We often hear about global companies, particularly those in the fashion, apparel and beauty industry, as title holders of intellectual property rights such as trademarks, trade names, patents and copyrights. Oftentimes, those companies grant licensing agreements to third parties, either related or not, to use their IP rights for the manufacture, distribution and/or marketing of products exported from one country to be imported into another. These licensing agreements are usually subject to royalty or licence fee payments upon use.

Companies exporting and importing products to Mexico or other World Trade Organization (WTO) member countries must evaluate if, as part of a licensing agreement, royalties and licence fees for using a product’s IP rights are subject to duty payments. 

The Mexican Customs Law (MCL) states that the taxable base for duties on imported products into Mexico is determined by the customs value of the products. This corresponds primarily to their transaction value. Under the MCL, the transaction value of the products corresponds to the price paid for the products, provided that they are sold to be exported to Mexico through a purchase made by the importer.

The MCL provides that in addition to the price paid for the products, the transaction value must include additional charges such as royalties or licence fees (as long as they are not included in the price paid), when the following conditions are met: 

i) that the payment of royalties or licensing fees is related to the imported products; 

ii) that the importer has to pay them directly or indirectly as a condition of sale of the products; and 

iii) they are objective and quantifiable at the time the products are imported.

Related to the imported products

Certain types of IP rights are linked to goods or products, while other IP rights are not. For instance, patents covering products or processes to manufacture products would be related to products, while trademarks covering services would not be associated.

If a royalty or licence fee is paid for the use of an IP right tied to a good or product, the fee paid would then be considered part of the total transaction value of the imported item. This meets the MCL’s first condition whereby certain additional charges, in this case royalties and licensing fees, are incremental to the transaction value of a good or product.

To compare, when a royalty or licensing fee is paid for the use of an IP right that is not related to a good or product, such as the use of a brand name to identify a commercial establishment or a company slogan for branding and marketing use in the country of import and distribution, the transaction value of the licensing agreement and additional charges will not carry a duty. In this case, the IP right is specific to the use and distribution of a brand and the reputation it carries, not a tangible item, even though the IP right is meant for the primary purpose of promoting a good or product.

Likewise, when a contract stipulates that an IP right fee be paid for the authorised use of confidential information related to the development of a business, or for the provision of technical or administrative assistance services, then the fee payment is not related to a product and therefore should not increase the customs value of the imported products. For example, if a cosmetics company wants to show their in-country business plan to individuals from their headquarters and requires technical services as part of the strategy deployment, then the use of these resources and the IP rights associated with institutional knowledge and skills would not be dutiable.

Condition of sale

Condition of sale is the critical component, without which the purchase and sale operation would not exist. If the importer does not cover the royalty or licence fee payment for the use of the IP right, the seller will not sell the products to be imported.

The Technical Committee on Customs Valuation of the World Customs Organization (WCO) spells this out. The WCO defines this and provides clarity on the concept of condition of sale stating: “The clearest indication that the buyer could not purchase the imported goods without paying the royalty or licence fee is where the sales documentation for the imported goods includes an explicit statement that the buyer must pay the royalty or licence fee as a condition of sale. Such a reference would be determinative in deciding whether a royalty or licence fee was paid as a condition of sale.”

However, there could be cases where the seller is not the owner of the IP rights related to the imported products. A condition of sale could exist when royalties or licence fees are paid, directly or indirectly to third parties, whether related or not to the seller.

In other words, there could be cases where the importer is not required to pay the seller royalties or licence fees to use an IP right, but instead to a third party (related or not), even though it will increase the transaction value for customs valuation purposes with the payment of such royalties or licence fees.

For example, cases where the licence to use an IP right to manufacture certain products is granted upon the payment of a royalty or licence fee, but the products are manufactured and sold by a third-party supplier; in this case, the importer may be prevented from manufacturing the products to be imported whether or not they are paying the royalty or licence fee that allows such products to be produced. This situation represents a case where the payment of royalties or licence fees could be considered as a condition of sale.

In connection with the above, the Technical Committee on Customs Valuation of the WCO has established certain factors to be considered when determining if the payment of a royalty or licence fee is a condition of sale or not:

• There is a reference to the royalty or licence fee in the sales agreement or related documents.
• There is a reference to the sale of the goods in the royalty or licence agreement.
• According to the terms of the sales agreement or the royalty or licence agreement, the sales agreement can be terminated if there is a breach of the royalty or licence agreement due to the buyer not paying the royalty or licence fee to the licensor. This is a direct relationship between the royalty or licence fee payment and the sale of the goods being valued.
• There is a term in the royalty or licence agreement that indicates if the royalties or licence fees are not paid, a manufacturer is forbidden from manufacturing and selling the goods incorporating the licensor’s intellectual property to the importer.
• The royalty or licence agreement contains terms that permit the licensor to manage the production or sale between the manufacturer and importer (sale for export to the country of importation) that go beyond quality control.

Right of distribution or resale

It is worth mentioning that applicable provisions establish that payments made by the buyer for the right of distribution or resale of the imported goods shall not be added to the price if they do not constitute a condition of the sale.

Right to reproduce

Moreover, it should be noted that applicable provisions establish that the charges for the right to reproduce the imported goods in the country of importation shall not be added to the price when determining the customs value.

Royalties paid on objective and quantifiable data

According to the MCL, in order for royalties and licence fees to qualify as an increase to the transaction value for customs valuation purposes, the royalties must be determined on the basis of objective and quantifiable data.

In other words, the transaction value of the products being valued will only increase to the extent that royalties or licensing rights to be paid, are objective and quantifiable at the time of importation.

Taking this into account, in the event there are royalties that must be added to the customs value, and at the time of importing the goods in question the importer does not have objective and quantifiable data to determine the amount to pay for those royalties, this requirement would not be met and there could be a reasonable argument there would be no obligation to increase royalties in relation to the customs value of said merchandise.

Other considerations

In addition, the following considerations should be taken into account when analysing whether the payment of royalties or licence fees for the use of IP rights should be considered as a condition of sale of a product to be imported into Mexico:

• Whether the owner of the IP rights is the seller in the transaction or not.
• Whether the manufacturer, seller, buyer and owner of the IP rights are related parties or not.
• Whether the licence is granted for the use of a patent to manufacture or a process to manufacture the product.
• Whether the products to be imported bear the licensed trademark or copyright.
• Whether the licence is granted to use trademark for distribution, resale and/or marketing purposes in the country of destination of the imported product.
• Whether the licence is granted to reproduce the imported good in Mexico.
• Whether the licence is granted to incorporate the IP rights in products after their importation into Mexico.  

Determining if the payment of royalties and licence fees for the use of IP rights on goods imported into Mexico would increase their transaction value for purposes of determining their dutiable base, is a task that must be performed on a case-by-case basis. Attention must be given to verifying the conditions outlined in the applicable regulations.

It is highly recommended to revise international sales, distribution and licence agreements that provide for the payment of royalties or licence fees for the use of IP rights in connection with imports into Mexico, to determine whether the payment of these fees increases the customs value for purposes of these operations. You may find this recommendation also applies to WTO member countries to which the Agreement on Implementation of Article VII of the General Agreements of Tariffs and Trade 1994 is applicable.

Based in Mexico City, Marcos Carrasco Menchaca is a partner in Foley & Lardner’s transactions and international trade practices, where he handles international business transactions, regulatory matters and administrative litigation. He can be reached at [email protected].