November 20, 2008 CLA-2 OT:RR:CTF:VS W563562 KSG
Port Director U.S. Customs & Border Protection 1901 Crossbeam Drive Charlotte, North Carolina 28217
RE: Internal Advice; royalty payments; proceeds; machine tool software packages
This is in response to a letter dated August 18, 2006, from counsel on behalf of Okuma America Corporation requesting a ruling. Since this issue arose out of a Focused Assessment, conducted by the Regulatory Audit Field Office, Charlotte, we are treating the request as a Request for Internal Advice. A conference was held on this matter at Headquarters on May 16, 2007. This file includes submissions dated May 11, 2007, July 10, 2007, October 26, 2007, November 19, 2007, and September 26, 2008.
This case involves the importation of computerized numerically controlled ("CNC") machine tools manufactured by Okuma Japan. The CNC machine tools are powered mechanical devices typically used to fabricate metal components of machines by, for example, cutting, shaping, turning, forming, drilling, or milling metal.
Each type of CNC machine tool consists of two principal systems: (1) the mechanical system; and (2) the CNC controller. The CNC controller consists of both hardware components and software components. CNC machine tools are controlled directly by software installed on the controller. This case involves payments made for software used in the CNC controller. Okuma Japan has a standard software package for the CNC controller that is installed on the product in Japan. If the end-user purchases the CNC machine tool that contains only the standard software package, no additional royalty payment is due.
Okuma America is a 100% owned subsidiary of Okuma Japan. Okuma America purchases CNC machine tools from Okuma Japan and resells them to end-use customers in the U.S. Okuma America orders machine tools from Okuma Japan for its inventory, pays Okuma Japan for these machine tools and then stores them in a warehouse in the U.S. until Okuma America has an order from a U.S. customer. This enables Okuma America to maintain an inventory of machine tools in the U.S. and have the ability to quickly deliver machine tools to U.S. customers. For instance, in one transaction that counsel described (transaction three), Okuma America ordered a machine tool from Okuma Japan in October 2006. This machine tool was produced in Japan in November 2006 and arrived at a U.S. port on December 12, 2006, where it was warehoused. An order was made for this machine tool by a U.S. customer on June 1, 2007, six months after the machine tool entered the warehouse.
Counsel stated that when the machine tools arrive in the U.S. port, Okuma America files a consumption entry. This is supported by documentation in the file from Federal Express. Okuma America paid duties owing on the imported machine tool based on the value of the machine tool, which included the value of the basic software package. Counsel confirmed in the submission dated September 26, 2008, that the cost of the basic software package is included in the price of the machine tool paid by Okuma America to Okuma Japan.
For 80% of the sales of these products, the end-use customer selects additional software options to customize the CNC machine tool for a particular use. If the additional software options are installed on the machine tools in Japan, the cost element of such software is included in the price paid by Okuma America to Okuma Japan.
In some of these cases, the additional software (and possibly, hardware) is added after the CNC machine tool has been imported into the U.S. In these cases, Okuma America pays Okuma Japan a royalty payment for the use of the additional software program(s) in addition to the purchase price of the machine tools. These payments are the subject of this ruling.
When an end-user places an order, a CNC machine tool is taken from the U.S. warehouse and customized by Okuma America for the end-user by adding on additional software programs. The end-user pays an additional amount to Okuma America, calculated in the order, for the additional software programs. Okuma America then makes payments, as specified in the royalty agreement, to Okuma Japan.
Royalty Agreement and six amendments
The royalty agreement between Okuma Japan and Okuma America (Okuma Machinery Inc. the predecessor corporation was the party to the agreement), dated November 28, 1985, provides that two payments are made by Okuma America to Okuma Japan. The first payment was an "initial fee" paid by Okuma America to Okuma Japan for technical information and training. 50% of the initial fee was to be paid within 30 days of the execution of the agreement and the other 50% paid no later than 30 days after Okuma America received the technical information.
Okuma America has the right to sell and install software in the U.S. The second fee is termed "on-going royalties." Okuma America agreed to pay such royalties for each unit of the software products created by Okuma Japan. The on-going royalties is divided into two categories: 1) payment for the basic software package and 2) payment for optional royalties payable for the user’s specifications. The royalties are calculated on the total number of units sold for each calendar half of a fiscal year. Okuma America delivers to Okuma Japan a statement of royalty calculation within 30 days of the close of each calendar half of a fiscal year and makes payment within 60 days of the close of such period. There is a formula provided in Appendix III to the royalty agreement for the on-going royalties. This formula was subsequently amended, most recently October 29, 2005. In a memorandum dated November 1, 2005, there was a 30 page price list that was agreed to for the royalty payment. Royalties under the CNC License Agreement, as modified by the November 1, 2005, memorandum, are calculated for all transactions during each month. Monthly totals are cumulated for six months and Okuma America makes payment of the six month total (less 10% U.S. federal withholding tax).
Termination of the contract is based on breach of the contract.
There is no sales agreement between Okuma Japan and Okuma America. Transactions for sales of the machine tools and components are based on purchase orders and commercial invoices. Counsel submitted sample purchase orders and a commercial invoice. None of the sample documents referenced the royalty payments.
Okuma machine tools have a long life and customers frequently purchase software upgrades long after the machine was originally purchased. For example, during the fiscal quarter ending June 30, 2007, approximately 18% of the royalties paid by Okuma America to Okuma Japan were for software upgrades and additional options provided to U.S. customers long after the original sale.
Whether the on-going royalty payments for the optional software described above are included within the transaction value of the imported merchandise as dutiable royalties.
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"), 19 U.S.C. 1401a. The preferred basis of appraisement under 19 U.S.C. 1401a 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. In order for imported merchandise to be appraised under the transaction value method, there must be a bona fide sale between a buyer and seller, and the sale must be a sale for exportation to the United States.
The additions to the price actually paid or payable include "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of sale of the imported merchandise for exportation to the U.S. 19 U.S.C. 1401a(b)(1)(D). An addition is to be made only to the extent these amounts are not included in the price actually paid or payable. Pursuant to 19 U.S.C. 1401a(b)(2)(A)(iv), transaction value is acceptable only where the buyer and seller are not related, or where related, the relationship does not influence the price actually paid or payable.
In the instant case, the buyer, Okuma America, is related to the seller, Okuma Japan. No information regarding the acceptability of the transaction value has been submitted. Accordingly, we do not address this issue. We are assuming for the purposes of this ruling that the relationship of the parties has not affected the price actually paid or payable and that therefore, transaction value is applicable.
Counsel argues that since the software programs at issue were transmitted to Okuma America by Okuma Japan telephonically and/or over the internet, the software is exempt from duty pursuant to General Note 16(b), HTSUS (now at GN 3(e)(ii), HTSUS).
However, valuation of the software program itself is not at issue in this case. The focus of this case is whether or not to include the payment of "on-going" royalties from Okuma America to Okuma Japan to the price actually paid or payable by Okuma America for the imported machine tools.
Based on the information presented, the sale between Okuma Japan and Okuma America is the sale that results in the exportation of the imported goods to the United States. Okuma Japan functions as a seller and Okuma America functions as a buyer, putting in a purchase order for the good, paying for the good, and filing a consumption entry with Customs.
The payment of the initial royalty fee was included in the price actually paid or payable by Okuma America to Okuma Japan. Therefore, the issue in this case is whether the "on-going" royalty payments, which are not included in the price actually paid or payable, made by Okuma America to Okuma Japan, are an addition under either 19 U.S.C. 1401a(b)(1)(D) or 1401a(b)(1)(E).
The Statement of Administrative Action ("SAA"), 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, which forms part of the legislative history of the TAA, distinguishes payments to third parties from payments to the seller of the imported merchandise. It states:
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 they were 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.
Thus, under the TAA, any royalty paid by the buyer to the seller will be included in transaction value unless the buyer can establish that the payment is distinct from the price actually paid or payable and not a condition of the sale for exportation to the U.S.
CBP has established a three-part test for determining the dutiability of royalty payments under section 402(b)(1) of the TAA. 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"). This 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. An affirmative answer to question 1 and 2 and a negative answer to question 3 points to dutiability. Question 3 goes to the heart of whether the payment is considered to be a condition of sale. Furthermore, the notice reaffirmed that royalty payments may be dutiable as part of the price actually paid or payable under the royalties provision pursuant to 19 U.S.C. 1401a(b)(1)(D), or as proceeds under 19 U.S.C. 1401a(b)(1)(E).
In analyzing these factors, CBP has taken into account certain considerations which flow for the language set forth in the SAA. These include, but are not limited to: (1) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise will generally be dutiable); (2) 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 party); (3) 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 royalties); and (4) payment of the royalties on each and every importation. See Headquarters Ruling Letter 546203, dated May 21, 1998.
As both the SAA and the General Notice make clear, royalty payments are dutiable as part of the price actually paid or payable, or as an addition thereto. The TAA defines the term "price actually paid or payable" as meaning "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). As a general matter, all payments made by the buyer to the seller are presumed to be part of the price actually paid or payable. See Generra Sportswear Co. v. United States, 905 F.2d 377 (Fed. Cir. 1990). However, this presumption may be rebutted by evidence which clearly establishes that the payments are independent and unrelated to the imported merchandise. In the particular circumstances of this case, the information submitted establishes that the on-going royalty payments are not made for the imported machine tools, but rather relate to the installation in the U.S. by Okuma America, of customer-specific software. Therefore, the on-going royalty payments are not part of the price actually paid or payable for the imported merchandise.
Nevertheless, as noted above, royalty payments may also be included in transaction value as an addition to the price actually paid or payable under 402(b)(1)(d)-(e) of the TAA. This case does not involve a patent. The royalty payments are made by the buyer to the seller. However, the purchase of the imported machine tools is not inextricably intertwined to the payment of on-going royalties. Rather, the payment of on-going royalties relates to the installation in the U.S. of customer-specific software packages, not to the sale of the imported machine tools. Therefore, we find that the payment of "on-going royalties" based on the royalty agreement between Okuma Japan and Okuma America are not a condition of sale and are not included in transaction value as an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D).
As noted above, royalties may also be included in transaction value under the provision for "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)(E).
With regard to proceeds, the Statement of Administrative Action provides that:
[a]dditons for the value of any part of the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrues directly or indirectly to the seller, do not extend to the flow of dividends or other payments from the buyer to the seller that do not directly relate to the imported merchandise. Whether an addition will be made must be determined on a case-by-case basis depending on the facts of each individual transaction.
SAA, H.R. Doc. No. 153, pt. 11, 96th Cong., 1st Sess. (1979). See also 19 CFR 152.103(g).
CBP has ruled that in order for proceeds of a subsequent resale to be dutiable under this section, they must pertain to the resale of the imported merchandise, and they must accrue directly or indirectly to the benefit of the seller. See HRL 545035, dated August 23, 1995. In this case, the payments for on-going royalties do not pertain to the resale of the imported machine tools. The payments for on-going royalties are tied to the sale in the U.S. of software packages, which are cumulated over a period of time, and do not pertain to the imported good at issue in this case. Therefore, we find that the payments for on-going royalties are not proceeds and not dutiable additions to the price actually paid or payable.
The payments from Okuma America to Okuma Japan for "on-going royalties" are not included in transaction value as part of the price actually paid or payable or as an addition thereto under 19 U.S.C. 1401a(b)(1)(D)-(E). This decision should be mailed by your office to the party requesting Internal Advice 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 the other methods of public distribution.
Monika R. Brenner Chief, Valuation & Special Programs Branch