Wednesday, October 28, 2015

Ruling of the Week 2015.29: Hasbro II, Royalties and Proceeds

Continuing my exploration of classic Customs and Border Protection rulings, we come to the confounding "General Notice" called Hasbro II. It was published at 27 Cust. B. & Dec. No. 6 (1993). Customs does not have Customs Bulletins online from that far back, so I put a copy here for you to read.

The issue arises from a ruling request concerning an apparent royalty payment. Hasbro, as the importer/buyer of merchandise agreed to pay the seller 7% of the resale invoice price of the imported goods. Presumably, in addition to the original purchase price, the contract requires Hasbro to pay an addition amount to the seller equal to 7% of whatever price Hasbro gets for the goods on resale in the U.S.

It seems fairly obvious that the 7% second payment, which is included in the purchase contract, is part of the total price paid or payable for the imported goods. That would tend to make it dutiable.

But, the law requires specificity. If the payment is not "for the merchandise when sold for exportation to the United States," it can only be added to the dutiable value if the statute specifically allows for it. On possibility is that the payment is the "proceeds of any subsequent resale . . . that accrue, directly or indirectly, to the seller." That would be dutiable under 19 U.S.C. 1401a(b)(1)(E). The other possibility is that the payment is a dutiable 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." That is dutiable under 19 U.S.C. 1401a(b)(1)(D).

Initially, Customs found the distinction between these two provisions to be unclear. Given the ambiguity, Customs looked at the legislative history to try to divine what Congress intended. Regarding proceeds of subsequent resale, the Statement of Administrative Action (which is how the White House explains a trade bill to Congress) stated only that to be dutiable the proceeds must related directly to the imported merchandise and that Customs should make the decision on a case-by-case basis.

Regarding royalties, the SAA was much more detailed. First, royalties related to patents covering processes to manufacture the imported goods will generally be dutiable. This makes sense given that the value of the royalty is access to the technology or know-how necessary to make the very product that is being imported.

On the other hand, royalties paid to third parties (i.e., not the seller) for the use in the United States of copyrights and trademarks related to the imported merchandise will generally be treated as the buyer's selling expenses (e.g., domestic marketing) and not dutiable. This also makes sense in that the product name or logo may be valuable from a branding perspective, but they do not necessarily reflect the intrinsic value of the merchandise sold by the seller. But, that is not always the case. If the payment is to the seller and the buyer is required to make the payment as a condition of the sale for exportation to the United States, then the fee is closely tied to the acquisition of the physical merchandise and may be dutiable. This also requires a case-by-case analysis.

After reviewing the legislative history, Customs turned to an analysis of court decision under the prior law. In summary, those decisions found that three questions help determine whether a payment is a dutiable royalty. Those questions are:

1. Was the importer merchandise manufactured under patent? If the answer is yes, then the payment is more closely tied to the production of the merchandise and is, therefore, more likely dutiable.

2. Was the payment involved in the production or sale of the imported merchandise? This question goes more deeply into the purpose of the payment. If the importer can show that the payment is for something other than the manufacture, production, or purchase of the imported goods, the payment may not be dutiable. Customs gave two examples in which the Court found that the putative royalty was for the use of the product in the United States, not for the patent rights related to the production or importation of the product. A positive answer to this question, therefore, leans toward dutiablity while a negative answer leans against.

3. Could the importer buy the product without paying the fee? If the fee is not optional and goes to the seller, it is more likely to be a dutiable part of the value of the merchandise. According to Customs, this question "goes to the heart" of whether the payment is a condition of sale. That means a negative answer to this question indicates dutiability.

Customs found that these questions provide a useful analytical approach under the current law.

Turning bask to the case at hand, it was unclear whether the product was made under patent, but the agreement gave the buyer the right to manufacture it. That is close to a "yes" on question one. Customs found that the 7% payment obligation accrued upon the sale of the product, regardless of when the buyer actually collected the sale price from its customer. Under these facts, Customs held the payment to be a dutiable royalty.

But wait, there's more!

Customs also said that the same payment can be analyzed separately to determine whether it is also the proceeds of subsequent resale. Here, the obligation to pay was based on the resale price. According to Customs, part of the income the buyer derived from the subsequent resale accrued to the seller. It is, therefore, dutiable as proceeds.

This ruling has had significant practical consequences. Not the least of which is that Customs and Border Protection takes royalties and license fees very seriously when conducting audits. A typical early step is an audit is for Customs to request a Chart of Accounts. From there, Customs will identify accounts labeled as "Royalties," "License Fees," "Commissions" and similar items. It will then ask to see activity in those accounts and expect either proof that the amounts were declared or an explanation as to why not.

This means that importers need to be aware of the compliance impact of royalties, license fees, proceeds, and similar mechanisms. Purchasing people need to communicate with compliance staff to ensure that dutiable royalties are declared and non-dutiable payments are properly vetted and documented. If the company has in-house lawyers, those who work in intellectual property fields should be fully briefed on this and should alert the compliance team to new agreements.

Finally, when in doubt, get a ruling.

Thursday, October 22, 2015

When Does A Treatment Start?

Do you know what I hate? Change. Once I get comfortable with something, I am not a big fan of changing it up until something demonstrably better comes along. I drive my cars until I can't and I have gone to the same place to get my hair cut for 15 years. I have an 8 year old computer at home that is only now getting annoying enough to merit a trip to the recycling center.

I also do not like it when Customs and Border Protection makes a change without an obvious and good reason. I get that if the Harmonized System Committee changes the law, Customs will implement the change. Also, I am completely in favor of the movement to ACE, which will provide demonstrable benefits to the trade. But other times, it seems to just be a matter of Customs rethinking the issue or never having been happy with the result the first time around. See, first sale valuation

This comes up in the context of American Fiber & Finishing, Inc. v. United States, a recent decision of the Court of International Trade. The case involves a change in practice with respect to the classification of cotton gauze fabric. AFF had been entering and Customs had been liquidating the guaze in 5803.00.10, which is a duty-free provision. In January of 2010, CBP issued a Notice of Action changing the classification to 5208.21.40, which carries a 10.2% rate of duty. AFF protested the rate increase.

In its protest, AFF asserted that Customs violated 19 USC § 1625(c) when it changed the classification of this merchandise without public notice and comment. Under that law, Customs must follow notice and comment procedures before it issues an interpretive ruling or decision that has the effect of modifying a treatment previously accorded by Customs to substantially identical transactions.

Unpacking that, if AFF can show that there was a "treatment" in place regarding the classification of these products, then Customs can't simply rate advance the entries. Before changing the treatment, Customs would need to publish a notice and give the public opportunity to comment on the change.

The first issue is whether the rate advance announced in a CF-29 Notice of Action is an interpretive ruling or decision. That question has been addressed in previous cases. If a decision is the functional equivalent of a ruling or internal advice, if it "unilaterally changes the rules," then it is an interpretive ruling or decision requiring notice and comment under 1625(c). In this case, there is some remaining question about whether the Notice of Action was the equivalent of a ruling, so the Court set that issue aside for now.

The second issue was whether AFF could show a treatment. To do that, AFF needs to prove that there was an actual determination by a Customs officer regarding substantially identical transactions and that over a two-year period immediately preceding the claim of treatment, Customs consistently applied that determination. At this point in the case, the parties have asked the Court to rule on when the relevant two-year period begins to run. As you can probably imagine, this would be important if there was evidence of inconsistent treatment at some point in the past. By selecting the proper two-year period, AFF might be able to establish a treatment.

Customs says the relevant period is the date of the protest, which is when AFF first asserted that a treatment existed. AFF says the protest is simply a document in which the treatment is referenced. According to AFF, the claim for treatment was made at the time of entry consistent with the prior treatment. That would push the starting point for the two-year period back as much as 494 days (314 for liquidation and 180 for the protest).

The Court found that a "claim" can be either the assertion of a right or the means by which the assertion occurs. Think about a prospector in the old west. The moment he is jumping up and down shouting that he struck it rich, he is making a claim. On the other hand, he has to go down to the county office to file his claim. Both are claims. Looking at the larger context of the relevant regulations, the Court held that the relevant claim is the assertion of the right, not the administrative mechanism. The "defining operative facts that gave rise to [AFF's] claims" are the entries. In other words, AFF jumped up and down asserting its right to duty-free treatment at the time of entry, not in the protest.

This case is not over. The issue of whether there is an interpretive ruling remains to be determined. In addition, the parties now must gather and present evidence of treatment for the two-year period immediately prior to the earliest entry. So, relax; there is more to come.

Wednesday, October 21, 2015

Ruling of the Week 2015.28: Billiards Procurement

Governments buy all kinds of unexpected stuff. Billiards tables, for example.

In HQ H268491 (Oct. 15, 2015), U.S. Customs and Border Protection issued a final determination on the country of origin of certain billiards tables for purposes of government procurement under the Trade Agreements Act of 1979. These rulings are not your run of the mill origin determination for purposes of labeling or duty determinations. Rather, an interested party may ask CBP for either an advisory or final decision on whether an article is a product of a designated country or instrumentality for purposes of securing a waiver of the "Buy American" rules for goods offered for sale to the U.S. Government.

This ruling involves four billiards tables assembled in the United States from components from various countries. The components are shipped to the customer and the tables are assembled on-site. It is sufficient to understand that there are a lot of steps and a lot of parts. Also, the assembly requires the careful leveling of the slate surfaces to ensure a flat table. For one of the tables, as an example, the U.S.-origin components and assembly operation is 43% of the total cost. Other components come from Brazil, Vietnam, Indonesia, and Taiwan.

Under the applicable origin rules, the billiard tables will be products of the United States if the non-U.S. materials have been substantially transformed into a new and different article of commerce with a new name, character, or use distinct from that of the imported article. 19 USC § 2518(4)(B). In making these decisions, Customs applies its analysis consistent with the Federal Acquisition Regulations that require the U.S. Government to purchase U.S.-made products or products of designated countries. The FAR uses the same substantial transformation test.

With that framework, Customs looked at the assembly operations involved. It compared the process to prior decisions concerning furniture assembly. Customs found that the assembly of between 71 and 91 individual components required two skilled and trained workers was "complex and meaningful." The process transforms the components into a new and distinct article of commerce, i.e., a billiards table. As a result, the tables are products of the U.S. and the U.S. government is cleared to purchase these billiards tables.

Here are some trick shots from a GoPro ad, for your work-day amusement.

That's all well and good. But, I have a far less important question. Aren't these actually pool tables? The ruling discusses the gutter system used for the ball return. That means there are pockets (or "holes") in the table. As a youngster, I spent some time in a bowling alley/pool hall owned by my grandfather, Sam Friedman. I was lead to believe that billiards is the largely-English game of knocking cue balls and strikers around a table for no apparent reason. Pool, on the other hand, is the game of The Hustler in which a white cue is used to strike colored balls into pockets, usually for money. None of this should be confused with snooker, whatever the heck that is. Pool is sometimes called "pocket billiards," which is good for purposes of disambiguation. Am I right that there is a difference or am I failing to understand that American English is full of imprecise usage?

Monday, October 12, 2015

Ruling of the Week 2015.27: Prototypes and Double Taxation

This is a review of what I will call a "classic" Customs and Border Protection ruling about which everyone in the trade should be familiar. In this case, we are talking about HQ 545907 (Oct. 11, 1996), which is the reconsideration of HQ 545278 (Apr. 7, 1994).

This ruling involves a contract between Ford Motor Company and Yamaha Motor Company. Under the terms of the deal, Yamaha was to design and develop a modified Ford engine. Ford agreed that it would purchase any prototypes Yamaha made. If the program was successful, Ford agreed to enter into a contract for the purchase of the modified engines.

To develop the modified engine, Yamaha produced 178 prototypes, which were purchased by Ford. Ford imported 156 of the prototypes and paid duty on them based on the price paid to Yamaha. Note that this is 1996, before tariff item 9817.85.01 was added to the tariff. The program was a success and Ford started importing the engines.

The relevant question is whether the sums Ford paid to Yamaha for the prototypes, some of which were imported and subject to duty, are to be included in the value of the engines imported for purchase by Ford. In the initial ruling, Customs held that the payments for the prototypes were inextricably linked to the cost of developing the modified engine. As such, those payments for the prototypes were part of the price paid or payable for the production engines and, therefore, subject to duty again when Ford imported the engines.

Ford raised several good points. First, it pointed out that this result violates the principle against double taxation. Here, the prototypes have already been subject to duty based on their declared value. That value, according to Ford, should not be subject to duty again. That is obviously true as it creates a disincentive to perform any part of the testing in the U.S. Had Ford tested them in Japan, this would never have been a problem.

In the request for reconsideration, Customs stuck to its original position. According to Customs, payments for the development of samples and prototypes are usually considered to be part of the price paid or payable for the subsequent production merchandise. Here, the prototypes were inextricably linked to the cost of developing the new engines. As such, payment for the prototypes are part of the total price paid for them. Because the prototype engines were not returned to Yamaha, they were not assists. But, the payments remain part of the total price paid or payable for the final production engines.

Most of the sting of this ruling has been mitigated by the addition of HTSUS item 9817.85.01, which provides for duty free entry of "Prototypes to be used exclusively for development, testing, product evaluation, or quality control purposes . . . ." There are a number of relevant Chapter Notes regulating the application of this provision. When trying to use 9817.85.01, be sure that the merchandise legally qualifies as a prototype for development, testing, etc. A similar result could be accomplished by using a Temporary Importation Bond or possibly drawback (if the prototypes or equivalent products are exported or destroyed).

Despite there being several strategies by which to avoid this issue, it continues to surprise some people that this is the rule. Companies that do not have good policies and procedures for handling prototypes can end up with a big, unexpected duty bill. This can happen when engineers, for example, arrange for prototypes to be shipped directly to them, outside of the normal compliance process. Don't let that happen. If your company imports prototypes, samples, evaluation items, ofr similar pre-production goods, make sure there is a well-published and understood process to making those entries. And, be sure to let your broker know that a shipment contains prototypes. A bit of upfront work on this front can avoid significant headaches later.

Monday, October 05, 2015

Composite Wood is not Necessarily Veneered

In Composite Technology International, Inc v. United States, the Court of International Trade considered the tariff classification of wooden door stiles and rails consisting of a 9.5 mm thick pine cap laminated to a based of laminated poplar wood layers. Each poplar layer is lass than 6 mm thick. The exposed surface is a layer of pine.

Customs classified the merchandise in 4421.90.97 as other articles of wood. The imported protested that classification and claimed that the correct classification is 4412.99.51 as other plywood, veneered panels, and similar laminated wood. The issue, therefore, was whether the imported merchandise is properly classified as plywood, veneered panels, or similar laminated wood. If so, it would not be classifiable as an "other article of wood."

According to the plaintiff, the merchandise described above fits squarely within the definition of a veneered panel or, in the alternative, as a "similar laminated wood."

For those of you who, like me, might have no idea what this case is about, here is a useful illustration:

From Homestead Interior Doors
Looking at the Explanatory Notes, the Court quickly identified the apparent problem for the plaintiff. The Explanatory Notes state that these products are a thin veneer of wood affixed to a base. Heading 4408 defines "sheets of veneering" as being not more than 6 mm in thickness, which indicates that a veneer for purposes of Heading 4412 must also be less than 6 mm. Here, the facing layer exceeds 6 mm and, therefore, is not a veneer.

Plaintiff relied on a prior decision of the Federal Circuit called Boen defining plywood construction for purposes of Heading 4412. That case defined plywood, but did not address the meaning of veneer.  Consequently, the CIT was not moved to follow it.

That leaves open the question of whether the merchandise is "similar laminated wood." On this, the CIT was also unconvinced. The Explanatory Notes define similar laminated wood as:

[1] Blockboard, laminboard and battenboard, in which the core is thick and composed of blocks, laths or battens of wood glued together and surfaced with the outer plies. Panels of this kind are very rigid and strong and can be used without framing or backing.

[2] Panels in which the wooden core is replaced by other materials such as a layer or layers of particle board, fibreboard, wood waste glued together, asbestos or cork.

On this point, the plaintiff failed to prove that the core of the product was blocks, laths, or battens glued together. That precludes classification under the first definition of "similar laminated wood." Similarly, because the cores are wood, and not some other material, the merchandise did not fit the second meaning of similar laminated wood.

There is not much more to say about this case. If there is an issue for appeal, it strikes me that the CIT read the Explanatory Notes definition of "similar laminated wood" as exclusive, which seems contrary to the broad meaning of the term "similar." If the heading were intended to cover only those two categories of "similar" products, the HTS language should say so. This reading of the notes seems to add a limitation that is not otherwise there. That is a no no, at least according to the Federal Circuit. 

Saturday, October 03, 2015

Withdrawal Not As Easy As Expected

The second recent Court of International Trade decision of interest primarily to lawyers is United States v. International Trading Services, LLC and Julio Lorza. In this case, the lawyer representing International Trading Services and Mr. Lorza tried to withdraw from his representation of the corporate defendant while apparently continuing to represent the individual.

It is not very easy to fire a client in the middle of litigation. The CIT's Rule 75(d) requires that an appearance by an attorney may only withdrawn by order of the Court. It requires that the lawyer make a motion and that the motion be served on the client. Here, the corporate defendant dissolved pursuant to Florida law before counsel was hired by Mr. Lorza to represent both the defunct company and the individual. Counsel seeks to withdraw from representing the corporation on the entirely reasonable grounds that it no longer exists. Consequently, according to counsel, he has no corporate client to represent.

The United States opposed the motion.

Florida Bar rules state that a lawyer may only withdraw when "withdrawal can be accomplished without material adverse effect on the interests of the client" or for "other good cause." In other words, clients cannot be abandoned mid-matter without some really good reason. Also working against withdrawal is CIT Rule 75(b)(1). which requires that corporations appear in the Court represented by counsel.

What this comes down to is the question: If there is no corporation, why does it need representation? The answer is that under Florida law, ITS remains amendable to suit and is still part of the case. As such, it can only appear in Court through counsel. Without substitute counsel to represent the interests of the defunct company, withdrawal will result in adverse effects on ITS.

We should not confuse the question of whether ITS can continue as a defendant and whether Customs and Border Protection will be able to collect from it. Enforcing a judgment against a dissolved corporation raises numerous legal issues. The status of the company is controlled by state law. In some states, the dissolved corporation continues to exist for purposes of winding up and also for prosecuting or defending any actions. However, once the assets are distributed to creditors, there remains the question of whether Customs can collect from the presumably bloodless turnip.

Of course, as an individual, Mr. Lorza does not have the ability to simply dissolve. He still needs a lawyer.

Friday, October 02, 2015

Duped "Importer" Liable for Customs Fraud

UPDATED: April 2, 2019.

Note: As originally drafted, this post was based on the first version of the CIT slip opinion. As published, the initial opinion included the name of the broker involved. As amended, that person is identified only as "Individual A." The amended slip opinion is here. On the request of the broker and consistent with the Court's decision to not identify the broker, I have removed the name below.


There have been several recent cases at the Court of International Trade that merit discussion. Two, in particular, are primarily of interest to lawyers. They show the truth of the old adage that bad facts make bad law.

The first is United States v. Jeanette Pacheco. In this case, the United States of America is pursuing Ms. Pacheco to the tune of $2.6 million for her "role" in a customs fraud scheme. The "scheme" went like this: A licensed customs broker approached Pacheco in a nightclub. He offered her a way to make some fast cash and gave her $200 to sign a customs power of attorney. It is not clear that Pacheco had any additional contact with the broker thereafter.

After that, the broker began making entry of dried peppers, declaring the value to be $0.11 per kilogram. It turns out that a legally correct value was $3.75 per kilogram. When Customs and Border Protection queried Pacheco about the value, she failed to respond. To complicate matters, the FDA declared the peppers adulterated, refused entry, and demanded redelivery. Pacheco failed to redeliver the peppers to Customs and Border Protection. That resulted in a liquidated damages claim of $184 thousand.

CBP issued penalty and pre-penalty notices to Pacheco. Eventually, the government sued her to collect the penalty and she failed to respond. In this decision, the Court of International Trade imposed a default judgment on Pacheco.

Pacheco's failure to appear in Court acts as an admission of liability. But, the Court of International Trade must still determine the amount of the penalty to be imposed. In doing so, the Court noted that "by providing her identity to [the broker] for $200 so that he could conduct customs business on his own behalf, Pacheco aided and abetted his fraud upon Customs." That emphasis is mine. The Court also noted that as the principal in the relationship, Pacheco can be held liable for the acts of the agent, meaning the broker.

Given that, the Court looked at the circumstances to determine the amount of the penalty to be imposed. The Court found some aggravating factors including failing to respond to a request for records and the fact that the importations threatened the public health and safety. Also, although it is not clear when it happened, it appears that Pacheco lied to Customs about whether the peppers were hers. On all of these facts, the Court imposed a penalty in the full amount requested by Customs: $2,651,312.

I hate this case. Not because it is wrong, but because it is probably right. Pacheco did so many things wrong here that she basically sealed her fate. But, there is another story that can be told. It appears that Pacheco made the very stupid choice of signing a power of attorney without any understanding of what that means. She did so for a quick $200, which ended up costing her (at least on paper) $2.6 million.

But, was she really the principal in this transaction? She was legally, because she signed the POA allowing the broker to make entry on her behalf. But, it also does not appear that she had any knowledge of the importations, she did not decide to undervalue the goods, she did not know the goods were adulterated. When she "lied" to Customs that the goods were not hers, I suspect she had no idea that the goods were being imported in her name. The peppers probably were not hers as far as she was concerned. As far as I can tell, she did not order them, did not pay for them, and did not take delivery of them.

I'm not even sure she was the principal. In agency law, the agent works for the principal. Here, the agent was working entirely for himself (or so it appears). He duped her into signing the document and then used her identity to make fraudulent imports. I don't see why that is not a mitigating circumstance. My assumption is that the broker is the subject of his own penalty case and may even be subject to criminal prosecution. I don't know what happened to him.

This is a bad set of facts. Obviously, Pacheco should never have signed the POA. She should have responded to CBP. She should have responded to the penalty notices. She should have thrown the broker under the first bus she could find. But, despite all those mistakes, what we seem to have is identity theft with the victim now on the hook for $2.6 million. While that is probably legally correct, that seems wrong.