H304606

U.S. Department of Homeland Security Washington, DC 20229 U.S. Customs and Border Protection HQ H304606 June 24, 2021 OT:RR:CTF:VS H304606 CMR/TRS CATEGORY: Valuation U.S. Department of Homeland Security Regulatory Audit and Agency Advisory Services 1699 Phoenix Parkway, Suite 200 College Park, GA 30349 Attn: Amy Moore, Field Director RE: Request for Internal Advice; Deduction of Royalty Payments from United States Sales Price; Fallback Deductive Value Calculation; Prior Disclosure Dear Ms. Moore: This is in response to your request of June 1, 2020, for a decision from this office regarding whether certain royalty payments paid by an importer for licensed trademarks and patents related to the assembly in the United States of imported components [article kits] into finished [articles] (hereinafter, [articles]) are deductible from the United States domestic sale’s price of such [articles] as a general expense under the deductive value methodology. The Office of Regulatory Audit and Agency Advisory Services (hereinafter, Audit) has determined that such royalty payments are an expense of production and are not deductible as a general expense. The importer disagrees with Audit’s determination and, through counsel, submitted a request for internal advice, dated October 31, 2019, along with exhibits to support the importer’s view that such payments are deductible. The importer, through its counsel, has asked that certain information submitted in connection with this internal advice request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 C.F.R. § 177.2(b) (7), confidentiality will be extended to the names of the parties and certain specifics of the royalty agreement. In addition, United States Customs and Border Protection (CBP) will withhold information regarding the type of goods at issue. The information contained within brackets will not be released to the public and will be withheld from the published version of this decision. This office has considered the information submitted in the internal advice referral including submissions from the importer’s counsel and the referral memorandum from Audit setting forth that office’s view. In addition, we have considered responses to questions posed to the importer’s counsel, the submission from importer’s counsel dated January 25, 2021, comments made during a meeting held on January 27, 2021, between the importer’s counsels and members of this office, and the supplemental submission from importer’s counsel received on March 2, 2021. FACTS: While Audit was performing a Risk Analysis Survey Assessment (RASA) on the importer, and before the RASA was finalized, the importer submitted a Prior Disclosure to CBP informing CBP that the importer had erred in using transaction value as the method of appraisement for imported merchandise purchased from its related party seller. The importer stated that the relationship influenced the price and thus, transaction value could not be used. The importer suggested that the merchandise which was the subject of the prior disclosure should be appraised based upon a fallback deductive value method. The Prior Disclosure addresses importations of the subject merchandise during the years 2013 through 2018. The Machinery Center of Excellence and Expertise referred the matter to Audit to determine if the importer’s suggested method of appraisement was appropriate and if the importer’s methodology to calculate the revenue owed was reasonable. Audit performed a technical assist and determined that the importer’s suggested use of fallback deductive value appraisement was reasonable. However, Audit determined that the importer’s methodology to calculate the revenue owed was incorrect. Specifically, the importer deducted royalty payments due under a licensing agreement with a related party, other than the seller, covering specific trademarks (including trade dress) and patents. The importer claims these payments are deductible as general expenses. However, Audit believes these royalty payments are dutiable as costs related to the assembly of the imported components into complete [articles] in the United States. According to the licensing agreement, the licensor, [the entity], is the assignee of the patent rights and trademark rights which are the subject of the agreement. The licensing agreement, entered into on April 27, 2011, with an effective date of June 1, 2009, grants to the importer, and the related party seller, “an exclusive license to manufacture, assemble and/or sell Licensed Products according to the [Brand] Patents and an exclusive license to use the [Brand] Trademarks together with the manufacturing, assembly and/or sale of Licensed Products.” “Licensed Products” are defined in the agreement as follows: Licensed Products shall include [articles], related accessories for such [articles] such as [XXX], and related promotional items such as clothing, beverage containers, and writing instruments. Upon the request of the Licensor, [the importer] will submit samples of any and all Licensed Products bearing [Brand] Trademarks to Licensor for review and approval. The royalty for the licensing rights is a set percentage of the importer’s net sales of Licensed Products and is paid on an annual basis. “Net sales” are specifically defined in the agreement as the importer’s gross sales less certain specified deductions. In addition, the patents and trademarks which are the subject of the licensing agreement are specifically identified in Schedules A and B of the agreement. Audit believes the royalty payments at issue, specifically the patent royalties, are costs related to the assembly in the United States of the imported components into the finished [articles]. As the calculation of the royalty payments does not distinguish between the trademark royalties and the patent royalties, but groups these together, and there is no means by which to distinguish the amount paid for one type of royalty versus the other, Audit believes the entire royalty payment should be considered a cost of production. Counsel for the importer states that the importer “uses the trademarks licensed under the subject royalty agreement in connection with its marketing and sale of the [i]mported [p]roducts in the U.S.” Counsel further states that “[t]he [p]atents referred to are used solely for the [articles] actually manufactured in the U.S., which are not a part of this matter. No patents or patented processes are used to assemble the [article kits].” Counsel presents the issue as whether royalty payments paid on a periodic basis based on the annual net sales of licensed merchandise are deductible from the U.S. sales price in a deductive value calculation. Counsel presents a letter from a Certified Public Accountant, employed by the tax service provider for the importer, stating that the “Royalty has been treated as a ‘Period Expense’ related to the overall sales of Licensed Products and reported as an ‘Other Deduction,’ which is booked as a general expense for US GAAP for financial reporting purposes.” This letter further states that “[t]he Royalty is an expense incurred as part of the selling process which generally takes place over a period of time.” Moreover, the statement provides that “[t]his classification has been consistently reported by the Company going back at least, if not prior, to the fiscal year ended March 31, 1998.” In addition, counsel has submitted a letter from the company that has “served as the principal independent auditors responsible for auditing the internal accounting books and financial records of [the seller] since 2002, and [the importer] since 2013.” In the letter, the author states that he has reviewed the license agreement and the importer’s accounting entries for the payments made pursuant to the license agreement. The letter’s author states that the importer “has properly booked its royalty payments under the License Agreement for financ

Merchandise imported into the United States is appraised for customs purposes in accordance with Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. § 1401a). The primary 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 amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. See 19 U.S.C. § 1401a(b)(1). When transaction value cannot be applied, then the appraised value is determined based on the other valuation methods in the order specified in 19 U.S.C. § 1401a(a). While transaction value may be used by related parties when the transaction is an “arm’s length” transaction and can be demonstrated as such, in this case, the importer has determined that transaction value cannot be used as its relationship with the seller influences the price of the imported components. Further, the use of the identical or similar merchandise method of valuation is not available as we are unaware of any identical or similar merchandise produced in the same country as the merchandise at issue and imported to the United States. The next method available by which to appraise the merchandise is the deductive value method at 19 U.S.C. § 1401a(d). The imported [article] components which are assembled in the United States prior to sale as [articles] are not sold in their condition as imported. Therefore, 19 U.S.C. § 1401a(d)(2)(A)(i) and (ii) are not applicable as they require the imported merchandise to be sold in its condition as imported within set periods of time. However, 19 U.S.C. § 1401a(d)(2)(A)(iii), commonly referred to as the “superdeductive method,” may be applicable in this situation. In accordance with 19 CFR 152.105(c)(3), the importer must elect at the time of filing the entry summary to appraise the imported merchandise under this