HQ 545279 - Internal Advice Request; assists; royalty payments as cost or value of assists; - United States International Trade Commision Rulings

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HQ 545279

November 30, 1994

VAL CO:R:C:V 545279 IOR

CATEGORY: VALUATION

Regional Director
Regulatory Audit Division
New York Region

RE: Internal Advice Request; assists; royalty payments as cost or value of assists;

Dear Sir:

This is in response to an internal advice request initiated by xxxxxxx xxxxxxxxxxxxxx xxxx (hereinafter referred to as the "buyer"), dated October 29, 1992, and forwarded from your office by letter dated April 7, 1993. This response follows a meeting between counsel on behalf of the buyer and members of my staff in the Value Branch. We regret the delay in responding.

FACTS:

The internal advice request arose in the context of an audit of the buyer covering entries made in the period from September 1, 1988 through August 31, 1990. The buyer is an importer of video game cartridges for use in home entertainment systems. The cartridges are produced by Z Company of Japan (hereinafter referred to as the "manufacturer"). This internal advice request concerns the appraised value of the imported cartridges. References to exhibits are for those included in the buyer's submission.

We have been informally advised that Regulatory Audit may have some appraisement questions relating to a buying agency issue and the appraised value of imported joysticks. However, as these issues have not been addressed in the subject audit report or your submission to this office, we will assume that those issues are not a subject of the internal advice request.

The imported game cartridges consist of read-only memory("ROM") integrated circuits soldered to printed circuit boards ("PCB"). The ROM embodies a computer program which contains the game, and the PCB assemblies are enclosed in plastic housings. The game concept is developed by the buyer and typically utilizes characters from movies, comics or television. The buyer engages an independent contractor (hereinafter referred to as the "contractor") to provide coding services, which consist of translating the buyer's game concept into the unique code required by the manufacturer. The code is provided to the buyer in the form of a floppy disc or by electronic transmission. The buyer then transfers the code to an erasable programmable read-only memory chip ("EPROM"). After reviewing the program and making certain additions to it, the completed EPROM is sent to the manufacturer at no charge. The manufacturer uses the EPROM to create a photomask which reproduces the programming pattern. The pattern is then transferred to silicon wafers, and the wafers are used to make the ROM, which is a component of the video game cartridge.

In all cases the importer obtains an interest in the copyright inherent in the game program (i.e. the code). In some cases, the contractor owns the rights to the character on which the game is based, in which case the buyer obtains a copyright/trademark license for the character as well as the copyright inherent in the game program. The character license gives the buyer the right to exploit the game characters in other types of merchandise such as posters and apparel. In most cases the buyer obtains worldwide rights. Some agreements provide for rights that do not include the U.S. See Exhibits D and E of buyer's submission.

Exhibit B consists of an agreement pursuant to which no character rights are transferred. Exhibit B provides in paragraph 1 that in consideration of payment by the buyer, the contractor agrees to:

...perform the necessary computer programming services required by [buyer] in order to create, from plans and descriptions furnished [contractor] by [buyer], [manufacturer's entertainment system software](the "Software"), in accordance with [buyer's] requirements and specifications. [Buyer] shall own absolutely and in perpetuity all proceeds of the services that are the subject of this agreement, including without limitation, the programs embodied in the Software.

Exhibit C consists of an agreement for the coding of a game by a contractor that owns the character rights. With respect to the coding, the agreement provides in paragraph 1.01 ("licensor" being the contractor and "licensee" being the buyer):

Licensor hereby grants to Licensee, for the term of this Agreement and subject to the terms hereinafter set forth, the exclusive license to utilize the Video Game Programs solely on and in connection with the manufacture, distribution and/or sale of Video Games for the [manufacturers entertainment system]....

A separate provision in Exhibit C, paragraph 1.02, provides for the buyer's character rights in connection with merchandise other than video cartridges (such as posters and apparel). The agreement provides for a royalty based upon the buyer's sale of video games ("with respect to the sale... of the Video games") in paragraph 4.02(a), and a separate royalty for exploitation of the character rights ("with respect to all income derived by Licensee from the exploitation of the Character Rights...") in paragraph 4.02(b).

According to the buyer, typically, the coding services agreements call for progress payments during preparation of the coding and at delivery of an acceptable code to the manufacturer. The buyer states that these progress payments are advances against royalties which are based on the buyer's sales of the game cartridges. The agreement in Exhibit C provides for an advance against the royalty. The "advance" is non-refundable, and is credited towards future royalties owed by the buyer. In the agreement in exhibit B, the progress payment is described as a non-refundable fee, to be paid in three installments in addition to the payment of a royalty to the contractor, based on each cartridge sold.

ISSUES:

1. Whether an assist has been furnished to the manufacturer. 2. What is the cost or value of the assist.

LAW AND ANALYSIS:

The subject merchandise was entered on the basis of transaction value, the preferred method of appraisement. This response assumes that transaction value is the appropriate method of appraisement for the subject merchandise. Transaction value is defined by ?402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act; of 1979 (TAA, 19 U.S.C. ?1401a(b)) as "the price actually paid or payable for the merchandise when sold for exportation to the United States..." plus certain additions specified in ?402(b)(1)(A) through (E). The term "price actually paid or payable" is defined in TAA ?402(b)(4)(A) as "the total payment ... made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller."

One of the statutory additions to "the price actually paid or payable" is "the value, apportioned as appropriate, of any assist." TAA ?402(b)(1)(C). The term "assist" is defined in TAA

...any of the following if supplied directly or indirectly, and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise:

...

(iv) Engineering, development, artwork, design work, and plans and sketches that are undertaken elsewhere than in the United States and are necessary for the production of the imported merchandise.

The issue is whether the creation of the code or program constitutes development "necessary for the production of the imported merchandise." In its submission, the buyer compares the code to specifications, stating that the code tells the manufacturer what game the buyer wants as opposed to instructing the manufacturer how to make the game. In the meeting at Customs, counsel also compared the code to written instructions for a board game. Counsel stated that without the code there would be no game, and the result would be a blank screen. We find that the code is more integral to the video game than instructions for a board game. Written instructions are not necessary for the actual manufacture of a board game. Written instructions can be obtained or added separately. In this case, as stated by counsel, without the code there would be no video game. Paragraph 1 in Exhibit B refers to the coding service as being "required" to create the software. Consequently the submitted evidence clearly supports the conclusion that the creation of the code is necessary for the production of the imported merchandise, and is an assist under TAA

It should also be noted that Customs has ruled in Headquarters Ruling Letter (HRL) 542498 dated June 16, 1981, that detailed specifications used directly by a vendor in the manufacture of equipment or material should be considered an assist for duty purposes. Although in the instant case the format of the coding undergoes changes (from floppy disc, to EPROM, to photomask, to silicon wafers, to ROM), these changes do not alter the code or program itself. The code is embodied in the ROM which is a component of the imported video game cartridge.

Pursuant to the agreements between the buyer and the contractors, the buyer's payments for the coding services and rights to use the codes consist of initial progress payments and continuing royalties. In those situations where the importer obtained character rights from the contractor, separate royalties were payable.

This situation is similar to those in TAA #13 (HRL 542152) dated December 4, 1980 and HRL 544459 dated May 30, 1991. The second transaction addressed in TAA #13 involved a cash advance given by the importer to a Canadian company to develop a drawing and a crude working model for a product. The design drawing and the model were used by the foreign manufacturer in fabricating the imported merchandise. The Canadian company obtained a Canadian patent for the invention and the importer agreed to pay the Canadian company royalty payments for the design after the advanced funds had been depleted. Customs determined that the design drawing and model were assists, and that the value of the assists, based on the cost of acquisition, included the cash advance amount and the royalty payments.

In HRL 544459, the importer had contracted with a foreign company to design and develop an automobile to be manufactured and sold to the importer by a third company. The design and development was provided to the manufacturer free of charge. The importer was required to pay a royalty to acquire the design and development of the imported cars. Customs determined that the design and development was an assist, and that the value of the assist was the royalty payments made by the importer, the importer's cost of acquisition of the assist.

In this case, the buyer is required to make progress payments and continuing royalty payments for the coding services and the code itself. It is the position of the Customs Service that where an assist is acquired by the importer from an unrelated seller, the value of the assist is the cost of acquisition. See TAA #13. The progress payments and the continuing royalty payments for the coding services represent the cost of acquisition of the assists provided to the manufacturer. Of course, any apportionment of the value of the assist will be done in a manner consistent with 19 C.F.R. ?152.103(e).

HOLDING:

1. An assist has been provided to the manufacturer of the imported merchandise.

2. The cost or value of the assist is the buyer's cost of acquisition. These costs are the progress payments and the continuing royalties attributable to merchandise imported into the U.S.

This decision should be mailed by your office to the internal advice requester no later than 60 days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs
personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels.

Sincerely,

John Durant, Director
Commercial Rulings Division

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