VAL CO:R:C:V 545307 CRS
Kathleen M. Murphy, Esq.
Katten Muchin & Zavis
525 West Monroe Street
Chicago, IL 60661-3693
RE: Royalties; proceeds; additions to the price actually paid or payable; transaction value;
pharmaceutical product manufactured under license; C.S.D. 92-12; HRL 545114
Dear Ms. Murphy:
This is in reply to your letter dated May 7, 1993, on behalf of [**************], in which
you requested a ruling on the valuation of a chemical product used in the manufacture of a finished
pharmaceutical preparation. Further submissions were made in letters dated January 21, 1994,
August 15, 1994, September 6, 1994, and October 7, 1994. In addition, this matter was discussed
at a meeting with members of my staff on August 8, 1994. Pursuant to your request, the proprietary
information submitted with the request will be treated as confidential; however, the royalty agreement
enclosed with your letter will be retained in our files. The bracketed portion of this ruling will be
deleted from any published version. We regret the delay in responding.
FACTS:
In 1980, [****] entered into a license agreement (the "agreement") with the U.S. subsidiary
of a foreign corporation. Under the terms of the agreement [****] was granted a license to use
certain knowledge, including scientific and technical information, owned by the subsidiary or its
parent, in connection with the manufacture and sale by [****], in the U.S., of a finished
pharmaceutical product. In exchange for this right, [****] agreed to pay a royalty based on a
percentage of the net sales of the finished pharmaceutical product. Subsequently, a transfer of rights
was effected, as the result of which, the agreement is now between [****] and the foreign parent (the
"licensor").
In addition, [****] (hereafter the "buyer") purchases and imports a chemical, from the
licensor, that forms the active ingredient of the finished pharmaceutical product. The imported
merchandise is combined in the U.S. with other materials, [*******************************]
in order to produce the finished pharmaceutical product. Although the active ingredient was
patented, the patent has now expired. As the result of the production process undertaken in the U.S.,
the imported merchandise undergoes a chemical reaction that leads to the formation of a new
chemical complex. Furthermore, the imported merchandise acquires a new property, that of
"sustained release."
You contend that the payments to the licensor are dutiable neither as royalties nor as
proceeds. In regard to the first point, i.e., whether the payments are dutiable as an addition to the
price actually paid or payable under the royalties provision, you maintain that the payments are not
a condition of sale of the imported merchandise. In regard to the question of whether the payments
should be considered proceeds, it is your position that the payment is not related to the active
ingredient and, consequently, not dutiable as an addition to the price actually paid or payable.
ISSUE:
The issue presented is whether payments by the buyer to the licensor/seller are part of the
price actually paid or payable for the imported merchandise.
LAW AND ANALYSIS:
Merchandise imported into the United States is appraised in accordance with section 402 of
the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a; TAA).
The preferred method of appraisement under the TAA is transaction value, defined as "the price
actually paid or payable for the merchandise when sold for exportation to the United States," plus
certain enumerated additions, including any royalty or license fees related to the imported
merchandise that the buyer is required to pay as a condition of the sale for export to the U.S., and the
proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue to the
buyer. 19 U.S.C. 1401a(b)(1)(D)-(E). For the purposes of this ruling we have assumed that
transaction value is the appropriate method of appraisement; however, we note that no information
has been presented to establish the acceptability of transaction value.
Under its agreement with the licensor, the buyer has the right to use certain knowledge in
order to manufacture and sell the pharmaceutical product in the U.S. The active ingredient used in
the product is purchased from the licensor's parent. In exchange for its rights under the agreement,
the buyer pays a royalty based on a percentage of the net sales of the product in the U.S. You
contend that the payments are dutiable neither as royalties nor as proceeds.
Pursuant to the notice on the dutiability of royalty payments, published in the Customs
Bulletin on February 10, 1993, several questions must be answered in order to determine whether a
royalty payment is related to imported merchandise and thus required as a condition of sale. As set
forth in the notice the questions are: (1) was the imported merchandise manufactured under the
patent? (2) was the royalty involved in the production or sale of the imported merchandise? and (3)
could the importer buy the product without paying the fee? 27:6 Cust. B. & Dec. 1 at 9-11.
Negative responses to the first and second questions, and an affirmative response to the third, suggest
that a royalty payment is non-dutiable under section 402(b)(1)(D) of the TAA.
Based on the information submitted, the imported merchandise was not manufactured under
patent. Similarly, the royalty paid by the buyer was not involved in the production or sale of the
imported merchandise. The agreement defines the licensed technology as being all information in the
possession of the licensor pertaining to the manufacture, handling, storage, testing and formulation
of any finished pharmaceutical preparation containing the active ingredient. Here the royalty is paid
for the right to use technical knowledge to make, use and sell finished pharmaceutical products
containing the imported active ingredient. In regard to the third question, it is our position that the
buyer can purchase the active ingredient without paying the royalty fee. The royalty is only triggered
by sales of the finished product, and not by sales of the active ingredient. The agreement also
provides that the buyer can manufacture the active ingredient if the licensor is unable or unwilling to
sell it. In view of the above, we conclude that the royalty payments at issue are not a condition of
sale of the imported merchandise and therefore do not constitute an addition to the price actually paid
or payable under section 402(b)(1)(D). Nevertheless, they still may be added to the price actually
paid or payable under the proceeds provision of section 402(b)(1)(E) of the TAA. 27:6 Cust. B. &
Dec. 1 at 6-7.
Section 402(b)(1)(E) provides that "the proceeds of any subsequent resale, disposal or use
of the imported merchandise that accrue, directly or indirectly, to the seller," are to be added to the
price actually paid or payable. 19 U.S.C. 1401a(b)(1)(E). You contend that the instant royalty
payments are not dutiable as proceeds since the royalty is not paid on the imported merchandise but
on the sale of the pharmaceutical product which includes elements other than the bulk chemical that
comprises the active ingredient. In addition, you argue that the royalty is paid on sales of the finished
product regardless of whether the active ingredient is imported or manufactured by the buyer.
In C.S.D. 92-12 (Headquarters Ruling Letter (HRL) 544656 dated June 19, 1991), royalties
were paid on the invoice sales price of machines made from both imported and domestic components.
There we stated in regard to dutiability under the proceeds provision:
[T]he payments are not based on the resale of the imported product. Rather, the
payments are based on the resale of a finished product that includes U.S. components.
Thus, a substantial portion of the payments is based on components that were not
imported. As a result, we hold that payments...are not dutiable under section
402(b)(1)(E) of the TAA.
The determination of whether an addition is made is decided on a case-by-case basis depending on
the facts of each individual transaction. 19 C.F.R. 152.103(g). However, if there is insufficient
information with respect to the amount of any proceeds, the transaction value of the imported
merchandise will be treated as one that cannot be determined. 19 U.S.C. 1401a(b)(1).
Section 402(b)(1) of the TAA provides that the addition for the proceeds of a subsequent
resale, disposal or use should be based on the imported merchandise; but the addition does not
include proceeds attributable to domestic components or ingredients. In this respect the Statement
of Administrative Action provides:
As noted previously, additions will be made only when there is information
sufficient to establish the accuracy of the additions. If such information is not
available, the transaction value cannot be determined. (Statute) As an example of
this, a royalty is paid on the basis of the price in a sale in the United States of a gallon
of a particular product that was imported by the pound and transformed into a
solution after importation. If the royalty is based partially on the imported
merchandise and partially on other factors which have nothing to do with the
imported merchandise (such as when the imported merchandise is mixed with
domestic ingredients and is no longer separately identifiable, or when the royalty
cannot be distinguished from special financial arrangements between the buyer and the
seller), it would be inappropriate to attempt to make an addition for the royalty.
Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in
Customs Valuation under the Trade Agreements Act of 1979, Department of the Treasury, U.S.
Customs Service (October 1981), at 49-550. HRL 544656 at 7.
C.S.D. 93-26 (Headquarters Ruling Letter (HRL) 545114 dated September 30, 1993), also
concerned an imported chemical used in connection with the manufacture under license in the U.S.
of a pharmaceutical product. Royalty payments were made by the importer for the right to use a
patented process and know-how necessary to manufacture the finished product, and were based on
the resale of the finished product. In holding that the payments were not dutiable as proceeds under
section 402(b)(1)(E) of the TAA we observed that the manufacturing involved more than simple
mixing and finishing. Moreover, once the finished product was produced, it was no longer possible
to isolate the imported merchandise.
You state that the instant case is similar to the situation in C.S.D. 93-26. In support of this
contention you have submitted information demonstrating that when combined with domestic
materials, the imported merchandise undergoes a chemical reaction that results in the formation of
a new chemical complex. In addition, you state that the imported merchandise undergoes a physical
reaction as the result of which a new property, that of "sustained release," is imparted to the finished
product. Furthermore, you enumerate certain advantages conferred on the finished pharmaceutical
product through the acquisition of the property of sustained release that distinguish it from the
imported merchandise. Thus you argue that the processing undertaken in the U.S., as in C.S.D. 93-26, constitutes much more than simple mixing and finishing, that a new product is created, and that
the finished product upon which the royalty payment is based is substantially different from the
imported merchandise.
Finally, as in C.S.D. 92-12, the amount of the payment is calculated with respect to the resale
of a finished product that includes U.S. components. Consequently, the royalty payment is based in
part on materials that were not imported. Since the payment is based partially on the imported
merchandise, and partially on other factors, viz., mixing the imported merchandise with U.S.
ingredients such that the former is no longer separately identifiable, we find that the payment at issue
does not constitute an addition to the price actually paid or payable under section 402(b)(1)(E) of the
TAA.
HOLDING:
Pursuant to the foregoing, the payments made by the buyer for the right to use know-how in
the manufacture and sale of a finished pharmaceutical product containing the imported active
ingredient do not constitute an addition to the price actually paid or payable for the imported
merchandise under sections 402(b)(1)(D)-(E) of the TAA.
Sincerely,
John Durant, Director
Commercial Rulings Division