VAL CO:R:C:V 544800 ER
Brian S. Goldstein, Esq.
Laurence M. Friedman, Esq.
Tompkins & Davidson
One Whitehall Street
New York, New York 10004
RE: Dutiability of royalty payments made by importer to related
manufacturer.
Dear Messrs. Goldstein and Friedman:
This is in response to your letter dated September 3, 1991,
on behalf of your client, Berlex Laboratories, Inc. ("Berlex"),
in which you request a ruling concerning whether certain
royalties paid by Berlex to a related party, Schering
Aktiengesellschaft ("Schering"), in Berlin, Federal Republic of
Germany, constitute non-dutiable charges under section 402 of the
Tariff Act of 1930, as amended ("TAA"; 19 U.S.C. 1401a).
Although we just recently met with counsel regarding this matter,
we nonetheless regret the delay in responding.
FACTS:
Berlex is a subsidiary of Schering. Both companies are
engaged in the business of research, development, manufacture and
marketing of pharmaceutical products. The parties entered into
Option and License Agreements in 1988 which provide that Schering
shall offer Berlex an option with regard to each pharmaceutical
product which Schering decides to market in the United States,
and the offer by Schering of an option on a product shall
indicate whether the license will be exclusive or not.
The only product which Berlex currently imports from
Schering on which it pays a royalty is Magnevist. Pursuant to
the terms of the License Agreement, entered into on April 5,
1988, Berlex has exclusive marketing rights for Magnevist in the
United States. The License Agreement also specifies that Berlex
will purchase its Magnevist requirements from Schering. Article
4(1) of the Option Agreement, dated January 18, 1988, provides
that the amount of compensation payable by Berlex will be fixed
by the License Agreement and will be in the form of a royalty and
may also include one or more down payments. The License
Agreement specifies that compensation will be in the form of
royalty payments at xxx percent of Berlex's net sales, in
addition to payment of an initial supply price for the
merchandise.
ISSUE:
1. Whether the royalty payments made by Berlex to Schering
are part of the price actually paid or payable for the imported
merchandise.
2. Whether the royalty payments could be included in the
transaction value of the imported merchandise as either royalties
under section 402(b)(1)(D) or proceeds of subsequent resale under
section 402(b)(1)(E).
LAW AND ANALYSIS:
For purposes of this ruling, we assume that transaction
value is the proper basis of appraisement and that the "related"
party status, within the meaning of section 402(g)(1), does not
influence the price actually paid or payable, as set forth in
section 402(b)(2)(B). Under this assumption, the transfer price
between the Berlex and Schering is acceptable for transaction
value providing it meets one of the tests set out in section
402(b)(2)(B). Transaction value, the preferred method of
appraisement is defined in section 402(b)(1) as the "price
actually paid or payable for the merchandise", plus five
enumerated statutory additions. Two of the statutory additions
are found in sections 402(b)(1)(D) and (E) which provide for
additions to the price actually paid or payable for:
(D) any royalty or license fee related to the imported
merchandise 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; and
(E) the proceeds of any subsequent resale, disposal or
use of the imported merchandise that accrue, directly
or indirectly, to the seller.
The Statement of Administrative Action ("SAA"), adopted by
Congress with the passage of the TAA, explains that "[a]dditions
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." Statement of Administrative Action, 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.
Counsel for Berlex contends that the royalty payments it
makes to Schering are not dutiable under either section
402(b)(1)(D) or section 402(b)(1)(E) for the reason that the
payments do not constitute part of the "price actually paid or
payable for the imported merchandise" and are not separately
dutiable as either royalties or proceeds which may be added to
the price actually paid or payable in determining the transaction
value of the imported merchandise.
Counsel cites to 544129 (August 31, 1988); 544061 (May 27,
1988) and HRL 544436 (February 4, 1991) to support the contention
that the royalty payments are not made as "a condition of the
sale of the imported merchandise for exportation to the United
States" and for the proposition that the payments are for rights
which are separate and apart from the right of ownership or
payment of the purchase price.
HRL 544129 involved a situation where the importer made
royalty payments to a licensor related to the seller. The
payments were for the exclusive right to use and sell a drug in
the United States. The royalty was xxx percent of the importer's
net sales. The importer also acquired the right to manufacture
the drug in the United States if the manufacturer could not
fulfill the requirements in the supply agreement and the importer
was granted the right to use the licensor's know-how. The amount
owed to the licensor was reduced by payments made to an unrelated
company that was originally involved in the early development of
the product. Customs held that the royalty payments were not
dutiable under section 402(b)(1)(D). The basis of the holding
was that the payments were not a condition of the sale of the
imported merchandise and the payments were for rights that were
separate and apart from the right of ownership on payment of the
purchase price.
In HRL 544061, the importer entered into a license agreement
with the licensor who owned certain proprietary rights in a
product. The agreement granted the importer an exclusive,
unrestricted and unlimited right and license to manufacture, use
and sell the product in the United States under the conditions
set forth in the agreement. Two payments of $xxx each were paid
within 12 months from the date of execution of the agreement.
The importer also paid the licensor a royalty based upon the net
sales of the product only in situations where the importer
purchased the product from a party other than the licensor.
Customs held that the royalty payments were not to be added to
the price actually paid or payable for the merchandise under
section 402(b)(1)(D). The basis for this decision was that the
payments were not a condition of sale of the imported goods and
were not tied to the importation of the product, being paid,
rather, for the right to manufacture and use the product in the
United States.
Although later in this ruling we will address the
dutiability of the royalty payments in the context of statutory
additions to the price actually paid or payable, Customs believes
that the subject payments are more properly dutiable as part of
the price actually paid or payable for the merchandise. Customs
reaches this conclusion based on the description found the Option
and License Agreements of the method for calculating
"compensation". Article 4(1) of the Option Agreement describes
compensation as follows:
The compensation payable by Berlex for a license to a
Product shall be fixed by the License Agreement as per
Art. 2(5). Such compensation will be in the form of a
royalty and may also include one or more down payments.
Royalties shall be payable during a term of 10 (ten)
years or the life of US patents covering a given
Product, whatever is longer.
The "License Agreement" referenced in this section was
subsequently executed on April 5, 1988. That agreement confirms
that Berlex will have exclusive marketing rights for Magnevist in
the United States. Article 4(1) of the Option Agreement, quoted
above, provides for the creation of a License Agreement in which
compensation for the product must be set in the form of a royalty
and down payments. The compensation as described in the License
Agreement includes an initial supply price of $xxx (CIF) (for a
specified volume) and royalties in the amount of xxx percent of
Berlex's net sales.
In a meeting with counsel on April 21, 1994, counsel argued
that because the License Agreement provided for an exclusive
marketing arrangement between the parties, the royalty payments
described in the agreement were paid for the right to market the
product and not as part of the price paid or payable or as a
condition of the sale. Customs disagrees. The License
Agreement must be read subject to and in context with the Option
Agreement. Nothing in the Option Agreement, in Article 4(1) or
elsewhere, describes an intent by the parties to distinguish the
royalty payments from the price actually paid or payable. To the
contrary, Article 4(1) expressly defines compensation to include
such payments. Moreover, Customs believes that even if we were
to focus exclusively on the License Agreement, we would reach the
same conclusion because nothing in that agreement evidences that
the royalty is paid for marketing rights as opposed to comprising
part of the price actually paid or payable.
Although Customs believes that those payments constitute
part of the price actually paid or payable, such payments could
otherwise be considered dutiable as statutory additions to the
price actually paid or payable.
In both HRLs 544129 and 544061, cited by counsel and
described above, one of the major factors for determining whether
the royalty was not dutiable under section 402(b)(1)(D) was
whether the royalty payments were calculated on the basis of
sales that occurred subsequent to the importation of the
merchandise. Neither ruling addressed the applicability of
section 402(b)(1)(E). Customs, however, has since concluded that
the method of calculating the royalty -- e.g., on the resale
price of the goods -- is not relevant to determining the
dutiability of the royalty payment. See, General Notice on the
Dutiability of "Royalty" Payments at page 12 (Vol. 27 Cust. Bull.
No. 6 dated February 10, 1993).
In HRL 544436 (C.S.D. 91-6; Vol. 25 Cust. Bull. No. 18 dated
February 4, 1991), commonly known as the "Hasbro ruling", the
importer was required to pay a percentage of the "resale price"
to the seller, for the imported merchandise, in addition to the
price originally paid. The importer had been paying duties on
these additional payments as "royalties" under section
402(b)(1)(D). Customs held that the payments were not dutiable
under this royalty provision, but were "proceeds of subsequent
resales" of the imported merchandise that accrued to the seller
and, accordingly were dutiable under section 402(b)(1)(E).
Customs subsequently reviewed Hasbro, soliciting public
comment thereon, and published the General Notice on the
Dutiability of "Royalty" Payments, referred to above and commonly
known as the "Hasbro II" decision, which incorporated Customs'
analysis of the comments received. Hasbro II upheld the Hasbro
ruling and modified it to the extent the subject payments were
found to be dutiable as either royalties under section
402(b)(1)(D) or as proceeds under section 402(b)(1)(E). In
Hasbro II Customs set forth a three-part analysis designed to
provide importers and Customs with a uniform approach to
determining whether certain payments constitute dutiable
royalties. The three-part analysis takes the form of the
following questions:
(1) Is the imported merchandise manufactured
under patent?
(2) Is the royalty involved in the production
or sale of the imported merchandise?
(3) Can the importer buy the product without
paying the fee?
Upon further review of the facts in Hasbro, Customs noted in
Hasbro II that it was unclear whether the imported merchandise
was manufactured under patent, although the importer was granted
the right to use any patents that existed on the products in the
territorial area designated. Customs found that the royalty was
involved in the sale of the imported merchandise and based this
finding on the fact that the individual sales agreements or
purchase contracts were subject to the terms and conditions of
the royalty agreement. Additionally, the royalty was to be paid
on each imported item that was purchased by the seller. Citing
to Congress' statement in the SAA that "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" (emphasis added), Customs
observed that the facts in the case failed to establish that the
payments were not a condition of the sale. Customs, accordingly,
ruled that the royalty payments could have been considered to be
dutiable under section 402(b)(1)(D).
As in the Hasbro rulings, in the instant case it is unclear
whether the imported merchandise is manufactured under patent.
Second, it does appear that the royalty (the term used by the
parties in both agreements) was involved in the sale of the
imported merchandise. This conclusion stems from the fact that
the Option and the License Agreements evidence the parties'
agreement to the payment of the royalty as part of the payment
for sales of the product from Schering to Berlex, as discussed
more thoroughly above. Also like the facts in the Hasbro
rulings, it further appears that the royalty is to be paid on
each imported item that is purchased and resold by Berlex in the
United States. We must therefore conclude that the facts in this
case clearly establish that the royalty payments are a condition
of sale of the imported merchandise. Under these circumstances,
the royalty payments are dutiable under section 402(b)(1)(D).
The next question is whether the payments constitute
proceeds of subsequent resale, disposal or use, pursuant to
section 402(b)(1)(E). Customs finds that the payments could also
be dutiable as proceeds of a subsequent resale that accrue
directly to the seller. Regarding proceeds, the SAA provides the
following:
Additions for the value of any part of the proceeds of any
subsequent resale, disposal or use of the imported
merchandise that accrue 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.
Statement of Administrative Action, H.R. Doc No. 153, 96 Cong.,
1st Sess., pt 2, reprinted in, Department of Treasury, Customs
Valuation under the Trade Agreements Act of 1979 (October 1981),
at 49.
The instant case involves the type of situation described by
Congress where "certain elements called 'royalties' may fall
within the scope of the language under either new section
402(b)(1)(D) or 402(b)(1)(E) or both." (emphasis added) See, The
General Notice on the Dutiability of "Royalty" Payments, quoting
from H.R. Rep. No 317, 96th Cong., 1st Sess. (1979), at 80 and S.
Rep. No. 249, 96th Cong., 1st Sess. (1979), at 120.
As in Hasbro, the importer's obligation to pay the seller
accrues upon the sale of the imported products. The amount of
the royalty payments is based on the resale price of the imported
merchandise (xxx percent of the "net sales" in the United
States), plus an amount for the initial supply price. The income
produced from the subsequent resale of the Magnevist accrues
directly to the seller and should be added to the price actually
paid or payable for the Magnevist, in accordance with section
402(b)(1)(E). Thus, the payments from Berlex to Schering
constitute proceeds of the subsequent resale of the imported
merchandise and are dutiable.
HOLDING:
The royalty payments made by Berlex to Schering constitute a
dutiable part of the price actually paid or payable for the
merchandise. Additionally, the royalties could be considered
dutiable as either royalties under section 402(b)(1)(D) or
proceeds of a subsequent resale under section 402(b)(1)(D).
Sincerely,
John Durant, Director
Commercial Rulings Division