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