specifications provided by [the importer, who then] determines ultimate pricing to propose to [its] customers, based on the supplier(s) quotes and margins it wishes to receive on sales to [its] customers.” In this pricing process, the importer is competing with other companies bidding on the same projects. When it needs to make additional cuts in proposed pricing to address customer needs, the importer engages in negotiations with suppliers to attempt to get more competitive pricing. In instances where unrelated suppliers have the required goods available at more competitive prices, the importer may purchase goods from unrelated as opposed to related parties. Examples of negotiations via email communications were submitted to demonstrate this point. In addition, documents were submitted, such as purchase orders and invoices, related to the submitted email negotiations to demonstrate the results of those negotiations. Counsel for the importer asserts that the submitted examples show the arm’s length nature of the price negotiations which should lead to a conclusion that the circumstances of the sale test, set forth in 19 CFR § 152.103(l), has been met.
In addition, the importer pays a royalty fee to related parties who are not suppliers of goods to the importer. The importer is a sub-licensee of the licensees who signed trademark license agreements with the holder of the trademark. All of the parties, the importer (sub-licensee), the licensees and the owner of the trademark are related parties. The importer is an affiliate of the licensees.
The relevant licensing agreement provides, in relevant part, that the License is “a non-exclusive, non-transferable license to use the Trademarks in the Territory – to the extent the specific Trademarks intended to be used by the Licensee or its sub-licensees are registered in the specific part of the Territory – in the promotion, distribution and sale of Products . . . .” It further provides in paragraph 4 of the agreement, in relevant part:
4.1 All Products made and sold by the Licensee under this agreement may carry the Trademarks. The Licensee shall comply strictly with the directions of the Proprietor regarding the form and manner of the application of the Trademarks, any deviation requires prior written approval of the Proprietor.
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4.3 Licensee is entitled to use the Trademarks in its advertisement materials, show rooms, exhibitions, etc.
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4.5 Licensee may use its own trade name on packaging, advertising and promotional materials for the Products.
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4.7 Any goodwill derived from the use of the Trademarks by the Licensee accrues to the Proprietor.
With regard to quality control and specifications for goods carrying the Trademarks, the agreement provides, in relevant part:
8.1 Proprietor may notify the Licensee of the standards of quality and specifications which must be adopted by the Licensee in the manufacture, promotion, distribution and sale of Products carrying the Trademarks, and Licensee undertakes to strictly comply with such standards and specifications. Licensee undertakes to strictly comply with all technical and technological instructions given by Proprietor and/or its entitled Affiliates in accordance with this agreement and the related agreements concluded between the Licensee and Proprietor’s Affiliates.
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8.4 Proprietor and/or its entitled Affiliates shall at its own expense have access during normal business hours to any of the Licensee’s premises used for the manufacture, storage and distribution of Products carrying the Trademarks to inspect samples and the methods of manufacture, storage and distribution. . . .
With regard to the License Fees, paragraph 9 provides in relevant part:
9.1 The Licensee shall make License Fee payments to the Proprietor in accordance with Schedule 4.
Finally, with regard to advertising and marketing, we note that in paragraph 10.3, the agreement states:
10.3 . . . . Licensee shall bear the costs of all advertising and promotion for its Products carrying Trademarks, and for advertising and marketing activities for its Products carrying the Trademarks and the Trademarks in its local home market.
Emphasis added.
Schedule 4 of the License Agreement provides, in relevant part:
Revenue based License Fee
Licensee shall pay a trade mark License Fee calculated as a percentage of total net sales. Net sales shall mean total sales less deductions and discounts including freight to customers excluding VAT. A license fee is not due in case products are supplied to other Affiliates which pay a license fee, e.g., in case semi-finished products are sold for further processing to another Affiliate.
Our decision discussed below is based on the information provided by your office, the information provided by counsel for the importer in response to our questions, the discussion at a meeting held with counsel and the importer at our offices on December 4, 2014, and a supplemental submission from counsel, dated January 26, 2015.
ISSUES:
Is transaction value acceptable for the appraisement of imported merchandise purchased by the importer from related party suppliers?
Are the royalty fees paid to related parties who are not suppliers of imported goods to the importer dutiable as either royalty fees that the importer is required to pay as a condition of the sale of the imported merchandise or dutiable as proceeds of a subsequent sale?
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
Acceptability of Transaction Value
The transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The Customs Regulations, in 19 Code of Federal Regulations (CFR), Part 152, set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, CBP examines the manner in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 CFR §152.103(l)(1)(i)-(ii). In addition, CBP will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. 19 CFR §152.103(l)(1)(iii). These are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well.
In this case, counsel for the importer has chosen to provide evidence to CBP, via emails between the importer and related and unrelated suppliers, that the importer negotiates and settles prices with its related party suppliers in the same manner it negotiates with unrelated suppliers. Counsel has attempted to show that the prices between the related parties, including the discounts, have been settled in a manner consistent with the normal pricing practices of the industry in question. Another method of showing that the prices are not influenced by the relationship would be to show CBP that the prices are settled consistent with the way in which the seller settles prices with unrelated buyers. As the importer buys from multiple related parties and buys from unrelated parties, rather than focus on sales by the related party sellers to the importer, as referenced in the regulations, counsel has focused on purchases by the importer from related and unrelated parties.
Among the exchanges provided by the importer are:
Negotiations between the importer and an unrelated party whereby a 3% discount for the purchase of various valves was agreed upon; and purchase orders reflecting those discounts. This example dates from 2011.
A discount extended by a related party in country A to the importer on the price of equipment ordered for a U.S. customer where the discounted equipment price was passed on to the customer and enabled the U.S. importer to secure the order. A copy of the sales proposal from the importer to its U.S. customer reflecting the price discount was submitted as evidence of the discount being passed on to the importer’s customer. This example dates from 2002.
An example where the importer purchased a machine from a related party in country B and requested the supplier provide a discount so that the importer could lower its price to the customer it was trying to conclude a contract with. The U.S. customer issued a purchase order to the importer for a piece of equipment for a fixed price in U.S. dollars. The importer had to source the equipment from its related party overseas. Due to a change in the exchange rate, the cost in U.S. dollars for the piece of equipment increased for the importer. The supplier refused to discount its price as it would result in a negative return on sales for it and suggested the importer lower its mark-up. An email from a principal at the importing company indicated that the importer was losing money on the order and at best would break even, but the sale provided an opportunity to get a new item to a U.S. customer. This example dates from 2010.
An explanation of a large discount provided by a related country B supplier of valves. The related supplier provides discounts off the list prices ranging from 25% to 58% to its industrial customers, related and unrelated. Due to the volume being purchased, the supplier provided an additional 10% quantity discount. The importer explained that both the discounts off the list prices and the quantity discounts are extended by the supplier to both related and unrelated customers. A copy of an Order Confirmation from the country B valve supplier was provided to show the supplier provided an unrelated purchaser of valves outside the U.S. a 48% discount with an additional 11.5% discount on its purchase of 5 different types of valves, and a 50% discount with an additional 11.5% discount on another type of valve in the order. This example dates from 2010. The total discount in an entry examined by CBP of valves from the same country B related supplier to the importer was 59.5% (a 55% discount and then a 10% special discount). A charge for a sales commission of 5% for the supplier’s U.S. sales agents was charged. The entry occurred in 2009.
Four additional examples showing the related country B supplier, referenced in the two previous examples, extending large discounts to unrelated non-U.S. buyers. The discounts ranged from as low as 20% off the list price for inexpensive commodity parts to as high as 60% of the list price with additional “special discounts” being extended for certain parts or based on volume. These examples dated from 2009 and 2010.
Examples of two purchases from unrelated suppliers where large discounts were extended to the importer. We note that the suppliers were U.S. suppliers. However, the documents regarding the purchases, i.e., purchase orders and invoices, were submitted to illustrate the typical industry discounts for component purchases. The examples were of purchases in which 60% and 52% discounts were extended in purchasing components. These examples date from 2014.
In Headquarters Ruling Letter (HQ) 554999, dated January 5, 1989, this office determined that related parties met the circumstances of the sale test where the importer negotiated the price with the related seller, rejected the prices if dissatisfied, and could purchase from other suppliers, both related and unrelated, or could refrain from stocking an item. This case is similar in that the importer negotiates with related and unrelated parties for purchasing goods necessary to produce the manufacturing processing equipment required by its customers. We have examined the submitted evidence and are satisfied that the relationship of the importer with related party suppliers does not influence the price. The examples establish to our satisfaction that the parties, though related, buy and sell as if they are not related and the prices are settled in a manner consistent with the normal pricing practices of the industry. To the extent the importer wishes to use transaction value, it should continue to maintain examples and be prepared to show how the prices are established as if they are not related and the prices are settled in a manner consistent with the normal pricing practices of the industry.
Royalties
Royalty payments may be included in transaction value as an addition to the price actually paid or payable under section 402(b)(1)(D) of the TAA. 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).
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, the royalty payments are not paid to the sellers of the imported merchandise. However, the payments are made to parties related to the sellers. Your office believes the royalty payments may be a condition of sale for the imported merchandise and as such are dutiable.
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 these questions and the case before us, the answers to the first two questions is no, and the answer to the last question is yes.
In this case, the royalty payments are due on goods the Licensee manufactures, promotes, distributes and sells which carry the trademark. Goods which the importer purchases and imports from related parties which are incorporated into a manufacturing process system, such as semi-finished products further processed by the importer, are not subject to a royalty fee as a consequence of their purchase and importation based upon the language of paragraph 1.1 of Schedule 4 of the License Agreement. The royalty is for the use of the trademark on the goods sold in the U.S., i.e., the manufacturing processing systems, and the use of the trademark in marketing, advertising materials, showrooms, exhibitions, etc. In the various provisions of the Licensing Agreement, cited above, reference is made to the manufacture and sale of products by the Licensee in the territory, which in this case is the United States. In Headquarters Ruling Letter (HQ) H024566, dated October 15, 2008, CBP found that a royalty was not dutiable as it was not the sale of the imported merchandise which triggered the obligation to pay the royalty, but the sale of the product in which the imported merchandise was a component that triggered the obligation to pay a royalty. Similarly, in this case, the importation of merchandise does not trigger the obligation to pay a royalty, it is the sale of manufacturing processing systems which incorporate the imported merchandise and on which the trademark will be displayed that triggers the obligation to pay the royalty. Therefore, we find that the royalty is not dutiable.
Your office relied upon our decision in HQ 546033, dated March 14, 1996, involving a similar situation wherein all parties involved were related and the Licensor was not the seller of the imported merchandise. However, that case is distinguishable as the Licensing Agreement in that case was replete with references to the sale of goods for which the royalty payment was due – paragraph 5.2 required a minimum purchase amount of products; paragraph 5.3 stated “[o]rders shall be placed . . . in accordance with a purchase schedule prepared by the [LICENSOR] . . .”; and paragraph 6.1 provided “All orders shall be subject to [LICENSOR’S] standard terms and conditions of sale[.]” See HQ 546033. In that case, we concluded that the royalty was a condition of sale of the imported merchandise. However, the facts in this case are clearly distinguishable as the royalty is not on the imported merchandise, but upon the merchandise made and sold by the importer in the U.S. bearing the trademark and for the use of the trademark in the marketing, advertising and promotion of its goods. Similarly, HQ 545841, dated June 13, 1996, relied upon by your office, is distinguishable based upon its facts. While, like here, the parties involved were all related and the royalty was paid to a licensor who was not the seller, the facts and the licensing agreements are substantially different and, therefore, the ruling is not determinant in this case.
With regard to the question of whether the royalty payments may be dutiable as proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller, the royalty payments go to a related party who is not the seller of the imported merchandise. Other than the fact that the sellers are related to the license holder and contract to use the trademark, there is no evidence that the sellers benefit from the payment of royalties to the license holder. Therefore, we find that the royalty is not intrinsically related to the sale of goods for export or is a condition of sale.
HOLDING:
Transaction value is acceptable in this case. The royalty payments at issue are not dutiable. Sixty days from the date of this letter, Regulations and Rulings of the Office of International Trade will take steps to make this decision available to Customs and Border Protection ("CBP") personnel and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch