HQ 545279: Internal Advice Request; assists; royalty payments as cost or value of assists;

Native CBP ruling rendition. Applicability is fact-specific; modification/revocation relationships and original publisher date are retained. Publisher sentinel year0001 means unknown date, not a historical legal adoption.

                            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
402(h) as:

     ...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
402(h)(1)(A)(iv).

     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


cc:  Mitchell Clow
     Import Specialist, Team #744
     Los Angeles, California