RR:IT:VA 545710 LR
Port Director
U.S. Customs Service
605 W. Fourth Ave
Anchorage, AK 99501
RE: Internal Advice concerning dutiability of royalty payments
for pharmaceuticals incorporating patented antibacterial
compounds; 19 U.S.C. 1401a(b)(1)(D)
Dear Director:
This is in response to your memorandum dated June 24, 1994,
forwarding a request for internal advice, submitted by counsel on
behalf of Merck & Co, Inc. (Merck), concerning the dutiability of
royalty payments made in connection with the use of patented
compounds. Counsel has made several submissions regarding this
matter. The most recent, dated February 4, 1998, was submitted
following a meeting at Headquarters on January 21, 1998.
Confidential treatment has been granted to the information
designated as such in counsel's submissions. This information is
bracketed and will be deleted from the public version of this
ruling. We apologize for the delay in responding.
FACTS:
Merck imports a patented antibacterial compound, known as
AM-715 or Norfloxacin ("Licensed Compound") from the patent
holder Kyorin Seiyaku K.K. (Kyorin) of Tokyo, Japan to be
incorporated in the pharmaceutical preparations Noroxin and
Chibroxin ("Licensed Products"). The Licensed Compound is the
active ingredient of the Licensed Products. In a License
Agreement, dated September 4, 1980, it is stated that ["
."]
A copy of the License Agreement was submitted.
Specifically, Kyorin granted Merck, an "exclusive license
(in certain countries, including the United States), with the
right to sub-license, under Licensed Patents and Know How, to
make, have made, use and sell Licensed Compound and to make, have
made, use and sell Licensed Products from Licensed Compound".
License Agreement 2.01. Licensed Patents are specified patents
relating to the Licensed Compound. License Agreement 1.01(a)
Know-how means all information not generally known and which is
available to Kyorin now and at any time during the term of this
Agreement regarding the preparation of the manufacture of
Licensed Products including the chemical, pharmacological,
biological and clinical properties of Licensed Compound and
Licensed Products. 1.01(f)
As consideration for these rights, Merck agreed to pay
Kyorin a royalty based on a specified percentage of net sales of
the Licensed Products sold by Merck or its sub-licensees or
subsidiaries. The percentage depends on whether or not there was
a valid enforceable Licensed Patent in effect in the country of
sale. See License Agreement 3.01. The royalties are calculated
and remitted semiannually. 3.04 [
].
On September 4, 1980, the date the parties signed the
License Agreement, [
.
]
Counsel contends that the royalty payments do not relate to
the imported merchandise and are not a condition of the sale of
the imported Licensed Compound and thus do not constitute
royalties to be added to the price actually paid or payable of
the imported Licensed Compound. Counsel also provided various
arguments in support of the position that the royalty payments
would not be dutiable as proceeds of the subsequent resale,
disposal, or use of the imported Licensed Compound. It is your
position that the royalties, or at least the portion of the
royalties attributable to the sale of the Licensed Products
manufactured from the imported Licensed Compound, are dutiable
either as royalties or proceeds.
ISSUE:
Whether the subject royalty payments constitute an addition
to the price actually paid or payable for the imported
merchandise as either royalties or proceeds of subsequent resale.
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 (TAA) codified at 19 U.S.C.
1401a. 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, directly or
indirectly, to the seller. 19 U.S.C. 1401a(b)(1)(D)&(E). These
additions apply only if they are not already included in the
price actually paid or payable. For the purposes of this ruling
we have assumed that transaction value is the appropriate method
of appraisement.
Royalties
Under section 19 U.S.C. 1401a(b)(1)(D), an addition to the
price actually paid or payable is made for 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."
The Statement of Administrative Action (SAA), H.R. Doc. No.
153, 96 Cong., St. 1st Sess., reprinted in, Department of the
Treasury, Customs Valuation under the Trade Agreements Act of
1979 (October 1981), at 48-49, which forms part of the
legislative history of the TAA, distinguishes payments to third
parties from payments to the seller of imported merchandise. It
states:
Additions 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 a case-by-case basis
and will ultimately depend on: (1) 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. For
example, if the buyer pays a third party for the right to
use, in the United States, a trademark or copyright relating
to the imported merchandise, and such payment was not a
condition of the sale of the merchandise for exportation to
the United States, such payment will not be added to the
price actually paid or payable. However, if such payment
was made by the buyer as a condition of the sale of the
merchandise for exportation to the United States, an
addition will be made. As a further example, 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 for the United States.
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
(trademark royalties dutiable when paid to the seller/licensor
but not when paid to a third party unrelated to the seller).
After reviewing the language of the statute along with the
legislative history and prior case law, Customs concluded that
the following three questions are relevant in determining whether
the requirements of 19 U.S.C.1401a(b)(1)(D) are met: 1) was the
imported merchandise manufactured under 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. An affirmative answer to question 1 and 2 and a
negative answer to question 3 points to dutiability. Question 3
goes to the heart of whether the payment is considered to be a
condition of sale. See General Notice, Dutiability of Royalty
Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993)
("Hasbro II ruling").
In the Hasbro II ruling, we determined that the royalty,
paid to the seller, was involved in the sale of imported
merchandise because the individual sales agreements and purchase
contracts were subject to the terms of the royalty agreement. In
HRL 544991, September 13, 1995, we held that a royalty was
involved in the sale of the imported merchandise payment of the
royalty was closely tied to the purchase of the imported product.
For example, in that case, the terms and conditions related to
the purchase of the imported products were set forth in the
license agreements. See also HRL 545380, March 30, 1995 (royalty
related to the production or sale of the imported merchandise
where under the terms of the licensing agreement, importer was
required to purchase components from the seller).
Some factors which Customs has considered in answering
question three, i.e., could the importer buy the product without
paying the fee, include to whom the royalty is paid (e.g.
payments to the seller, as opposed to a unrelated third party,
are generally dutiable); whether the purchase of products and the
payment of royalties are inextricably intertwined (e.g. are they
set forth in the same agreement, do the agreements make reference
to one another, is the purchase agreement terminated if the buyer
fails to pay the royalties); and whether royalties are paid on
each and every importation. See HRL's 544991, 545380; 545361;
and Hasbro II ruling, supra.
In this case, the answer to the first question is "yes".
The Licensed Compound (i.e., imported product) is manufactured by
Kyorin who holds a patent for that product. Thus, the Licensed
Compound was manufactured under patent. Royalties and license
fees for patents covering processes to manufacture the imported
merchandise will generally be dutiable. See SAA, supra, at 48.
See also HRL 545998, November 13, 1996, (patent covering chemical
composition of imported product is type of patent intended to
come within the purview of question one).
With regard to the second question, counsel states that the
answer is "no". Counsel contends that the royalty is not
involved in the production or sale of the imported product.
Rather, the claim is made that the royalties are involved only in
the production or sale of the Licensed Products produced by Merck
in the United States. It notes that the Merck's obligation to
pay royalties arises only upon the sale of the Licensed Products,
not the imported Licensed Compound. Counsel also indicates that
the Licensed Products are physically distinct from the Licensed
Compound and that the Licensed Compound is not physically
identifiable nor segregable from the other ingredients comprising
the Licensed Products. Counsel analogizes the instant situation
to that discussed in section 152.103(b)(3), Customs Regulations
(19 CFR 152.103(b)(3)), where it is explained that when a
royalty, "is based partially on other factors which have nothing
to do with the imported merchandise (such as if the imported
merchandise is mixed with domestic ingredients and is no longer
separately identifiable, or if the royalty cannot be
distinguished from special financial arrangements between the
buyer and the seller); it will be inappropriate to attempt to
make an addition for the royalty."
Counsel also cites to HRL 545307, February 3, 1995 in
support of its position. There, the importer paid the seller a
royalty for the right to use technical knowledge to make, use and
sell finished pharmaceutical productions containing the imported
active ingredient. The licensed product was the finished
product, and the royalties related only to the manufacture of the
finished product in the United States. Although the active
ingredient was patented, the patent had expired. Moreover, no
royalties were paid for technical know-how relating to the
imported active ingredient. Customs determined that the
royalties did not relate to the imported merchandise and thus
were not dutiable under 19 U.S.C. 1401a(b)(1)(D).
Based on our review we conclude that the royalty was
involved in the production and sale of the imported merchandise.
First, Customs has determined 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
"Hasbro II ruling", supra. Thus, in this case, the fact that
royalty is based on a percentage of the sales price of the
Licensed Product is not relevant. Second, despite the further
processing of the imported Licensed Compound, it is clear that
the royalties paid relate to the production and sale of the
imported Licensed Compound. This stems from the fact that the
imported Licensed Compound is specifically covered by the License
Agreement. Under the License Agreement, Kyorin granted Merck an
exclusive license with the right to sub-license under Licensed
Patents and Know How to make, use and sell the imported Licensed
Compound and Licensed Products from the Licensed Compound within
the U.S.
Also, the imported Licensed Compound is "manufactured under
patent" and the license for which royalties are paid specifically
covers those patent rights. This shows that the royalty is
involved in the production and sale of the imported merchandise.
See HRL 545998, supra.[
]
The facts here are distinguishable from HRL 545307, the
ruling cited by counsel. As indicated above, there, the importer
paid the seller a royalty for the right to use technical
knowledge to make, use and sell finished pharmaceutical products
containing the imported active ingredient. The finished
pharmaceutical product, not the imported active ingredient, was
the licensed product for which royalties were paid. Customs
determined that the royalties related only to the manufacture of
the finished licensed product in the United States and were not
dutiable. In contrast, the imported active ingredient in this
case (referred to in the License Agreement as the Licensed
Compound) is one of the licensed products for which royalties are
paid. See 2.10 License Agreement granting Merck an "exclusive
license .... under Licensed Patents and Know How, to make, have
made, use and sell Licensed Compound . . .". Thus, the royalties
relate to the manufacture of the imported product. In addition,
as this provision makes clear, the royalties in this case relate
to patents covering the imported Licensed Compound. See also [
]. In HRL 545307, the royalties paid did not
relate to patents covering the imported product. Although the
imported product was manufactured under patent, the patent had
expired.
The terms of the License and [ ] demonstrate
that the sale of the imported product and the payment of
royalties is closely related. Again, the imported product is the
Licensed Compound as that term is defined in the Agreements for
which royalties are paid. Also, the [
].See HRL 545998, supra, HRL 546038, July 19, 1996
and HRL 544991, September 13, 1995. Also, [
]. These facts demonstrate that the royalties are
involved in the production and sale of the imported merchandise.
The third question, can the importer buy the product without
paying the fee, goes to the issue of whether payment of the
royalty is a condition of the sale for exportation of the
imported product. Counsel argues that the payment of the royalty
is not a condition of sale of the Licensed Compound and that
Merck can buy the product without paying the royalty. Again,
counsel points to the fact that under the License Agreement
royalties accrue only on the sale of the Licensed Products and
not on the sale of the Licensed Compound by Kyorin to Merck.
Counsel also indicates that there are numerous occasions where no
royalty accrues. For example, when the importer fails to produce
the royalty product with the imported product, no royalty payment
will be owing to the licensor; if no sale of the finished
products occurs, no royalty is owing. Counsel also indicates
that no royalty accrues on the manufacture by Merck or any of its
sublicenses of Licensed Compound which is used to make Licensed
Products.
Despite these arguments, we conclude that Merck could not
buy the product without paying the royalties. First, we note
that the royalties covered by the License Agreement are paid by
Merck to Kyorin, the seller of the imported Licensed Compound.
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
(trademark royalties dutiable when paid to the seller/licensor
but not when paid to a third party unrelated to the seller); HRL
545752, April 1, 1996; HRL 544991, supra.
Second, although there could be some instances where no
royalties are paid in connection with imported Licensed Compound,
we conclude that there would be no sale of the imported product
unless Merck agreed to pay the royalties provided for in the
License Agreement. This is evidenced by the fact that the payment
of the royalties is closely tied to the sale of the imported
product: [
]. Under these circumstances, Customs
has considered the payments of royalties to be a condition of the
sale of the imported merchandise. See 545998, supra. In that
case similar arguments were raised (e.g., that some of the
imported merchandise was not subject to royalties because it was
not sold). Nonetheless, Customs determined that payment of the
royalty was a condition of sale of the imported product. See
also HRL 544991, supra.
Based on the above considerations, we find that the
royalties at issue relate to the imported merchandise and that
Merck is required to pay them as a condition of the sale for
exportation to the United States of the imported Licensed
Compound. Accordingly, we find that they are additions to the
price actually paid or payable as royalties under 19 U.S.C.
1401a(b)(1)(D).
Counsel further contends that if Customs determines that the
royalties are dutiable, the issue of apportionment must be
addressed since the royalty is paid partially for the imported
Licensed Compound and partially for the exclusive territorial
rights and rights granted with respect to the finished product.
In this regard, counsel claims that under the terms of the
License Agreement, the amount of the royalty is dependent upon
the net sales worldwide of pharmaceuticals and is further
dependant on where the finished product is sold. In countries
where exclusive territorial rights are granted, such as the U.S.,
the royalty is higher than in countries where no exclusive
territorial rights are granted. Since the difference is
attributable to exclusive territorial rights in the U.S. it is
claimed that this portion should not be dutiable. Counsel also
states that Merck has expended considerable costs in developing
the finished products made from the imported Licensed Products
and that any royalty paid must be allocated by differentiating
between the cost of the imported Licensed Compound and the cost
of the Licensed Products made from the imported Licensed
Compound.
Previous rulings have not addressed the issue of
apportionment of royalties. While apportionment may be
appropriate in cases where it is clear that a portion of the
royalty payment does not relate to the imported product, this is
not the case here. First, it appears that the different royalty
amount paid in the different countries is attributable to whether
there is a valid enforceable Licensed Patent in effect in the
country of sale. See 3.01a & b, License Agreement. [
]. Under these circumstances, no
apportionment is warranted.
HOLDING:
Based on the information provided, the subject royalty
payments constitute an addition to the price actually paid or
payable for the imported merchandise under 19 U.S.C.
1401(b)(1)(D). Having reached this conclusion, it is not
necessary to address the issue of whether the payments could
alternatively be considered proceeds under 19
U.S.C.1401(b)(1)(E).
This decision should be mailed by your office to the
internal advice requestor 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,
Thomas L. Lobred
Chief, Value Branch