July 2020
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Royalties and Advertising Fees
Mark K. Neville, Jr.
In what is without question the most consequential customs valuation case to be decided in the United States in decades, the US Court of International Trade has recently issued its decision in Trimil SA v. United States.1 The CIT did nothing short of upending at least thirty year’s of CBP practice on customs valuation questions. Trimil concerned the non-dutiable treatment of advertising expenses and third-party trademark royalties. The December 2019 decision promises to be an oft-cited landmark decision, right up there with the Nissho Iwai case on First Sale for Export2 and the Generra and Chrysler cases on the Price Actually Paid or Payable (the PAPP),3 the legal standard discussed at length below. The plaintiff was a joint venture between two Italian designers, Giorgio Armani SPA and Ermengildo Zegna, and was an importer of Armani apparel into the United States. The court closely examined two sets of agreements that provided for Trimil to receive (1) design and advertising services provided by a pair of related parties—Armani and its subsidiary, Modefine and (2) trademark license rights, in which the licensor was Modefine. Importantly, the licensor of the trademarks was unrelated to the apparel factories which were the sellers of the imported merchandise. Thus, from the perspective of the sale for export to the US, in which the foreign factory sold the goods to Trimil, the license agreement was a third-party agreement. In the case of both agreements, the fees would be based on Trimil Corp.’s future U.S. sales.
The case did not go to trial but was decided in Trimil’s favor by summary judgment, which meant that both Trimil and the government agreed on the material facts and sought a judgment on the legal consequences of those facts.4 The government had the double misfortune of (1) dealing with Trimil’s first rate legal counsel, a team led by veteran Bob Silverman of the Grunfeld law firm5, and (2) drawing a judge who was not unduly deferential to the agency but took a fresh look at the legal questions. The court papers filed by Trimil’s counsel, which I reviewed, repeatedly called upon the court to focus on the actual language of the statute and its legislative history as well as the administrative regulations that had been promulgated. To his credit, Judge Eaton did exactly that.
The CBP interpretation did not survive a faithful reading of the legal authorities and a close examination of the underlying agreements. Trimil had conceded that the design services it received under the design and advertising agreements constituted dutiable assists, elements of value which are provided free or at reduced cost to foreign producers or sellers and whose omission from the PAPP unfairly lowers the dutiable value.6 The court held that the advertising fees and the trademark royalty fees paid by Trimil were not dutiable—they did not comprise a part of the PAPP for the imported merchandise, and they did not fit within one of the statutorily authorized additions to the PAPP. We shall examine the two types of payment in turn, but we should first lay out the legal standards. And, as the court instructed, “Each of the fees paid by Trimil to Armani or Modefine, to be dutiable, must fit within the statute.
Transaction Value, Statutory Additions
The strict hierarchy set out in the customs valuation statute begins with the “transaction value” method, which is where we encounter the PAPP. That method is broadly defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States.”7 In its turn, the PAPP is defined as “the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.”8 For the most part, this results in the use of an invoice price, but there are certain additions to that invoice price which are mandated by the statute.9 These five “statutory additions” include, in relevant part, dutiable assists and royalties and license fees.10 Not all royalties or license fees will be dutiable. Instead, royalties must have real ties to the imported merchandise. The royalty must relate to the imported goods and the payment must be required as a condition of sale for export to the US of the imported merchandise. The two most important features of this system are (1) the PAPP itself is defined as being payment “for the imported merchandise” and does not include all payments to the seller11 and (2) it cannot be adjusted, i.e., added to by any amount that does not fall within the definition of a royalty or license fee or one of the other statutory categories. This is the closed system for transaction value.
Advertising Fees
The agreement s in place for design and advertising services called for Armani to conduct advertising for the imported merchandise and the trademarks but, importantly, the court emphasized that the advertising campaign was to be conducted in an exclusively post-importation environment as it related solely to enhancing the sales environment in the territory. For our purposes, then, this advertising was actually in support of Trimil’s resales of the imported merchandise: “The marketing and advertising services that Armani rendered were intended to enhance retail sales of the trademarked merchandise within the United States.”12 Trimil also emphasized that the customs regulations actually carved out an express reservation for advertising expenses: Indirect payment.An indirect payment would include the settlement by the buyer, in whole or in part, of a debt owed by the seller, or where the buyer receives a price reduction on a current importation as a means of settling a debt owed him by the seller. Activities such as advertising, undertaken by the buyer on his own account, other than those for which an adjustment is provided in §152.103(b), will not be considered an indirect payment to the seller though they may benefit the seller. e costs of those activities will not be added to the price actually paid or payable in determining the customs value of the imported merchandise.13 [Emphasis added]
The government made much of the fact that the advertising fees were part of a wider “brand integrity” scheme and also sought to whip up a souffle with the notion that payment of the design and the advertising fees would allow it to continue to produce the goods. This despite the fact that Trimil did not produce the goods. More on this below, but this was an attempt at what I shall term “dutiability by osmosis.” The court rejected the government’s argument that the advertising fees were a part of the PAPP in a straightforward and well-ordered statutory analysis. First, the payment of the advertising fees to Armani were not payments “to” the foreign sellers of the imported merchandise. Next, the court found that that the fees were not “for the benefit” of the seller. The court found that the phrase “for the benefit of the seller” should be given a narrow meaning. First off, there is the carve-out in the regulation and then there were a series of earlier rulings issued by CBP which had held that such marketing and advertising fees were not dutiable.14 In the court’s view, the parties which benefited from the agreements for design and advertising were Armani, which got uniformity of advertising and design, and Trimil, which would have the ability to purchase and resell the product.15 As the court put it, “if it exists at all,” any benefit to the seller was so tangential as to be“ unquantifiable.” Under the government’s logic in defining “benefit of the seller,” virtually any and all payments by the buyer for anything and everything would be dutiable as a part of the PAPP. For example, an importer/buyer’s lease payments for its warehouse or its retail stores payable to a US property owner would be dutiable, as indeed would all of its accounts payable. This is because these payments—at a cosmic level but only at a cosmic level—will benefit the seller of the imported merchandise.
The logical progression is (1) all of those expenses would be presumed to support or promote increased resales of the imported merchandise and (2) if there were more resales, then there would be more purchases by the buyer of the imported merchandise and (3) if there were more purchases by the buyer then the seller would benefit and (4) if the seller would benefit, then those payments should be added to make customs value. Next stop, Mars! As the payment of the advertising fees were neither to nor for the benefit of the sellers, they could not be part of the PAPP for the imported merchandise. The court also disposed of the possibility that the advertising fees fell within any of the five statutory additions. They were not license fees and, in any event, they were aimed at resales of the imported merchandise in the US, with the relevant advertising and promotional activities occurring completely in the US. The court cited to but did not quote the relevant customs regulation, which specifically declares that: “Royalties or license fees paid to third parties for use, in the United States, of copyrights and trademarks related to the imported merchandise generally will be considered selling expenses of the buyer and not dutiable. ”16 The court accepted Trimil’s argument that the fees “fall squarely within the con- text of post-import transactions” and were not dutiable. The court next turned its attention to the royalty payments.
Royalty
In the case of the royalty payments, the government again turned to a PAPP argument that the royalties were for the benefit of the seller. Applying its Martian logic, the government argued for the royalty to be a part of PAPP because the underlying agreements were a pre-condition for the manufacture of the goods and if Trimil lost its rights due to nonpayment of the royalty and fees then it would be forced to direct the factories not to make the goods and then there would obviously not be a sale. The court rejected this interstellar logic as it had in the advertising fee context. The court determined that the term “benefit” has a narrow meaning within the statute and regulation defining the PAPP. Moreover, all of the rights and responsibilities accruing under the agreements are exercisable by or imposed upon only the parties to those agreements and not the sellers of the merchandise, which are strangers to those agreements. As for the dutiability of the royalty as one of the defined statutory conditions, we have already seen that the royalty must be related to the imported merchandise and its payment must be a required “ condition of the sale” of that merchandise. The court pointed out that the presence of a legally enforceable condition could not be inferred where an express condition was absent from the sales contract.17 Just because the non-payment of the royalty might lead to a halt in production does not make the royalty payment a condition of the sale of the imported goods. On this point I have previously argued that the parties to the sale cannot rely on the payment or non-payment of a royalty in either forcing performance or as an excuse from performing under the sale agreement. If the buyer wanted to walk away from its obligation to buy the goods, it cannot cite to non-payment of the royalty to a third-party licensor as an excuse for its nonperformance. In the case of the seller seeking to walk away from its obligation to make and sell the goods to the buyer, the seller cannot excuse its nonperformance by pointing to the nonpayment of the royalty to a third-party licensor. Simply put, in the absence of the payment status exerting such a dispositive effect on the sale of the imported goods, the payment of the royalty cannot be said to be a condition of the sale. All contrary interpretations which deviate from this contract law analysis and are, instead, founded on a “practical effect” or real world” perspective, are misguided. The court accepted Trimil’s argument that the trademark royalty fees were a “selling expense associated with the clothing’s resale value after importation into the United States.”
Impact of the Trimil Decision
First, this decision has been received favorably. I am not aware of any criticisms. It sends a strong message to the trade community that they can obtain an impartial hearing. The decision should satisfy those importers of luxury and other consumer goods which rely on third-party licensing arrangements. It is reassuring to those legal scholars who think that CBP should administer the statutes in closer harmony with their texts. This was a matter of first impression, as no previous court has been called upon to define “benefit” and the court applied a strict construction in its exegesis. The government rolled the dice and lost. The most striking aspect of the case is that the government neither appealed the loss nor, at the time of this writing, issued a Limiting Treasury Decision.18
As of now, the decision stands as the last word. Of course, the decision may spawn later court challenges by the government seeking to re-litigate these issues or by importers seeking to challenge other CBP interpretations. Perhaps the government might be waiting for a later case to re-litigate, one where it might have less skilled opposing counsel and “better” facts. Another important point is that the government never argued for dutiable status of the royalty payment as “subsequent proceeds” that accrue to the seller, as provided for in the customs valuation statute.19 The third-party status of the seller would seem to rule out a “proceeds” argument but, if the government were going to launch rarefied “benefit of the seller” arguments in the context of the PAPP, one would expect the alternative subsequent proceeds argument as well. This “proceeds” argument has been a fallback argument in CBP’s royalty practice for close to thirty years, since ruling no. 544436 (2/4/91), the original “Hasbro” ruling which was later confirmed by “Hasbro II” in 1993.20 The silence here is consistent with the fact that citations by CBP to Hasbro II have fallen off dramatically in the past decade and, taken together, this would suggest that CBP is moving away from the Hasbro II standard.
The decision aligns the US and Canadian judicial interpretations of what is meant by the “condition of sale” criterion for dutiable royalty status,21 with both jurisdictions adopting a more conservative statutory construction than the stance of the TCCV. It is important to note that the TCCV is not an entirely impartial body as it considers technical questions on customs valuation arising under the CVA. It is comprised of delegates who represent their respective customs authorities. For the most part, the delegates have no legal training. Importers have been reluctant to challenge CBP and shoulder the considerable expense of taking a case to trial. Thus, rarely is an important valuation case presented to the CIT, and when a decision is issued, the trade world takes notice. Perhaps importer passivity has emboldened CBP to unfairly apply customs statutes and regulations and maybe this case, a win for the importer, will inspire the customs bar to challenge CBP more often. Importers may well challenge other questionable positions CBP has taken in recent years. After this decision on the PAPP and the meaning of “benefit,” one could imagine a challenge to the CBP view that a payment to a party related to a seller is treated as though it were a payment to the seller.22
As misbegotten as Generrais, and we hold out hope that its legitimacy might someday be re-examined, it did not reach this proposition. Put plainly, this line-blurring tenet of CBP has never been tested. Outside customs valuation, we could also foresee a judicial review of CBP and its broadened reliance on the“ predetermined end-use” test for origin in government procurement enunciated in Energizer Battery, Inc. v. United States, 190 F. Supp. 3d 1308 (2016).23 Another open question for me is whether the US will take positions in international forums, such as the TCCV, that are aligned with Trimil whenever advertising fees, third-party royalties or, indeed, PAPP questions are on the table. Finally, the Trimilcase also opens up an obvious planning opportunity. Importers can rely upon this case to draft agreements where fees for advertising expenses and other services and trademark royalties are paid to third-party service providers or licensors and the bright line standards set out in the case are observed.
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2. Nissho Iwai American Corp. v. United States, 982 F.2d 505 (Fed. Cir. 1992).
3. Generra Sportswear Co. v. United States,905 F.2d 377 (Fed. Cir. 1990) and Chrysler Corporation v. United States, 17 CIT 1049 (1993).
4. See generally Neville,“Summary Judgment at the CIT,” 28 JOIT 17 (Nov. 2017).
5. Full disclosure—Bob and I are old friends, having started our careers as trial attorneys in the same Justice Department office, in my case in 1975.
6. Dutiable assists are one of the elements of a transaction value which may be added to the PAPP, as discussed below. For further discussion, see Neville,“Dutiable Assists can lead to Dutiable Difficulties,”18 JOIT 17 (Sept. 2007) or Neville (ed.), International Trade Laws of the United States: Statutes and Strategies, ¶5.20 [2].
7. 9 U.S.C. section 1401a(b). In the WTO’s Customs Valuation Agreement (CVA), formally the AGREEMENT ON IMPLEMENTATION OF ARTICLE VII OF THE GENERAL AGREEMENT ON TARIFFS AND TRADE 1994, this definition is at Art. 1.
8. 19 U.S.C. section 1401a(b)(4)(A).
9. The WTO Valuation Agreement analogue is Art. 8.4.
10. The CVA speaks of the PAPP being “adjusted” but, in all cases, the adjustment is, in fact, an addition to the PAPP.
11. This was the important limitation on Generraimposed by the decision in Chrysler. Parenthetically, the CBP reading of the Chrysler standard—the importer must be able to show that the amount in question is “com- pletely unrelated” to the imported merchandise,” is not faithful to the statute nor to the Chrysler decision, which requires more narrowly that the payment be “in exchange for merchandise,” and is ripe for challenge. The Chrysler court emphasized that the accounting treatment accorded the shortfall fees x ere separate from the cost of the imported merchandise. Surely this is an important factor and should not be over- looked in any discussion of the PAPP. For another expression of a conservative reading of the statute,see Caterpillar Inc. v. United States, 941 F. Supp. 1241 (CIT 1996) (refunded VAT is not a part of the PAPP).
12. Plaintiff’s Separate Statement of Material Facts Not in Issue, at 6, no. 41.
13. 19 CFR section 152.103(a)(2). The nearly identical CVA analogue is at Interpretive Note to Art. 1 at para. 1.2. For more on the customs valuation status of advertising, marketing and promotion costs (AMP), see Neville,“Some Observations on Customs Valuation Law Status of AMP Payments, ” 27 JOIT 24 (Apr. 2016). That discussion addresses the criterion of the expense being on the buyer’s “own account. ”
14. ee, e.g., ruling nos. 544482 (8/7/90), 544638 (7/1/91) and H287490 (10/16/17).
15. I am not sure that the court was entirely correct on this last point. While the advertising services provided to Trimil pursuant to the design and advertising agreements would surely enhance the prospects for its resales, the right to manufacture, purchase and sell the goods was conferred by the license agreements. As described in the briefs, breach of the design and advertising agreements would not trigger a termination of the license agreements.
16. 19 CFR section 152.103(a)(2)(f).
17. CBP had previously followed this narrower interpretation. See, e.g., ruling no. 548368 (12/24/03). CBP later deviated from this interpretation. Seeruling no. H233376 (9/19/16). For a more thorough discussion, as well as a review of World Customs Organization’s Technical Committee on Customs Valuation (TCCV) Advisory Opinion 4.15, seeNeville (ed.), International Trade Laws of the United States: Statutes and Strate- gies, ¶5.20 [3].
18. CBP is authorized to issue Limiting Treasury Decision s (Limiting TD s) which effectively allow it to restrict the precedential effect of its losses in the courts. 19 U.S.C. section 1625(d). For a critique and a call to an end of this Limiting TD practice, seeNeville, “Limiting Treasury Decision s: CBP Prefers not to Yield, ” 31 JOIT 42 (Mar. 2020).
19. General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993) (“Hasbro II ruling”).
20. In the US, this is set forth at 19 USC § 1401a (a) (1); in the EU, this is set forth at Articles 70 and 74 of the UCC.
21. Canada (Deputy Minister of National Revenue) v. Mattel Canada Inc., 2001 SCC 36, 2001 Can. Sup. Ct. LEXIS 40 (Canada Supreme Court 2001) and Reebok Canada v. Canada (Deputy Minister of National Revenue), 2002 FCA 133, 2002 Fed. Ct. Appeal LEXIS 90 (Canada Fed- eral Court of Appeal 2002).
22. See, e.g., ruling no. W563354 (10/21/10) (It is CBP’s position that payments made by the buyer to a party related to the seller are indirect payments made to, or for the benefit of, the seller); see also, ruling no. 544221 (6/3/91).
23. See Neville,“CBP’s Hammer: Misuse of Energizer Battery,” 30 JOIT 30 (Nov. 2019).