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Are Your Royalties Or License Fee Payments Dutiable?

October 2, 2007

"No," you say. However, after reading Customs and Border Protection’s ("CBP") newest ruling on the topic, HQ W548692, dated March 2, 2007, you may need to rethink your response.

Merchandise imported into the United States must be appraised in accordance with Section 402 of the Tariff Act of 1930, as amended (19 U.S.C. § 1401a).  Under the Statute, the preferred method of appraisement is Transaction Value, which is defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain enumerated additions.1  One of the enumerated additions applies to "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States."  19 U.S.C. § 1401a(b)(1)(D).2 

According to the Statement of Administrative Action (SAA), which forms part of the legislative history of § 1401a, royalties and license fees for patents covering processes to manufacture imported merchandise are generally considered dutiable, whereas royalties and license fees paid to third parties for the use, in the United States, of copyrights and trademarks related to the imported merchandise, are not, as they may generally be considered to be selling expenses of the buyer.3 The SAA, however, cautions that the dutiable status of royalties and license fees must be determined on a case-by-case basis, and may ultimately depend on:

  1. Whether the buyer was required to pay the fees as a condition of sale of the imported merchandise for exportation to the United States; and
  2. To whom and under what circumstances the fees were paid.

If an importer pays a third party for the right to use, in the United States, a patent, trademark or copyright relating to the imported merchandise, and such payment is not a condition of the sale of the merchandise for exportation to the United States, then the payment will not be considered an addition to the transaction value of the imported merchandise. If the payment is made by the importer as a condition of sale of the merchandise for exportation to the United States, an addition will be made. This, of course, begs the question of what constitutes a “condition of sale” for exportation to the United States.

CBP has established a three-part test for determining the dutiability of royalty or license fee 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"), wherein, Customs asks 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?
  3. Could the importer buy the product without paying the fee?

CBP noted that affirmative responses to factors one and two and a negative response to the third would indicate that the payment was a condition of sale and, therefore, dutiable.

As this test has evolved, many importers have concluded that if the payment of the royalty or license fee was contingent on the sale of the imported merchandise in the United States, then the payment was not a condition of sale of the merchandise for exportation. However, as a result of CBP’s recent ruling in HQ W548692, this conclusion may no longer be valid. 

HQ W548692 involved the payment of a royalty fee by the importer to the holder of certain patent rights related to the use of software, firmware, hardware, specifications, documentation and other materials for certain "Pointing Devices," such as mice, game pads and joysticks. A third party that was unrelated to either the patent holder or the importer performed the actual manufacture of the products. 

Under the licensing agreement, the importer was to pay the patent holder (a) an up-front non-refundable license fee, (b) a non-refundable royalty fee advance, and (c) an ongoing per unit royalty based upon the direct or indirect sale of devices by the importer in the United States.

In applying its three-part test, CBP said that it was not disputed that the imported merchandise was manufactured under patent, insofar as the patented technologies were utilized in the manufacturing process. 

With regard to the second part of the test, CBP stated that the Licensing Agreement established a nexus between the royalties and the production of the merchandise. It based this conclusion on the fact that the Licensing Agreement granted the importer a license under the patents to have another party embody the patented technology into the Pointing Devices. CBP said that the importer exercised this right by engaging the foreign manufacturer to make the imported items. It did so by granting the foreign manufacturer a license to manufacture the products in accordance with specifications provided by the agreement. Customs concluded that the exercise of these rights, which it said clearly involved the production of the imported goods, gave rise to the obligation to pay the royalty. It concluded, therefore, that the royalty was involved in the production of the imported devices.

Customs then addressed the remaining question: whether the importer could buy the merchandise without paying the fee. The importer, relying on rulings HQ 544436 and HQ 544129, argued that it could purchase the Pointing Devices without paying the royalty, because the royalty was only triggered by the sale of the finished devices in the United States. Customs differentiated the facts of this situation from those in the cited rulings and said:

It is evident from the language of the Licensing Agreement that the Pointing Devices only will be manufactured, imported and subsequently resold based on the understanding or condition that such royalties are paid . . . Section 4, which makes royalties payable on each unit sold, show the clear, substantial nexus existing between the imported merchandise, patented technology, and applicable royalty payments.

Customs concluded, therefore, that the importer could not buy the imported merchandise without paying the fee; and thus, that the royalty payments “relate to, and were a condition of sale of the imported merchandise, in accordance with 19 U.S.C. § 1401a(b)(1)(D).”

As a result of HQ W548692, it is no longer possible to conclude that merely because royalty or license fees are based on the resale of products in the United States, the payment of the fee is not “a condition of sale of the merchandise for exportation to the United States.” Rather, if there is a clear and substantial nexus between the imported merchandise, patented technology embodied in the imported articles and the applicable royalty payments, such payments will be considered "a condition of sale of the merchandise for exportation to the United States."

While the ruling does not specifically address the treatment of royalty or license fees paid to a third party for the right to use a trademark or copyright relating to the imported merchandise, it is clear that if the royalty or license fee is paid to a third party for the right to exercise patent rights connected to the manufacture of the imported products, such payments may now be considered a condition of sale of the merchandise for exportation to the United States, even though the payment of the fee is calculated on the number of units sold in the U.S. and not on the number of units imported.

HQ W548692 will require many U.S. companies to re-evaluate the treatment of royalties and license fees paid to third parties for technology and patent rights related to the manufacture or production of their imported merchandise. Under HQ W548692, these payments may be deemed to be a condition of sale of the merchandise for exportation to the United States, even though payment is based on the number of units sold in the U.S. and not on the number of units imported. This can be of particular importance to many importers of semiconductors, integrated circuits, computers, computer accessories, and other electronic devices that incorporate patented technologies.

Please feel free to contact us at geo@tuttlelaw.com or (415) 986-8780 if you would like more information on how this ruling might affect your imports.

George R. Tuttle, III, is an attorney with the Law Offices of George R. Tuttle in San Francisco. 

_______________________________

1 See 19 U.S.C. § 1401a(b)(1). 

2 Other additions include: packing costs, assists, technical data, and any additional proceeds of resale that are paid to the supplier. These additions apply only if they are not already included in the price actually paid or payable.

3 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.

The information in this article is general in nature, and is not intended to constitute legal advice or to create an attorney-client relationship with respect to any event or occurrence, and may not be considered as such.

Copyright 2007 by Tuttle Law Offices.

All rights reserved. Information has been obtained from sources believed to be reliable. However, because of the possibility of human or mechanical error by our offices or by others, we do not guarantee the accuracy, adequacy, or completeness of any information and are not responsible for any errors, omissions, or for the results obtained from the use of such information.

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