RR:IT:VA 545381 KCC
Port Director
U.S. Customs Service
#1 La Puntilla
San Juan, Puerto Rico 00901
Re: IA; diagnostic kits; pharmaceutical products; transaction
value; price actually paid or payable; related parties;
License and Supply Agreements; indirect payment; related to
imported merchandise; HRL 546038; Generra Sportswear Co.;
Chrysler Corporation; royalties; 402(b)(1)(D); General
Notice, Dutiability of Royalty Payments; SAA; HRLs 544129,
544061, 545361; 542844, 545998 and 544991; proceeds of any
subsequent resale, disposal or use; 402(b)(1)(E)
Dear Port Director:
This is in response to your memorandum (APP-6-08-DD:CO:IA
CT452) dated June 24, 1993, which forwarded an internal advice
request initiated by Boehringer Mannheim America, Ltd., Puerto
Rico Branch, now known as Corange International, Limited, Puerto
Rico Branch ("Corange") regarding royalty payments made to
Boehringer Manheim GMBH ("BMG"). We are in receipt of Corange's
submission dated June 10, 1993, and supplemental submissions
dated February 21, 1995, and November 25, 1997. Information
contained in Consumption Entry Audit Report No. 412-93-CEO-001
dated January 17, 1995, and information presented at a meeting on
July 1, 1997, was taken into consideration in reaching this
decision. We regret the delay in responding.
The information furnished in connection with this IA will be
treated as confidential pursuant to 177.2(b)(7), Customs
Regulations (19 CFR 177.2(b)(7)), and 5 U.S.C. 552, as set
forth in a letter to Counsel dated December 12, 1997.
FACTS:
The subject issues arose in the context of an audit of the
importer, Corange, which is a branch office of Boehringer
Mannheim America, Ltd. ("BMAL"), a Bermuda corporation. BMAL is
legally domiciled in Bermuda. As an exempt company, BMAL is
authorized to operate anywhere in the world except Bermuda.
Corange manufactures rapid diagnostic test kits and dipstick kits
("diagnostic kits") for sale to Boehringer Manheim Corporation
("BMC"), a related U.S. company. BMC then sells the diagnostic
kits to unrelated customers. BMAL owns and controls BMC. BMC is
affiliated with BMG. Counsel notes that Corange, BMC, BMAL and
BMG are related companies pursuant to 402(g)(1) of the TAA.
Imported materials, as described below, used in the manufacture
of the diagnostic kits are purchased by Corange from BMG, BMC and
other unrelated suppliers.
The diagnostic kits are used by patients, by medical
personnel in doctor's offices, and by technicians in medical
laboratories, for the detection of various substances in the
blood or urine. A diagnostic kit contains a packaged vial of
dipsticks with instructions, color code label and may include a
barcode calibration slip.
In its submissions, Corange describes the processing
involved in manufacturing the diagnostic kits. Corange receives
rolls of plastic elvax foil, protective foil, logo foil and
reagent foil. The initial step of the manufacturing process
consists of using the rolls of material to permanently bond the
reagent material to a plastic backing and sealing or enmeshing
(depending on the type of kit being made) the reagent material to
protect the integrity of the reagent chemistry. After sealing
and enmeshing, the enmeshed or sealed rolls are cut into
individual dipsticks and the requisite number are placed in a
vial. The vial is then sealed with a stopper assembly. Next,
"bar code" strips are developed which are used to calibrate the
electric meter which reads the diagnostic dipstick during the
test procedure. A separate bar code is developed for each lot of
dipsticks manufactured, in accordance with the exact color
changes produced by that lot of dipsticks. The lot specific bar
codes are based on Corange's testing of each dipstick lot. The
bar code strips are packaged with each vial. The final step is
the labeling and boxing operation for each vial. The labels
contain lot specific color codes which can be used for comparison
purposes, to provide a visual reading of the dipsticks. Pictures
of the 300 meter rolls of reagent material in their condition as
imported by Corange from BMG, samples of reagent material cut
from a imported roll showing the condition of the reagent
material as imported, and samples of the diagnostic kits
manufactured by Corange and sold to BMC were submitted for our
examination.
Prior to 1979, the diagnostic kits were manufactured in
Germany by BMG and sold to BMC. No royalties were paid under
this arrangement. On July 26, 1979, BMG and BMC entered into a
License Agreement covering the manufacture of the diagnostic kits
in the U.S. Under Article 2.1 of the License Agreement, BMG
grants BMC a non-exclusive license ("the license") under BMG's
patent rights, and agrees to make available all technical
information necessary "to make, to have made, use and sell" the
"products" in the U.S. Article 1.1 of the License Agreement
defines "products" as "the diagnostic test kits and rapid
diagnostic dipsticks sold under the label of BM[G] as listed in
the Annex I and II to this Agreement to be amended
from time to time for which BM[G] has granted patent licenses
and/or made available TECHNICAL INFORMATION...."
In consideration of the license granted, BMC agrees to pay a
"license and service fee" ("royalty fee") of a percentage of net
sales of all "products" manufactured by BMC and sold or otherwise
disposed of by BMC. BMC has construed this clause to include all
"products" manufactured for BMC by Corange. BMC pays BMG the
royalty fee on a quarterly basis. In a letter to BMAL dated July
6, 1988, BMG granted BMAL and, thus Corange, a non-exclusive
license to manufacture the "products", as defined in the License
Agreement between BMG and BMC, for sale of such "products" to
BMC. Additionally, Article 3.3 of the License Agreement states
that BMC agrees not to sell the "products" unless having received
quality control (QC)-release by BMG QC-laboratory.
Pursuant to Corange's June 10, 1993 submission, it
manufactures 30 types of diagnostic kits out of the 139 products
covered by the License Agreement, listed in Annex I to the
License Agreement. The remainder are manufactured by BMC in
Indiana. Corange notes in its November 27, 1997 submission that
the individual products are constantly improving. Thus, changes
are regularly made in the types and numbers of diagnostic kits
manufactured for sale by BMC. However, Corange notes that these
changes are monitored and the License Agreement is regularly
modified. Corange submitted the July 3, 1996 amendment to the
License Agreement, a revised Annex I. Corange notes that a
comparison of the product numbers on the 1996 Annex I with the
product numbers on the 1979 Annex I shows that none of the
products covered by the 1979 License Agreement remain on the 1996
License Agreement.
Additionally, Corange states that since the submission of
the internal advice request, a new family of diagnostic kits is
being manufactured in the U.S. for BMC. These new diagnostic
kits, which contain a greater percentage of imported components
than the diagnostic kits subject to the 1979 License Agreement,
are based upon the use of technology wholly developed in the U.S.
Therefore, they are neither subject to the 1979 License Agreement
between BMC and BMG, nor are they subject of any royalty
payments. Corange states that if the royalty paid by BMC was for
imported component materials from BMG, then the diagnostic kits
should not only be subject to a royalty, but should carry a
higher royalty than the diagnostic kits which have fewer imported
components.
The materials used by Corange in manufacturing the
diagnostic kits are supplied by both foreign and domestic
companies, of which BMG and BMC are the only related suppliers.
BMG primarily supplies reagent materials. However, BMG has
supplied elvax foil, protective foil, aluminum bags and glue to
Corange. The remaining supplies are from the U.S., Germany and
Belgium. Corange also purchases reagent material, which is
manufactured in Indiana using BMG's technical information, from
BMC. Corange states that BMC is free to have the licensed
products completely manufactured in the U.S. from materials and
components which are wholly of U.S. origin and the identity of
the suppliers of materials used by Corange has no effect on BMC's
obligation to pay the royalties.
A Supply Agreement, dated July 26, 1979 between BMC and BMG
requires that BMG supply all of BMC's commercial requirements of
the listed bulk material for specified products manufactured by
BMC. Article 3 of the Supply Agreement, specifically reads:
Supply. In order to enable BMC a continuous
manufacture of FINAL PRODUCTS of a constant quality
BM[G] shall, subject to the terms and conditions set
forth herein, supply all of BMC's commercial
requirements of BULK MATERIALS, in as far as this
concerns products made by BM[G], and BMC shall purchase
such BULK MATERIAL from BM[G].
There is no separate Supply Agreement between BMG and Corange.
However, as stated above, one of Corange's supplier is BMC.
Article 4 of the Supply Agreement states that to facilitate BMG's
planning or production, BMC shall submit to BMG, four months
prior to the beginning of each calendar year, "an annual estimate
of BMC's requirements of the BULK MATERIAL."
Final Products is defined in Article 1.1 of the Supply
Agreement as "..any and all test kits or regent systems and rapid
diagnostic dipsticks manufactured by BMC o the basis of BULK
MATERIAL." Bulk Materials is defined in Article 1.2 of the
Supply Agreement as "[t]he products as specified in the Annexes
to this Agreement." Annex I of the Supply Agreement lists
twenty-five components. Corange states that it has never
purchased any of the twenty-five components in Annex I.
Additionally, Corange states that most of those components are no
longer used by BMC.
Annex II of the Supply Agreement covers "[r]olls, tubes,
stoppers and labels for the manufacture of..." ten Chemstrip
products which are identified by identification number and
product name. Corange states that none of the identification
numbers listed in Annex II of the Supply Agreement currently
corresponds to a product manufactured by Corange, and only three
of the ten named Chemstrip products are still manufactured by
Corange, although under different identification numbers which
reflect an improved version. Corange states that unlike the
License Agreement, the Supply Agreement was never amended. Thus,
Corange contends that the Supply Agreement is effectively
obsolete; it does not cover component materials used in any
products currently made by Corange or component materials of any
of the products which are currently subject to the License
Agreement.
Moreover, Corange states that the products listed in Annex
II of the Supply Agreement, i.e., rolls, tubes, stoppers and
labels for the manufacture of ten Chemstrip products, which were
to be purchased from BMG are actually purchased from other
unrelated German companies. Corange states that the only
component material purchased from BMG are "rolls" of reagent
material, none of which are mentioned in the Supply Agreement.
Article 9 of the Supply Agreement indicates that the
agreement "shall be valid as long as BMC manufactures FINAL
PRODUCTS." Corange states that none of the "final products"
specified by identification number in Annexes I and II of the
Supply Agreement are still manufactured by BMC. Corange contends
that since these Annexes have never been updated by amending the
Supply Agreement, the Supply Agreement is said to have expired by
its own terms. Corange states that the Supply Agreement was
effectively obsolete no later that January 1, 1993. As evidence
of the expiration of the Supply Agreement, Corange submitted a
letter from the Corporate General Counsel of BMG, Dr. Bernhard
Jurisch. Dr. Jurisch negotiated, drafted and signed both the
License Agreement and Supply Agreement on behalf of BMG. Dr.
Jurisch stated that the License Agreement "was designed to
facilitate the orderly and gradual transfer of certain
manufacturing operations from Germany to the United States....
The Supply Agreement also served to facilitate production
planning by BMG because it committed BMC to providing estimates
of its needs and submitting orders in advance."
Additionally, Dr. Jurisch described the relationship between
the License Agreement and the Supply Agreement as follows:
It was never the intention of BMG to create, by this
[Supply] Agreement, a captive market for certain
materials manufactured by BMG. On the contrary, the
practice between the two companies has been to shift
the sourcing of materials to BMC or to other companies,
without penalty, as BMC has gained manufacturing
experience. This course of conduct has, over the
years, made the original 1979 Supply Agreement an
obsolete document that has never been amended or
updated to reflect the current practice of the two
companies with regard to component sourcing.
Additionally, Dr. Jurisch addressed the royalty issue stating:
The royalty paid under the License Agreement is for the
technology transferred by BMG to BMC which is necessary
to make, use and cell [sic] certain products in the
United States. The royalty is not dependent upon or
otherwise related to BMC's use of any imported
components whether obtained from BMG or elsewhere. The
royalty is never mentioned or reference in the 1979
Supply Agreement, because BMG is entitled to its
royalty payments on certain finished products
manufactured and sold in the United States, regardless
of where or from whom the components are sourced.
You submitted this internal advice request for a
determination regarding the dutiable status of the subject
royalty fees in light of Headquarters Ruling Letter ("HRL")
544436 (C.S.D. 91-6) dated February 4, 1991, and General Notice,
Dutiability of Royalty Payments, 27 Cust. Bull. 12 (February 10,
1993), which is effective for all entries made after May 11,
1993. As of this date the entries at issue are those made after
May 11, 1993. You inquire as to the royalty fees paid with
respect to merchandise imported by BMC from BMG, by Corange from
BMG and any other BMAL related company having the same type of
royalty contract with BMG. The Audit report concludes that the
royalty fees may be included in the transaction value of the
imported merchandise. There is a particular concern raised in
the audit report that the terms of the licensing agreement
remained the same despite changing relationships between BMC and
Corange in corporate reorganizations.
Corange takes the position that the royalty fee paid by BMC
to BMG is not included in the appraised value of materials
imported by Corange because 1) the royalty fees are not related
to the imported merchandise, 2) the buyer of the imported
merchandise is not required to pay the royalty fees, either
directly or indirectly, 3) the royalty fees are not a condition
of the sale of the imported merchandise for exportation to the
U.S. and 4) the royalty fees do not represent the proceeds of any
subsequent resale, disposal or use of the imported merchandise.
ISSUE:
1. Whether the royalty fees paid by the BMC to BMG are part of
the price actually paid or payable for the merchandise imported
by Corange, BMC or any other BMAL related company.
2. Whether the royalty fees paid by the BMC to BMG are included
in the transaction value of the merchandise imported by Corange,
BMC or any other BMAL related company having the same type of
royalty contract with BMG under 402(b)(1)(D) of the TAA.
3. Whether the royalty fees made by the BMC to BMG are included
in the transaction value of the merchandise imported by Corange,
BMC or any other BMAL related company having the same type of
royalty contract with BMG, as proceeds of subsequent resale,
disposal or use under 402(b)(1)(E) of the TAA
LAW AND ANALYSIS:
Transaction value is the preferred method of appraisement.
Transaction value is defined in 402(b), Tariff Act of 1930, as
amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a(b);
TAA), as the "price actually paid or payable for the merchandise
when sold for exportation to the United States." 402(b)(1) of
the TAA provides 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.
Imported merchandise is appraised under transaction value
only if the buyer(s) and seller are not related, or if related,
the transaction value is deemed to be acceptable. In this
situation, Corange, BMC, BMAL and BMG are related pursuant to
402(g)(1) of the TAA. 402(b)(2)(B) of the TAA provides that
transaction value between related parties is acceptable only if
an examination of the circumstances of the sale indicates that
the relationship between the parties does not influence the price
actually paid or payable, or the transaction value of imported
merchandise closely approximates the transaction value of
identical or similar merchandise in sales to unrelated buyers in
the U.S. or the deductive or computed value for identical or
similar merchandise. This ruling does not address the
acceptability of transaction value. We assume for purposes of
this ruling that transaction value is the proper method of
appraisement for the imported merchandise.
1. Price Actually Paid or Payable
The "price actually paid or payable" is defined in
402(b)(4)(A) of the TAA as the "total payment (whether direct or
indirect, and exclusive of any costs, charges, or expenses
incurred for transportation, insurance, and related services
incident to the international shipment of the merchandise...)
made, or to be made for the imported merchandise by the buyer to,
or for the benefit of, the seller."
There is a rebuttable presumption that all payments made by
the buyer(s) to the seller, or party related to the seller, are
part of the price actually paid or payable. See, HRL 545663
dated July 14, 1995. This position is based on the meaning of
the term "price actually paid or payable" as addressed in Generra
Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990).
In Generra, the court considered whether quota charges paid to
the seller on behalf of the buyer were part of the price actually
paid or payable for the imported goods. In reversing the
decision of the lower court, the appellate court held that the
term "total payment" is all-inclusive and that "as long as the
quota payment was made to the seller in exchange for merchandise
sold for export to the United States, the payment properly may be
included in transaction value, even if the payment represents
something other than the per se value of the goods." The court
also explained that it did not intend that Customs engage in
extensive fact-finding to determine whether separate charges, all
resulting in payments to the seller in connection with the
purchase of imported merchandise, were for the merchandise or
something else.
Additionally, we note that in Chrysler Corporation v. United
States, CIT Slip Op. 93-186 (September 22, 1993), the Court of
International Trade applied the Generra standard and determined
that although tooling expenses incurred for the production of the
merchandise were part of the price actually paid or payable for
the imported merchandise, certain shortfall and special
application fees which the buyer paid to the seller were not a
component of the price actually paid or payable. With regard to
the latter fees, the court found that the evidence established
that the fees were independent and unrelated costs assessed
because the buyer failed to purchase other products from the
seller and not a component of the price of the imported engines.
Therefore, this presumption may be rebutted by evidence which
clearly establishes that the payments, like those in Chrysler,
are completely unrelated to the imported merchandise.
In this case, the party to whom the royalties are paid is
the seller/licensor. A buyer of the materials, Corange, is not
the party directly paying the royalty fee. BMC, a related
company, pays the royalty fee. However, it is our position that
the parties' relationships creates a situation where Corange is
indirectly paying the royalty fee through BMC to BMG. As stated
in its request for internal advice, Corange is related to BMC.
Corange is a branch office of BMAL which owns and controls BMC.
As previously stated, BMAL is legally domiciled in Bermuda,
however, it is an exempt company which is authorized to operate
anywhere in the world except Bermuda. Thus, BMAL, with its
operating branch Corange, indirectly pays the royalties through
its subsidiary BMC.
Although the License Agreement between BMC and BMG and the
non-exclusive License Agreement between BMG and BMAL-Corange
rights are separate and distinct from one another, we find that
the License Agreements are closely tied together. In the July 6,
1988 letter to BMAL, BMG grants a "non-exclusive license as of
January 1, 1988 to manufacture Products, as that term is defined
in the non-exclusive License Agreement dated September 19, 1979
by and between" BMG and BMC. Thus, all the parties, BMG, BMC,
BMAL-Corange are fully aware of the terms and conditions of the
original License Agreement.
Thus, the royalty fees paid by BMC to BMG, the
seller/licensor, are presumed to be part of the price actually
paid or payable for the merchandise imported by Corange and BMC.
Now, the importers must establish that the royalty fees are
completely unrelated to the imported merchandise. Counsel
maintains that these payments are not part of the price actually
paid or payable because they are made irrespective of the
imported product. Counsel states that the royalty fees are not
"for the imported merchandise", but rather, are for the right to
"to make, to have made, use and sell" the diagnostic kits in the
U.S. with the use of the BMG's technical information related to
the domestic manufacturing operation which was transferred to BMC
and Corange.
We agree with Counsel that the royalty fees are not related
to the imported merchandise. The royalty fees paid BMC are for
the right to make, use and sell the diagnostic kits in the U.S.
with the use of technical information made available by BMG to
BMC and Corange. The technical information transferred under the
License Agreement relates to the manufacture, quality control and
marketing of the diagnostic kits in the U.S., not to the
manufacture or production of any of the imported components. As
evidence, Corange refers to the new family of diagnostic kits
manufactured in the U.S. for BMC. These new diagnostic kits,
which contain a greater percentage of imported components than
the diagnostic kits subject to the 1979 License Agreement, are
based upon the use of technology wholly developed in the U.S.
Therefore, they are neither subject to the 1979 License Agreement
between BMC and BMG, nor are they subject of any royalty
payments. Corange states that if the royalty fees paid by BMC
were for imported component materials from BMG, then the
diagnostic kits should not only be subject to a royalty, but
should carry a higher royalty than the diagnostic kits which have
fewer imported components.
We note that on the same day that BMC signed the License
Agreement to acquire the manufacturing capabilities, it also
signed the Supply Agreement which obligated BMC to purchase all
of its requirements of bulk material from BMG as defined in the
Supply Agreement. Thus, the question arises whether the License
Agreement and the Supply Agreement are inextricably intertwined
such that BMC paid for the capabilities to manufacture the
diagnostic kits and at the same time that it became obligated to
purchase bulk material to manufacture the diagnostic kits.
In HRL 546038 dated July 19, 1996, we found that royalty
payments made to gain U.S. trademark rights, patent rights, and
manufacturing capabilities for a pharmaceutical product were part
of the price actually paid or payable and were also considered an
addition to the price actually paid or payable as a royalty
pursuant to 402(b)(1)(D) of the TAA. In this situation, on the
same day the unrelated parties entered into the royalty
agreement, they signed a supply agreement which obligated the
licensee/buyer to purchase all of its requirements of the royalty
product from licensor/seller. Thus, we held that the royalty and
supply agreements were inextricably intertwined such that the
licensee/buyer paid for the capability to manufacture the product
at the same time that it forfeited that right by entering into
the supply agreement.
It is our position that in the instant case, even though the
License Agreement and the Supply Agreement were signed on the
same day, the two agreements are not inextricably intertwined
such that the royalty fees are related to the imported
merchandise. In HRL 546038 the supply agreement obligated the
licensee/buyer to purchase all of its requirements of the royalty
product from licensor/seller. In this case, Article 3 of the
Supply Agreement states that BMG agrees to supply BMC "[i]n order
to enable BMC a continuous manufacture of FINAL PRODUCTS of
constant quality...." Final Products is defined in Article 1.1
of the Supply Agreement as "..any and all test kits or regent
systems and rapid diagnostic dipsticks manufactured by BMC on the
basis of BULK MATERIAL." Bulk Material is defined in Article 1.2
of the Supply Agreement as "the products as specified in the
Annexes to this Agreement. Thus, BMC was not obligated to
purchase the royalty product, but some components used to
manufacture the royalty products as listed in the Annexes to the
Supply Agreement.
Additionally, there is no language in either agreement which
links the License Agreement and the Supply Agreement together.
Moreover, Corange has submitted compelling evidence that the
Supply Agreement is effectively obsolete as it no longer reflects
the actual course of the transactions between BMG and BMC. We
note Dr. Jurisch's statements regarding the License Agreement and
the Supply Agreement which are verified by the BMC and Corange's
manufacturing operations and purchase transactions with BMG and
other unrelated companies. None of the "final products"
specified by identification number in Annex I and II of the
Supply Agreement are still manufactured by BMC and Corange.
Additionally, the only bulk materials purchased by BMC are
reagent rolls. However, none of the rolls listed in Annex II of
the Supply Agreement are currently purchased and imported by BMC
or Corange. Moreover, Corange submitted evidence showing that
the other bulk materials listed in Annex II of the Supply
Agreement, i.e., tubes, stoppers and labels are actually
purchased from other unrelated German companies. Unlike the
License Agreement, the Supply Agreement was never amended. Thus,
we agree with Corange that the Supply Agreement has expired by
its own terms.
Without a connection between the License Agreement and the
Supply Agreement, there is no evidence that the royalty fees are
related to the imported merchandise. Therefore, we conclude that
the royalty fees are not part of the total payment made or to be
made by the buyer(s), directly or indirectly, to the seller for
the imported merchandise.
2. Royalties
With regard to royalties, the Statement of Administrative
Action ("SAA"), adopted by Congress with the passage of the TAA,
provides 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. In this regard, royalties and license fees for
patents covering processes to manufacture the imported
merchandise will generally be dutiable, whereas
royalties and license fees paid to third parties for
use, in the United States, of copyrights and trademarks
related to the imported merchandise, will generally be
considered as selling expenses of the buyer and
therefore, will not be dutiable. However, the dutiable
status of royalties and license fees paid by the buyer
must be determined on case-by-case basis and will
ultimately depend on: (i) whether the buyer was
required to pay them as a condition of sale of the
imported merchandise for exportation to the United
States; and (ii) to whom and under what circumstances
they were paid.
SAA, H.R. Doc. No. 153, Pt II, 96th Cong., 1st Sess. (1979),
reprinted in Department of the Treasury, Customs Valuation under
the Trade Agreements Act of 1979 (October 1981), at 48-49.
After reviewing the language of the statute along with the
legislative history and prior case law, Customs determined that
the following three questions are relevant in determining whether
a royalty is dutiable:
1) Was the imported merchandise manufactured under patent?
2) Was the royalty involved in the production or sale of
the imported merchandise?
3) Could the importer buy the product without paying the
fee?
See, General Notice, Dutiability of Royalty Payments, 27 Cust.
Bull. 12 (1993) (hereinafter referred to as the "General
Notice"). Affirmative responses to factors one and two and a
negative response to factor three would indicate that the
payments were a condition of sale and, therefore, dutiable as
royalty payments.. The General Notice includes a review of HRL
544436 (C.S.D. 91-6) dated February 4, 1991, commonly known as
the "Hasbro ruling." The analysis set forth in the General
Notice is applicable to entries of imported merchandise on or
after May 11, 1993.
Prior to Customs' issuance of the General Notice, a major
factor for determining that royalties were not dutiable under the
"royalties" provision, was that the royalty payments were
calculated on the basis of sales that occurred subsequent to the
importation of the merchandise. See, HRL 544129 dated August 31,
1988; HRL 544061 dated May 27, 1988; and HRL 542844 dated June
17, 1982. However, Customs 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. General Notice, at p.12. Instead, Customs must
now look to the answers to the
above three questions for assistance in determining whether the
royalty fees are related to the merchandise and were a condition
of sale.
Although the SAA provides that determinations about the
dutiability of royalty payments are to be made case-by-case, it
is more likely that the royalty will be dutiable when the
licensor and seller are one and the same and the royalty is paid
directly to the seller. Under these circumstances, payment of
the royalty is more likely to be a condition of the sale for
exportation of the imported merchandise than when the royalty is
paid to an unrelated third party. See, HRL 545361, July 20,
1995, which held that trademark royalties are dutiable when paid
to the seller/licensor but not when paid to a third party
unrelated to the seller.
In this case, the party to whom the royalties are paid is
both the seller and the licensor. According to the SAA, any
royalty or license fee paid to the seller is part of transaction
value unless the importer can establish that it is distinct from
the price actually paid or payable for the imported merchandise
and that such payment was not a condition of the sale of the
imported merchandise for exportation to the United States. In
other words, there is a presumption that royalties paid to the
seller are dutiable unless the importer can show otherwise. See
also, HRL 544991 dated September 13, 1995.
As previously stated, a buyer of the materials, Corange, is
not the party directly paying the royalty fee. However, it is
our position that the parties relationships create a situation
where BMAL, with it operating branch Corange, is indirectly
paying the royalty fee through BMC to BMG. Additionally, it is
our position that the License Agreements are closely tied
together. The rights set forth in the License Agreement between
BMC and BMG and the non-exclusive License Agreement between BMG
and BMAL-Corange are separate and distinct from one another.
However, all the parties involved, BMG, BMC, BMAL-Corange are
fully aware of the terms and conditions of the original License
Agreement. In the July 6, 1988 letter to BMAL, BMG granted a
"non-exclusive license as of January 1st, 1988, to manufacture
Products, as that term is defined in the non-exclusive License
Agreement dated September 19, 1979 by and between" BMG and BMC.
Thus, the royalty fees are paid to the seller directly by BMC or,
by BMAL with its operating branch Corange, indirectly through
BMC.
With respect to the first question, Corange states that most
of the component materials purchased from BMG are not produced
under patent. However, there are some reagent rolls used in the
manufacture of Chemstrip products which are covered by unexpired
process patents. Although the imported merchandise was
manufactured under patent, the License Agreement at issue does
not cover the patented imported products. The License Agreement
provides for the technical information necessary "to make, to
have made, use and sell" the "products" in the U.S. Article 2.1
of the License Agreement. The "products" are defined in Article
1.1 of the License Agreement as "the diagnostic test kits and
rapid diagnostic dipsticks sold under the label of BM[G] as
listed in the Annex I and II to this Agreement...." The patented
imported products are not listed in the Annexes and are,
therefore, not covered by the License Agreement. Cf. HRL 545998
dated November 13, 1996, which held that, based on the License
Agreement, the royalties were paid in part for the patent
concerning the composition of the imported pharmaceutical
product.
Second, we find that the royalty fees are not involved in
the production or sale for exportation of the imported products,
whether imported by Corange or BMC. BMG, the seller of the
imported products and licensor, agrees to make available to BMC
and the related Corange all technical information necessary "to
make, to have made, use and sell" the licensed diagnostic kits
in the U.S. Corange manufactures the diagnostic kits pursuant to
a non-exclusive license, as defined in the License Agreement
between BMG and BMC, for sale of such products to BMC. Thus,
Corange's manufacturing rights are linked to the License
Agreement between BMG and BMC. In consideration, BMC agrees to
pay a royalty fee based on the percentage of net sales of all
products manufactured by BMC and sold or otherwise disposed of by
BMC. BMC has construed this to include all products manufactured
for BMC by Corange. The rights granted BMC under the License
Agreement are for the manufacture, use and sale of the completed
diagnostic kits, not the materials imported by BMC or Corange.
In HRL 544991 dated September 13, 1995, royalty payments
were paid in consideration of licensed technology and technical
assistance provided by the parent, seller/licensor, to the
importer/buyer. The imported merchandise (parts) from the
licensor/seller was used to manufacture a finished product
(machines) and the royalties were based on the selling price of
the finished product. In that case, an agreement between the
seller/licensor and the importer/buyer effectively linked the
payment of the royalties to the purchase of the imported parts.
Consequently, it was determined that as the importer/buyer could
not buy the imported merchandise without paying the fee, the
royalties were a condition of sale and, therefore, a proper
addition to the price actually paid or payable of the imported
merchandise under 402(b)(1(D) of the TAA. See also, HRL 546038
dated July 19, 1996, supra.
It is our position that the above rulings are
distinguishable from the present factual situation. As stated
previously, unlike HRL 546038, BMC was not obligated to purchase
the royalty product, but some components used to manufacture the
royalty products as listed in the Annexes to the Supply
Agreement. Additionally, unlike HRL 546038 and HRL 544991, we
find that the License Agreement and Supply Agreement are not
inextricably intertwined. As previously discussed, even though
they were signed on the same day, Corange has submitted
compelling evidence that the Supply Agreement is effectively
obsolete as it no longer reflects the actual course of the
transactions between BMG and BMC. See, Supra at 1 The Price
Actually Paid or Payable. Thus, we agree with Corange that the
Supply Agreement has expired by its own terms.
Without a connection between the License Agreement and the
Supply Agreement, our analysis focuses on the License Agreement
and whether the royalty fees are involved in the production or
sale for exportation of the imported products. It is our opinion
that the royalty fees are not closely related to the imported
merchandise, whether imported by BMC or Corange. The royalty
fees are paid for BMG's technical information necessary to make,
to have made, use and sell the diagnostic kits in the U.S. Thus,
we find that the royalty fees do not pertain to the production or
sale for exportation of the imported merchandise by either
Corange or BMC.
With regard to the third question, i.e., could the importer
buy the materials without paying the royalty fee, Customs
acknowledged that the answer goes to the heart of whether a
payment is considered a condition of sale. Both BMC and Corange
may import the materials from BMG without paying the royalty fee.
Corange represents that BMC's obligation to pay the royalty fee
is not relieved by BMC's or Corange's purchase of materials from
sources other than BMG. BMC must pay the royalty fee based on
the resale price of the finished diagnostic kits regardless of
where the component materials are sourced. As discussed above,
Corange submitted evidence showing that there is no obligation to
purchase bulk materials from the seller/licensor, BMG. Thus, it
is our position that the BMC and Corange could purchase the
imported bulk materials without paying the royalty fee.
Based on the above considerations, we find that the royalty
fees are not considered royalties pursuant to 402(b)(1)(D) of
the TAA. The royalty fees, made in connection with BMC's and
Corange's manufacture of the products in the U.S., are not
related to the imported merchandise.
3. Proceeds of Subsequent Resale
The next issue is whether the royalty fees constitute
proceeds of subsequent resale, disposal or use, pursuant to
402(b)(1)(E) of the TAA. The SAA addresses the dutiability of
proceeds of subsequent resale as follows:
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.
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)(2)(E) or both." See, The General Notice
on the Dutiability of "Royalty" Payments. The SAA states that
the payments must only accrue directly or indirectly to the
seller. See also, Generra Sportswear Co. v. United States, 8
CAFC 132, 905 F.2d 377 (1990).
There is no dispute that the royalty fees become due upon
BMC's sale of the finished diagnostic kits. The amount of the
royalty payments is based on the "Net-Sales" which is defined as
the amount billed for sales of products to final users or
wholesalers and/or distributors of labeled products. See,
Article 1.6 of the License Agreement. However, the royalty fees
do not arise from the resale of the imported components because,
as described above, the imported components are not resold, they
are manufactured into the diagnostic kits. This manufacturing
operation is not a simple assembly or finishing operation.
Corange purchases the reagent material for the urinalysis test
strips from BMG. The manufacturing operations performed by
Corange involve enmeshing, defect marking, cutting, testing, bar
and color code preparation, packaging and labeling, which
transform the imported reagent material into a finished product.
Since the royalty fees are partially based on the imported
product and partially on other factors, the royalty fees in this
situation are not statutory additions to the price actually paid
or payable as proceeds of a subsequent resale, disposal or use of
the imported merchandise pursuant to 402(b)(1)(E) of the TAA.
The royalty fees are not dutiable whether the materials are
imported by BMC or Corange. Under the facts submitted, we find
that the changes in corporate structure do not affect the
analysis pertaining to the royalties. However, without being
provided with License Agreements between other related companies
and BMG, we cannot make a determination with respect to those
royalty fees.
HOLDING:
The royalty fees paid by BMC to BMG are not part of the
price actually paid or payable for the merchandise imported by
BMC or Corange. Additionally, the royalty fees made by BMC
pursuant to the License Agreement between BMC and BMG are not
included in the transaction value of materials imported by BMC or
Corange, as royalties or proceeds of subsequent resale, disposal
or use pursuant to 402(b)(1)(D) and (E) of the TAA.
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,
Acting Director
International Trade Compliance
Division