RR:CTF:VS 548649 GG
Mr. R. Keith Richard
Field Director
Regulatory Audit Division
U.S. Customs and Border Protection
1901 Crossbeam Drive
Charlotte, NC 28217
RE: Transaction value; Related buyer and seller; Royalties; Research and Development; Import and Export Commissions
Dear Mr. Richard:
This is in response to your internal advice request dated February 25, 2005, which raises certain appraisement issues concerning Company A. The issues emerge as a result of a focused assessment of Company A conducted by U.S. Customs and Border Protection’s (“CBP”) Charlotte Field Office of the Regulatory Audit Division. The focused assessment examined transactions that occurred during the 2002 calendar year. Our response takes into account the comments of Company A’s counsel, Barnes Richardson & Colburn, in letters dated May 3, 2004 and November 16, 2005. We grant Company A’s request that its name and certain business sensitive information be kept confidential.
FACTS:
Company A is a wholly owned subsidiary of Company B, a Swiss Company. It has five divisions: Textile, Leather & Paper Chemicals; Pigments & Additives; Masterbatches; Functional Chemicals; and Life Sciences & Electronic Chemicals. Company A imports and manufactures a wide range of chemicals for various industrial applications. For example, Company A makes pigments for paints and lacquers and plastics, and supplies special chemicals and dyes for the textile, leather and paper industries. Company A sources over XX% of its imported merchandise from related affiliates, including its parent company, Company B.
In addition to paying for the imported merchandise, Company A also makes royalty and export and import commission payments to Company B. Company B in turn pays Company A for research and development (R&D) expenses that Company A incurs on behalf of Company B. These various payments are the focus of this internal advice request. The facts surrounding each category are set forth below.
Royalties
Company A submitted a letter dated May 3, 2004 to the Charlotte Regulatory Audit Division in response to a request for information about the royalty payments. A copy of the License Agreement between Company B and Company A, entered into on July 1, 1995, and amended and restated on July 1, 1997, was enclosed. The letter noted that there are no sales agreements between Company A and its foreign suppliers. Relevant sections of the License Agreement are as follows:
ARTICLE 1: DEFINITIONS
1.01 “Industrial Chemicals” means all chemical compounds and products made therefrom including but not limited to:
textile dyes ...
textile chemicals ...
leather dyes and chemicals ...
paper dyes and chemicals ...
pigments ...
additives ...
masterbatches ...
surfactants ... and
fine chemicals ...
1.02 “Proprietary Rights” means all United States patents, including reissues and extensions thereof, patent applications (including divisions continuations and continuations-in-part thereof), inventions and copyrights that pertain to the composition, preparation, manufacture, packaging use or sale of Industrial Chemicals and which are owned by or otherwise subject to license by or at the direction of Company B at the date of this Agreement or which Company B hereafter owns or acquires the right to license.
1.03 “Proprietary Information” means knowledge, expertise, ability and other information, whether published or secret and whether or not patentable, which constitutes know-how applicable to or useful in the composition, preparation, formulation, processing, manufacture, packaging, use or sale of Industrial Chemicals which Company B owns or has the right to license at the date of this Agreement or hereafter develops or acquires the right to license, other than materials or process technology services subject to a cost sharing agreement between the parties.
1.04 “Trademarks” means all trademarks, service marks, trade names, label filings, logos and applications therefor, whether registered or unregistered, which Company B owns or has the right to license at the date of this Agreement or which Company B hereafter acquires.
1.05 “Net Sales” means total gross sales of Company A reduced by cash and trade discounts, returns and allowances actually granted and sales, excise, turnover or similar taxes.
However, the term Net Sales shall not include amounts paid to Company A for intermediates purchased for resale from Company B, nor shall it include resales by Company A of Industrial Chemicals purchased by Company A from Company B affiliates or third parties.
ARTICLE 2: LICENSE OF PROPRIETARY RIGHTS
2.01 Company B hereby grants or agrees to have granted to Company A, and Company A accepts, the non-exclusive, indivisible and non-transferable license to use any and all of the Proprietary Rights.
ARTICLE 3: LICENSE OF PROPRIETARY INFORMATION
3.01 Subject to Section 6.03 hereinafter [no such section in License Agreement], Company B hereby grants or agrees to have granted to Company A, and Company A accepts, a nonexclusive, non-transferable license to use and have used any or all of the Proprietary Information in the composition, formulation, preparation, manufacture, processing, packaging, use or sale of Industrial Chemicals in the United States.
ARTICLE 4: LICENSE OF TRADEMARKS
4.01 Company B hereby grants to Company A, and Company A accepts, a non-exclusive, non-transferable license to use the Trademarks in connection with the advertising, promotion, sale and marketing of Industrial Chemicals sold and distributed by Company A in the normal course of its business.
ARTICLE 7: COMPENSATION
7.01 In consideration of the licenses granted under Articles 2, 3, 4 and 5 of this Agreement, Company A shall pay to Company B a royalty equal to XX percent (XX%) of Net Sales during the continuation of this License Agreement. The parties may agree to reduce or suspend such royalty on a product category by product category basis during such times as the sustained profitability of the applicable business unit is breakeven or negative due to factors or conditions not related to the Proprietary Rights, Proprietary Information or Trademarks licensed hereunder.
The auditors would like clarification of whether the royalties are indirect payments or are statutory additions to the price actually paid or payable for the imported merchandise. Company A’s position is that the royalties are not dutiable because they relate only to manufacturing and marketing activities that take place in the United States, and are not a condition of the sale for export to the United States of the imported merchandise. They become due even in those instances when Company A sells goods that it has manufactured exclusively with domestically sourced intermediates. The auditors question why Company A has continued to pay royalties in those years when the company was unprofitable, instead of taking advantage of the clause in the License Agreement that forgives such payments during lean periods. They posit that this may be an indication that royalty payments are required as a condition to purchase imported merchandise from its parent and affiliated vendors. They also highlight the manner in which the royalties are calculated as a possible indicator that the royalties relate to the imported chemicals, because it appears that they are based on more than just the value added by the U.S. manufacturing. They also question why R&D payments are recorded along with royalty payments in Company A’s royalty expense account.
Research and Development
Company A conducts R&D at its various divisions in the United States. Pursuant to a Research Agreement entered into between Company A and Company B on July 1, 1995, Company B reimburses Company A for this R&D activity. It does so because Company B owns the rights to any intellectual property or other results of such development efforts. Company B agrees to pay Company A an amount equal to the sum of all budgeted costs and expenses incurred by Company A plus XX% of internal costs and expenses. In 2002, Company A was not fully reimbursed by its parent for R&D expenses incurred. Its records reflect that it received only $XX million of the $XX million that it had spent on R&D. The auditors question whether the non-reimbursed expense is an indirect payment or, alternatively, a statutory addition to the price actually paid or payable for merchandise imported from Company B and related vendors. The more general issue as to whether the research costs are applicable to imported merchandise under the Research Agreement is also raised.
Export Commissions
Company A pays export commissions to Company B. The auditors were concerned because the only documents relating to the export commissions were an Export Commission Agreement entered into between Company C and Company D on March 6, 1985, and assorted correspondence primarily discussing amendments to the Agreement regarding Canada and Hong Kong. In an internal Company A memorandum dated May 18, 1999, it was explained that the 1985 Agreement remained in effect after a 1995 spin-off and name change. Counsel in its letter dated November 16, 2005 provided a copy of the Certification of Name Change issued by the New York Department of State, which certified that Company C changed its name to Company A on June 30, 1995. The 1985 Export Commission Agreement establishes that Company C [Company A] will pay Company D [Company B] a XX% commission on all sales to “takers outside the United States and Canada” in exchange for Company D [Company B] canvassing orders for Company C [Company A] products from outside the United States and Canada.
In addition to their concerns about the Export Commission Agreement being in the name of companies other than Company A and Company B, the auditors expressed concern that Company A booked royalty and R&D expenses in an account for export commissions.
Import Commissions
Company A pays import commissions to a related company in China, Company A China (also called “Company A Hong Kong” by counsel for Company A). The audit team verified import commission payments of approximately $XX in 2002, but was not provided with an agency agreement and thus was unable to distinguish between buying and selling commissions. Company A’s position is that the commissions were paid to Company A China for its assistance in procuring merchandise from unrelated vendors, and as such are buying commissions. To support this claim counsel enclosed Company A’s “Principles For Sourcing Centres of China and India for Raw Materials and Intermediates” (“the Principles”) with its letter of November 16, 2005. This document, adopted in 1996, indicates that the objective of a Sourcing Centre is to provide service to the Company A Group by exploring and finding third party sources for raw materials and intermediates at the lowest total cost level (considering quality, price, packaging, inventory level, customs duty etc.). In furtherance of this objective the Sourcing Centre will, among other things, establish a working relationship with the selected suppliers, communicate requirements, and help to negotiate prices and secure quality. It will assure logistics support and supply information to enable timely delivery. The Sourcing Centres are described as “true cost centres and can charge up to XX% based on supplier invoices for their services in order to cover their costs.” The Principles require the Sourcing Centres “to provide full transparency.”
Although it was disclosed that Company A computes import commissions based on XX% of the invoice price of the imported merchandise, the auditors discovered that several of the commission calculations were based on a lower price and one on a higher price. In its letter dated November 16, 2005, counsel explains that the discrepancy is due to the fact that the agent estimated eventual sales prices that in fact differed from the prices ultimately charged by the manufacturers. Counsel also wrote that “Company A US is not privy to the communications between the agent and the Chinese manufacturers, so Company A US does not know the precise volumes and unit price quoted before the goods were shipped.” Where the difference between the agent’s estimated price, which is used as the basis for its commission fee, and the actual price is less than XX%, Company A does not consider it worthwhile to make corresponding adjustments to the commissions.
ISSUE:
1) Whether the royalty payments made by Company A to Company B are included in the transaction value of the imported merchandise as part of the price actually paid or payable, or whether they are additions to the price actually paid or payable pursuant to 19 U.S.C. § 1401a(b)(1)(D) or (E), respectively.
2) Whether the R&D expense is included in the transaction value of the imported chemicals.
3) Whether the export commissions that Company A pays to Company B are part of the price actually paid or payable for the imported merchandise.
4) In the circumstances described, whether Company A China functions as Company A’s bona fide buying agent in the purchase of the imported chemicals and if so, whether payments for such services are non-dutiable buying commissions.
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 if they are not already included in the price actually paid or payable. These additions include any selling commission incurred by the buyer with respect to the imported merchandise, any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export 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)(B), (D) & (E).
However, as you know, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, the relationship did not influence the price actually paid or payable, or the transaction value closely approximates certain “test values.” 19 U.S.C. § 1401a(b)(2)(B). In the instant case, the buyer and seller are related in most of the transactions. The internal advice request indicates that Company A’s cost accounting manager informed the auditors that affiliate pricing is done according to the methodology set out in Company A’s transfer pricing agreement, and that Company A had recently undergone an IRS audit focused on transfer pricing in which Company A passed with no findings. The internal advice request also states that CBP auditors did not review Company A’s transfer pricing agreement or the IRS report.
At this juncture we would merely note that IRS approval of an importer’s transfer pricing methodology might satisfy IRS arm’s length pricing requirements but not necessarily CBP valuation requirements. Company A would still have to satisfy one of the two related party tests – circumstances of sale and test values – to demonstrate that its goods were properly appraised under transaction value. The provision in Article 7 of the License Agreement that allows the suspension of royalty payments if profits are breakeven or negative might be indicative of an absence of arm’s length dealings between Company A and its parent company. Since there was no review of the acceptability of the related party pricing and no further information on this issue has been presented we are unable to determine here if transaction value is an appropriate basis of appraisement.
Nevertheless, assuming that transaction value is the appropriate basis of appraisement, the following constitutes our position on the dutiability of the royalty, R&D and various commission payments.
Royalty Payments
In regard to the dutiability of royalty payments and license fees, 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. 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 were they 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 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, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49.
As the language of the SAA makes clear, 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. The term “price actually paid or payable” is defined as “the total payment (whether direct or indirect…) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.” 19 U.S.C. § 1401a(b)(4)(A). Thus the first inquiry is whether the payments at issue are part of the price actually paid or payable for the imported merchandise.
Based on Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990), U.S. Customs and Border Protection (“CBP”) presumes that all payments made by the buyer to the seller or to a party related to the seller are part of the price actually paid or payable for imported merchandise. In Generra, the Court of Appeals held that the term “total payment” is all-inclusive and that “as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods.” The court also stated:
Congress did not intend for the Customs Service to engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, are for the merchandise or for something else. As we said in Moss Mfg. Co. v. United States, 896 F.2d 535 (Fed. Cir. 1990), the “straightforward approach [of section 1401a(b)] is no doubt intended to enhance the efficiency of Customs’ appraisal procedure; it would be frustrated were we to parse the statutory language in the manner, and require Customs to engage in the formidable fact-finding task, envisioned by [appellant].
Generra, 905 F.2d at 380 (brackets in original).
The presumption that all payments made by the buyer to the seller, or to a party related to the seller, are part of the price actually paid or payable may be rebutted, however. In Chrysler Company v. United States, 17 CIT 1049 (1993), the Court of International Trade applied the standard in Generra and determined that certain shortfall and special application fees which the buyer paid to the seller were not a component of the price actually paid or payable for the imported merchandise. The court found that the evidence established that these fees were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller and were not a component of the price of the imported engines. The burden of establishing that the payments are totally unrelated to the imported merchandise rests with the importer. Generra, 905 F.2d at 380.
Company A in its letter of May 3, 2004, asserts that the royalty payments are not dutiable additions to the price actually paid or payable because they are not made in exchange for imported goods, but rather are for the use of proprietary know-how and trademarks to manufacture and market industrial chemicals within the United States. A review of the submitted documentation generally supports this assertion. In particular, Articles 3 and 4 of the License Agreement indicate that the royalties are paid in furtherance of domestic manufacturing and marketing activities. In similar situations CBP has held that the royalties would not be included in the price actually paid or payable for the imported merchandise. See Headquarters Ruling Letter (“HRL”) 545951, dated February 12, 1998, and HRL 546660, dated June 23, 1999. In both of those cases it was found that the rights for which the royalties were paid related solely to the manufacture and sale in the United States of finished products made in part from the imported merchandise. There is, however, a distinction between those cases and Company A’s, namely in HRL’s 545951 and 546660 the value of the imported merchandise was excluded in calculating the amount of the royalties, whereas it appears that such value is included in Company A’s royalty calculation. The two cited rulings found the exclusion of the value of the imported merchandise from the royalty calculation to be a factor in establishing that the royalties were not related to the imported merchandise. In contrast, a finding that the value of the imported merchandise is included in the royalty calculation might be an indication that the royalty does so relate.
Section 1.05 of the License Agreement is particularly relevant to the question of whether the value of the imported merchandise is included in the royalty. To reiterate, that section provides:
1.05 “Net Sales” means total gross sales of Company A reduced by cash and trade discounts, returns and allowances actually granted and sales, excise, turnover or similar taxes.
However, the term Net Sales shall not include amounts paid to Company A for intermediates purchased for resale from Company B, nor shall it include resales by Company A of Industrial Chemicals purchased by Company A from Company B affiliates or third parties.
In an internal Company A memorandum dated March 8, 2002, Company A’s in-house counsel offers the following interpretation of the second paragraph of Section 1.05:
I would interpret this to mean that the value of an unfinished product sourced from an affiliate (“intermediate” in a broad sense) is not subject to royalty. The value added in finishing would be subject to royalty since the finishing know-how is owned by Company B.
We disagree with the inference that the royalty will be based only on the value added by the processing, and not also on the value of the intermediates that are incorporated in the manufacturing process. Accordingly, in our opinion the royalty calculation will include an amount that is attributable to the value of imported goods in those instances when the domestically manufactured product is comprised in whole or in part of imported chemicals. The question that this raises is whether this establishes a sufficient relationship between the royalty payments and the imported chemicals to consider them to be part of the price actually paid or payable under Generra.
As directed by the SAA, the dutiable status of royalties and license fees paid by the buyer must be determined on a case-by-case basis. Notwithstanding the inclusion of the value of imported goods in the royalty calculation, other factors weigh in favor of finding that the royalties are not part of the price for the imported chemicals. Specifically, the License Agreement clearly indicates that the royalties are paid for the use of intellectual property in the domestic manufacturing and marketing of products. The requirement to pay a royalty arises when Company A sells the U.S. manufactured products, and would apply even in those situations where the finished product is made exclusively with domestically sourced intermediates. The License Agreement bases the royalty amount on a fixed percentage of Company A’s total net sales, yet specifically excludes from the term “Net Sales” amounts paid to Company A for intermediates or industrial chemicals that Company A purchases and then resells without further processing. (According to Company A’s Cost Accounting Manager, only 10% of imported merchandise is manufactured domestically and resold; if that is the case then 90% of the imported product will never be associated with a royalty payment.) Based on this evidence it thus appears that the royalty is for the use of the intellectual property in domestic manufacturing and marketing operations, and not for the right to purchase and import chemicals. Absent other agreements or evidence linking the royalties to the imported products, Company A has met its burden of establishing that the royalty payments are unrelated to the imported merchandise.
Although we have determined that the royalty payments made by Company A to Company B are not part of the price actually paid or payable, we will also examine whether they are an addition to the price under 19 U.S.C. § 1401a(b)(1)(D) or (E). 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? Negative responses to the first and second questions, and an affirmative response to the third, suggest non-dutiability. Question 3 goes to the heart of whether the payment is considered to be a condition of sale.
In analyzing these factors, CBP in most recent rulings has taken into account certain considerations that 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 will generally 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 HRL 546478, dated February 11, 1998; see also, HRL 546433, dated January 9, 1998, HRL 544991, dated September 13, 1995, and HRL 545951, supra.
In regard to the payments at issue, it is unclear whether the first question posed by the General Notice elicits a positive or negative response. Company A does not address this directly in either of its two letters. In its letter of May 3, 2004, however, it suggests that the imported products may be manufactured under patent, by declaring on page 3 that:
Consistent with industry practice, to the extent intellectual property is reflected in the products that Company A sources from its foreign vendors, any payment for the value of such property is included in the price that Company A pays for the imported product. Therefore, no “royalty” is paid for such articles which must be added to the declared value, pursuant to 19 CFR § 152.103. Company A is unaware of the nature of these property rights or how the value of these products and their embedded intellectual property is calculated by its foreign vendors in determining its selling price to Company A. However, the Company wishes to reiterate that royalties are not separately accounted for or paid by Company A on the products it imports.
We find this explanation somewhat unsatisfactory given the fact that Company A imports the majority of its products from related vendors, and thus presumably could have access to information about the intellectual property that may have been associated with some of the products it imported. Nevertheless, based on the language above it appears likely that at least some of the imported products were manufactured under patent. Accordingly, we will assume a positive response to the question posed as to whether the imported merchandise was manufactured under patent.
As to the second question, based on our review of the information submitted there is no linkage between the payment of the royalties and the production and sale for exportation of the imported chemicals. Instead, it appears that the royalties paid by Company A are for the know-how, trademarks and patents that enable Company A to further process the raw materials it sources from foreign and domestic vendors so as to create new finished products. The answer to the second question is, therefore, in the negative.
The third question posed by the General Notice, i.e., whether the importer could buy the merchandise without paying the fee, is central to the question of whether a royalty payment is a condition of sale. Payments that must be made for each imported item are a condition of sale. However, the method of calculating the royalty, e.g., on the resale price of the goods, is not relevant to determining the dutiability of a royalty payment. 27:6 Cust. B. & Dec. 12. In HRL 544991, for example, royalty payments were paid in consideration of licensed technology and technical assistance provided by the seller/licensor to the importer/buyer. An agreement between the licensor/seller and the importer/buyer effectively linked the payment of the royalties to the purchase of the imported parts by providing that the licensor/seller would supply the licensee/buyer with parts in accordance with such terms and conditions as were separately agreed. Consequently, it was determined that the importer could not buy the imported merchandise without paying the fee and that the royalties were a condition of sale.
In the instant case, it does appear that Company A could purchase the chemicals without paying the royalties. Thus, unless there are other undisclosed agreements between Company A and Company B or the other sellers that link the payment of the royalties to the purchase of the imported goods, we find that the payment of the royalties is not a condition of the sale for exportation to the U.S. of the imported merchandise. Notwithstanding the fact that some or all of the imported merchandise may have been manufactured under patent, it is our determination that other factors indicate that the royalties do not relate to the imported merchandise and are not required to be paid as a condition of the sale for export to the United States. Consequently, they are not an addition to the price actually paid or payable for the imported chemicals.
As noted previously, royalty payments may also be dutiable under section 402(b)(1)(E) of the TAA, which provides that the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller, are to be added to the price actually paid or payable. However, CBP has held that payments based on the resale of a finished product made in part from the imported merchandise are not dutiable as proceeds under section 402(b)(1)(E). See, e.g., HRL 544656, dated June 19, 1991, HRL 545770, dated June 21, 1995, and HRL 545951 and HRL 546660, supra. The royalty payments at issue are not based on the sale of the imported merchandise. Instead, the payments are based on the sale of finished products that may or may not contain the imported merchandise. Accordingly, the payments at issue are not dutiable under the proceeds provision.
Research and Development Costs
Under the terms of the Research Agreement entered into between Company A and Company B, the former will conduct research projects for Company B in exchange for payment of the sum of all budgeted R&D costs and expenses incurred plus XX% of internal costs and expenses. The auditors have expressed concern because in 2002 Company A was not fully reimbursed for R&D expenses incurred. Specifically, during that year Company A incurred $XX million in R&D expenses and received only $XX million in R&D reimbursements from Company B. The auditors also note that Company A did not explain why certain R&D costs were partially being booked to its Royalty Expense account. Finally, because the Research Agreement does not refer to any specific projects for which the research is being conducted the auditors could not determine whether research costs are applicable to imported merchandise. The auditors question whether the non-reimbursed expense is an indirect payment or an addition to the price actually paid or payable. They cite to HRL 548306, dated July 9, 2003, in support of the notion that the expense is dutiable.
Counsel addresses these concerns in its letter dated November 16, 2005. It is explained that the R&D activities in question pertain only to products made in the United States. In support of this assertion, Company A provided two statements made by senior-level employees at its U.S. facilities in State A and State B, which are the two divisions that undertake most of the Company A U.S. development activity. The employee based in State B indicates that all of the development activity that takes place there relates to U.S.-manufactured masterbatch products. The State A statement provides the following explanation of its development activities:
The State A Plant is the only Company A facility in the USA where pigments are manufactured. While Company A does import and re-sell other pigments that are produced in Germany, China and elsewhere, the development activities described above (the cost of which I understand is at least partially reimbursed by Company A’s parent company), are almost wholly associated with pigments produced, or to be produced, at the State A site.
Both statements give examples of the type of development work performed at the U.S. facilities. These include developing new products for the U.S. market to be manufactured at the State A facility; modifying existing State A produced products for the requirements of the U.S. markets; and solving various technical problems associated with U.S. manufactured products, such as those relating to pressure, color or viscosity.
With regard to the discrepancy between the expenses incurred and the reimbursement received, counsel explains that certain expenses do not qualify for reimbursement but simply reflect operating costs of the U.S. subsidiary. Counsel points out that the Research Agreement specifically excludes “engineering or process technology development services” from the definition of “Research.” It also notes that costs for development activities are allocated among the divisions.
Counsel’s final comment with respect to the R&D expense is offered to clarify the confusion over the booking of some R&D costs to a Royalty Expense account. There was concern during the audit that the commingling of export commissions, R&D, and royalties in the same account indicates that Company A does not fully understand the nature of these payments. Counsel attributes the confusion to an apparent misunderstanding of the account headings in the trial balance. The automated account record reviewed by the audit team indicated the account name “R&D Commissions,” which was, according to counsel, in fact an abbreviated title for “R&D, Commissions and Royalties.” Within this larger account heading are breakdowns for R&D costs, both reimbursable and non-reimbursable, royalty payments of different types, and import and export commissions. It is thus asserted that Company A is fully aware of and is able to keep track of the various kinds of expenses.
After reviewing the documentation concerning R&D costs, it is our conclusion that they are not a part of the price actually paid or payable for the imported goods. Of primary consideration is the fact that the payments are being made by the seller to the buyer, and not the other way around. Thus it does not appear as though the R&D payments are being made for imported merchandise by the buyer to, or for the benefit of, the seller. The auditors correctly questioned the lack of a full reimbursement for the expenses incurred by Company A, because this might suggest that Company B is subsidizing its affiliate for something else, for example Company A’s purchase of imported products. We do not think, however, that the evidence establishes a nexus between the non-reimbursed R&D expense and the imported merchandise to reach such a conclusion. Based on the representations of counsel and the written statements of the senior employees, we are satisfied that the R&D payments made by Company B support development work on products that will be made and sold in the domestic market. We view this situation as distinguishable from the one described in HQ 548306, which the auditors cited as having a similar fact pattern. In HQ 548306 the buyer of imported merchandise made separate R&D payments to the seller, whereas in Company A’s case the seller makes the payments to the buyer.
Export Commissions
Company A paid export commissions to Company B. The evidence submitted by Company A’s counsel supports their position that Company A and Company B are the successor companies to the two parties that entered into an Export Commission Agreement in 1985, Company C and Company D, respectively. It also establishes that the 1985 Agreement remains in effect between Company A and Company B. In accordance with CBP’s position in response to the Generra and Chrysler court cases, discussed previously, Company A must rebut the presumption that its payments to Company B are for the imported merchandise. A review of the Export Commission Agreement establishes that the payments are for services related to the marketing abroad of Company A’s U.S. produced products. They do not appear to be related to the chemicals that Company A imports from Company B and from other manufacturers. With regard to the concerns expressed about the manner in which the expenses are booked, the same explanation as that provided regarding the recording of R&D expenses would apply here, too. We are of the opinion that Company A has sufficiently alleviated concerns in this regard. Accordingly, we find that the payments for the export commissions are not part of the price actually paid or payable for the imported merchandise.
Import Commissions
As indicated above, selling commissions are a statutory addition to the transaction value. It is a well-established principle of Customs law, however, that a bona fide buying commission is a non-dutiable expense. See New Trends, Inc. v. United States, 10 CIT 637, 640, 645 F. Supp. 957, 960 (1986) (“It is fundamental that a buying commission paid to a bona fide agent of the importer is not a proper element of dutiable value.”) Pier 1 Imports, Inc. v. United States, 13 CIT 161, 164, 708 F. Supp. 351, 353 (1989); Rosenthal-Netter, Inc. v. United States, 679 F. Supp. 21, 23; 12 CIT 77, 78 aff’d., 861 F.2d 261 (Fed Cir. 1988); Jay-Arr Slimwear, Inc. v. United States, 681 F. Supp. 875, 878, 12 CIT 133, 136 (1988). The importer has the burden of proving that a bona fide agency relationship exists and that payments to the agent constitute bona fide buying commissions. Rosenthal-Netter, supra, New Trends, Inc. v. United States, 10 CIT 637, 645 F. Supp. 957, 960 (1986); Pier 1 Imports, Inc., supra. Buying commissions are fees paid by an importer to his agent for the services of representing him abroad in the purchase of the goods being valued.
In deciding whether a bona fide agency relationship exists, all relevant factors must be examined and each case is governed by its own particular facts. J.C. Penney Purchasing Corp. v. United States, 80 Cust. Ct. 84, 95, C.D. 4741, 451 F. Supp. 973, 983 (1978). Although no single factor is determinative, the primary consideration is the right of the principal to control the agent’s conduct with respect to the matters entrusted to him. J.C. Penney Purchasing Corp., 451 F. Supp. at 983. In this regard, counsel in its letter dated November 16, 2005 maintains that:
The Principles set forth in the corporate document, and the separate invoicing from Company A’s agent to Company A for its services, demonstrate Company A’s control of the agent with respect to these services. In addition, Company A specifically maintains the right of refusal. In this regard, the fact that Company A Hong Kong [Company A China] is a related overseas entity whose sold purpose is to provide these services, supports the conclusion that Company A controls its actions as agent in procuring this merchandise.
While we agree that the activities attributed to the Sourcing Centers in the Principles are those that would typically be undertaken by a buying agent, there are other factors that indicate that Company A China may be serving in another capacity.
In J.C Penney, in examining whether the importer exerted sufficient control over the buying agent, the court noted certain significant factors that were illustrative of the importer’s active role and control. These factors included the importer’s frequent visits to the factories where the goods were produced, his direct negotiations with manufacturers as to price and shipping specifications, the manufacturers’ awareness that the importer was the ultimate purchaser, and the lack of any discretion, on the part of the agent, as to the purchasing of the merchandise. J.C. Penney Purchasing Corp., 451 F. Supp. at 983-84. The plaintiff prevailed in representing that a principal-agency relationship existed.
A different situation presented itself in New Trends, where the record reflected that the importer New Trends did not participate in negotiations, the agent conducted all negotiations with the factories while New Trends dealt only with the agent, and New Trends did not know how much the agent paid the manufacturers for the merchandise. New Trends, 645 F. Supp. at 959. The court found an insufficient degree of control, commenting that “[u]nlike the J.C. Penney case, the record in this case does not reveal a similar active role and control on the part of New Trends... In this case, the evidence shows that the agents were granted a great deal of discretion and authority throughout the entire purchasing process.” The statement in the November 16, 2005 letter that Company A was not privy to the communications between the agent and the Chinese manufacturers, and did not know the precise volumes and unit price quoted before the goods were shipped, indicates that Company A did not exercise the necessary degree of control to establish that its relationship with Company A China was one of principal-agent. The apparent lack of requisite control, together with the absence of other evidence such as a buying agency agreement, do not support a finding in this case that the commissions were non-dutiable buying commissions. Accordingly, the commissions constitute part of the price actually paid or payable for the imported chemicals.
HOLDING:
1) The royalty payments are not included in the transaction value of the imported merchandise as part of the price actually paid or payable, or as a statutory addition to the price actually paid or payable either pursuant to 19 U.S.C. § 1401a(b)(1)(D) or (E).
2) The R&D payments made by Company B to Company A do not constitute part of the price actually paid or payable for the imported goods.
3) The export commissions made by Company A to Company B are unrelated to the imported chemicals and are not included in the price actually paid or payable for the chemicals.
4) The available evidence does not support a finding that the Company A China functions as Company A’s buying agent. Accordingly, the payments made by Company A to Company A China for what are described as “import commissions” are part of the price actually paid or payable for the imported merchandise.
Please mail this decision to Company A through its counsel 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 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