• HQ H137435
• Jan 05, 2012

• Type : Valuation Acting Field Director • HTSUS :
•  Related:   545320; 548331; 548306; 546012; 545998; 545710; 544436; 546478; 546433; 544991; 545951; 545361; H128018; H100056; W548649   

OT:RR:CTF:VS H137435 BGK

U.S. Customs and Border Protection Office of International Trade
Regulatory Audit
499 NW 70th Avenue, Suite 201
Plantation, Florida 33317

RE: Pharmaceutical Development Payments; Royalties; Milestone Payments; Valuation under 19 U.S.C. § 1401a

Dear Acting Field Director:

This is in response to two letters from your office, dated December 6, 2010, and January 7, 2011, requesting internal advice on value issues regarding certain pharmaceutical development, royalty, and milestone payments made by the Importer. In issuing our response, we have given consideration to the submissions from your office, along with a submission from the Importer forwarded to us by your office. We also received additional submissions from the Importer on May 19, 2011, June 2, 2011, and November 14, 2011, and spoke with the Importer on June 2, 2011.

FACTS:

The Importer, a U.S. based subsidiary of the Parent, is importing the active pharmaceutical ingredient (API), also known as "the Compound,” from its foreign Parent, for a finished drug currently manufactured in the U.S.1 Once in the U.S., excipients are added in order to create separate doses in caplet or tablet form. The chemical formula in the License Agreement for the Compound is the same as the one provided in the drug facts information sheet in the "Prescribing Information" section. Two agreements were signed on December 15, 1998, between the

1 The Importer states that· they will begin using a different supplier for the imported merchandise; however, this ruling will not address this scenario. This is an internal advice request that has arisen in an audit situation. Additionally, no information or contracts have been provided for the new supplier. Parent and the Importer: The License Agreement, and the Development Agreement. On June 29, 2000, the Supply Agreement was signed between the same parties.

The Parent has an exclusive license from a foreign third party for “. . . patents and know-how relating to the compound...” The Parent then granted to the Importer, in the License Agreement, "an exclusive license to manufacture, have manufactured, use, have used, distribute, have distributed, sell and have sold to SUBLICENSEES the COMPOUNDS and to develop, have developed, manufacture, have manufactured, use, have used, distribute, have distributed, market, have marketed, sell and have sold the LICENSED PRODUCTS in the TERRITORY under the PATENTS and KNOW-HOW.” The Agreements define "Compound” as “all compounds encompassed by the PATENTS ... and the free acid forms of such compounds and all other pharmaceutically acceptable salts of such free acid forms.” Licensed Products are defined as "human pharmaceutical products in ready-for-sale forms containing the Compound as the sole active ingredient” and “human pharmaceutical products in fixed dose ready-for-sale forms containing the Compound together with one or more other active ingredients.” "Patents” covers all patents listed in the License Agreement and any other patents related to the Compound or Licensed Products. The "Territory” is considered every country in the world.

In consideration for these rights, the Importer agreed to pay both milestone payments and a royalty. The milestone payments are (1) a payment due 30 days after the execution of the Agreement, (2) all costs already incurred by the Parent in relation to the product up to the date of execution (minus milestone payments to the foreign third party), (3) a payment due 20 days after the initiation of the first phase Ill clinical trial, (4) a payment due 20 days after the first application is accepted for review by the appropriate health authority for any country, (4) a payment due 20 days after the first launch of the product in any country.

The royalty payments are made by the Importer to the Parent at a rate equal to the royalty paid by the Parent to the foreign third party under the Head License Agreement, plus a certain percent mark-up. The Importer must continue to make the payments until the Parent's obligation to the third party expires. The Parent's royalty to the foreign third party is calculated based on a percentage of net sales of the Licensed Products.

The License Agreement terminates when the Importer's obligation to make payments to the Parent under the royalties provision of the contract ceases or certain events occur with relation to the feasibility of development, launch, or sale of the Licensed Products, including adverse events relating to the Compound. Additionally, either party may terminate the Agreement should the other party become insolvent or commit a material breach of any of the terms of the Agreement.

Under the Development Agreement, the Parent agreed to provide the Importer with services related to the development of "the Product,” as defined in the License Agreement, above. All information and know-how relating to the Product that arises out of the services provided under the agreement is owned by the Importer. The Development Agreement, by its terms, terminates automatically on termination of the License Agreement. In consideration for the development services, the Importer agreed to pay the Parent all costs related to the services plus a markup. The Development Agreement covers general development work, manufacturing development work, and regulatory development work, and “general services.”

The general development work is related to the development of the Product, based on a development schedule. The development schedule covers from the initial formulation development, manufacturing, clinical testing, and further development to manufacturing.

Manufacturing development includes, but is not limited to, general advice to the Importer in relation to manufacture and formulation, establishing and managing facilities not in the Importer's location, contractor assessment/selection and negotiation of terms, assistance in managing day to day issues as requested, and ongoing technical support. The manufacturing development also includes assisting the Importer in establishing manufacture and packaging of the dosage form at the Importer's facility in the U.S., assisting in the assessment/selection/negotiation for the manufacture and/or packaging of any commercial dose form, developing and maintaining expertise in the process and methodology required to support bulk drug and formulated product manufacture and packaging, and technical support and advice related to the compilation of the international chemistry and pharmacy documents _used for regulatory submissions worldwide and the subsequent maintenance thereof. This also includes maintaining a stock of the bulk drug to meet regulatory requests and development activities.

Regulatory development includes, but is not limited to, the preparation of reports, meeting with agencies, preparing briefing documents, and reviewing documentation for the purpose of seeking agency approval to conduct clinical studies; providing regulatory input into the development team; compiling a dossier of the reports for submission to many different countries; acquiring certificates and preparing for inspection; and coordinating the provision of samples.

The Development Agreement also includes “General" services like liaising with the foreign third party for disclosure of know-how to the Importer necessary for the development of the Licensed Product, as required by the License Agreement, and using the materials referred to in a provision of the License Agreement, for which payment is also covered by the License Agreement.

 The possibility of the execution of a supply agreement in the future is set forth in Article Five of the License Agreement. Article 5.2 of the License Agreement sets the price at which the Importer may purchase the Compound from the Parent, should a supply agreement be entered. The Supply Agreement was signed on June 29, 2000 and begins with the following provision in the Preamble: “Whereas [the Importer] has rights under patents and know-how on a worldwide basis in respect of [the Compound.]” Under the Supply Agreement, the Parent contracted to sell, and the importer contracted to buy its requirements of the Compound at the price set by the License Agreement. The Compound is to be delivered in bulk form either CIF or CIP, depending on if it arrives by sea or air freight, respectively. The Importer must order its actual requirement of the Compound, giving at least twelve months’ notice of the actual delivery date. The Supply Agreement may be terminated upon written notice by either party in the event either party shall "withhold from the other for a period of two months any monies due to the other. . .” under the Supply Agreement. This termination clause is not limited to money due under the Supply Agreement.

ISSUES:

I. Whether the payments for development should be included in, or added to the price actually, paid, or payable.

II. Whether the milestone payments and/or royalty payments should be included in, or added to, the price actually paid or payable.

LAW AND ANALYSIS:

I. Development Payments

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; 19 U.S.C. § 1401a). The preferred method of appraisement is transaction value, which is defined as the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus certain statutory additions. 19 U.S.C. § 1401a(b)(1). The "price actually paid or payable” means the total payment (whether direct or indirect, and exclusive of any charges, costs, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation. to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller." 19 U.S.C. § 1401a(b)(4)(A). For the purpose of this internal advice, we have assumed that transaction value is the appropriate basis of appraisement; however, this is not always the case in a related party situation such as this.

While research and development (R&D) payments are not specifically listed under the statutory additions to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1)(A)-(E), the development payments may still need to be included as part of the price actually paid or payable. I It is U.S. Customs and Border Protection's (CBP) position that payments made by the buyer to a party related to the seller are indirect payments made to, or for the benefit of, the seller. All such payments are included in transaction value unless it is established that they were made in exchange for something other than the imported goods. See, Generra Sportswear Company v. United States, 905 F.2d 377(CAFC 1990), and Chrysler Corporation v. United States, 17 CIT 1049 (CIT 1993). CBP has ruled that the price actually paid or payable for imported merchandise includes payments for tooling, research and development, testing, as well as payments for samples and prototypes. Headquarters Ruling Letter (HRL) 545998, dated November 13, 1996 (citing HRL 545320, dated February 28, 1995). In this case the development payments are made from the buyer, the Importer, to the seller, the Parent. Therefore, if the development payments relate to the imported merchandise, they will be included as part of the price actually paid or payable.

However, 19 U.S.C. § 1401a(b)(3) provides that "[t]he transaction value of imported merchandise does not include any of the following, if identified separately from the price actually paid or payable and from any other cost or other item referred to in Paragraph (1) …” (emphasis added). This includes "[a]ny reasonable cost or charge that is incurred for (i) the construction, erection, assembly, or maintenance of, or the technical assistance provided with respect to,

the merchandise after its importation into the United States…” 19 U.S.C. § 1401a(b)(3)(A)(i). Therefore, if the development payments are made for work provided with respect to the Compound after its importation, they will not be included in the price actually paid or payable.

In HRL 548331, dated October 31, 2003, R&D expenses were shared, pursuant to an agreement, between a parent and its subsidiaries, and the importer purchased the imported merchandise from another subsidiary, not their parent. CBP held that the importer had not established that the payments made by it to the R&D pool were not indirect payments made by a buyer to or on behalf of a seller of merchandise exported to the United States. CBP also held that the relationship between the pool payments and the imported merchandise were sufficiently direct to conclude that they should. be included in the price actually paid or payable. In making this holding CBP also commented on how much of the pool payments should be included in the price actually paid or payable:

CBP is of the understanding that sound corporate accounting can provide the importer with a basis for determining the percentage of R&D pool payments that were devoted to a specific R&D project, which percentage of pool payments are part of the price actually paid or payable for the developed, imported merchandise. The precise determination of the appropriate allocation of research and development payments to specific merchandise imported by [the importer] should be decided on a case-by-case basis.

HRL 548331.

In HRL 548306, dated July 9, 2003, CBP relied on the Court's comments in Generra regarding the limited resources available to CBP and the frequently complex financial relationships when placing the burden on the importer to prove that payments made to foreign sellers are not part of the price actually paid or payable, in holding that at least part of the R&D payments should be included in the price actually paid or payable. Our office left the determination of the appropriate allocation of the payments to the Port Director and counsel for the importer to resolve.

In HRL 546012, dated May 6, 1996, concerning the design and importation of parts for construction of a ladle metallurgy facility in the U.S., CBP discussed the effect of Generra and Chrysler, as well as 19 U.S.C. § 1401a(b)(3), on the dutiability of development payments. CBP held that where the importer had adequately shown that the payments were "completely unrelated" to the imported merchandise or pertained to "construction, assembly, or technical assistance provided with respect to the merchandise after its importation, the payments should not be included as part of the price actually paid or payable. However, where the payments were "not 'completely unrelated” to the imported documents and did not pertain to construction, assembly, or technical assistance concerning the merchandise after importation, it was held to be appropriate to include those payments in the price actually paid or payable. CBP held that payments such as time scheduling, reporting services, basic engineering services related to the layout or arrangement of the merchandise at the U.S. facility, and supervision and technicalassistance related to the installation and erection of the merchandise of the U.S. facility were completely unrelated to the imported merchandise such that these payments could not be dutiable. Payments for services related to both the imported merchandise and its use at the U.S. facility were not considered completely unrelated to the imported merchandise nor pertaining to construction, assembly, or technical assistance concerning the merchandise after importation, and thus were held to be dutiable as part of the price actually paid or payable. These included payments for technical documentation, related to both imported and domestically sourced parts; detail engineering, including mechanical engineering related to components; electrical engineering related to control systems and control diagrams; instrumentation diagrams and equipment; utility supply services for control apparatus etc.; computer engineering services with regard to computer equipment; engineering relating to particular imported components; and software engineering.

In HRL 545998, dated November 13, 1996, the importer imported a bulk API from an unrelated company to be manufactured into finished doses in the U.S. (Licensed Product). FDA approval was required for both products. The importer entered into five agreements with respect to the API, including a license agreement, supply agreement, and co-promotion agreement. All agreements besides the supply agreement were between the importer and the licensor, a party related to the seller, and the supply agreement was between the importer and the seller. Under the license agreement the importer agreed to pay the licensor a fixed sum within 60 days of receiving the results of two pre-clinical studies conducted by the licensor on the long­ term toxicity of the imported API. The importer also reimbursed the licensor for the results of carcinogenicity and toxicology studies conducted on the API. All the studies related to the general safety and were necessary in order to obtain FDA approval of the final product. Under the supply agreement, the importer agreed to purchase all of its requirements of the API for five years from the date of the first commercial sale of a Licensed Product. Under the co-promotion agreement, the licensor was permitted to assist the importer in marketing the finished drug in the United States.

With regard to the payments for the clinical studies in HRL 545998, the importer argued against dutiability as part of the price actually paid or payable because the studies were conducted for the purpose of obtaining FDA approval of the finished product, which was manufactured in the U.S. The importer equated the payments to marketing payments, much like the argument of the Parent in the situation at issue. CBP, however, held that the payments were related to the imported merchandise and were part of their total payment. Therefore, the payments were dutiable as part of the price actually paid or payable. CBP came to this conclusion because they were essentially research and development costs relating to the product and an important element in the cost of the pharmaceutical, as tests of the API were necessary for the sale of the pharmaceutical. Also, of importance to CBP was the ability of the importer to terminate the license agreement if the results of the studies were unsatisfactory. In discussing the various ways for companies to recoup research and development costs, CBP stated that "[w]hen the seller or its related company passes along these costs to the buyer, they become part of the price actually paid or payable for the imported merchandise, or in the case of royalties, an addition thereto.” HRL 545998. The Importer in this case argues that HRL 545998 should be distinguished because the tests were pre-clinical studies on the API, whereas the tests in the situation at issue are clinical studies on the finished goods.

In addition, the Importer argues the payments under the Development Agreement are not dutiable because they are payments for services that the Parent will provide to assist the Importer in future sales of the Licenses Product that the Importer will manufacture, and as such are more similar to the co-promotion payment in HRL 545998. The co-promotion payments in HRL 545998 resulteddirectly from the licensor's marketing and promotion efforts with respect to the finished drug, not the imported API. Therefore, the co-promotion fees were not dutiable as part of the price actually paid or payable. It was clear to CBP that the amounts paid directly related to the specific undertakings of the licensor in promoting the sale of the finished product in the U.S.

As the development payments in this case are made to the seller, it is the Importer's burden to prove that the payments are completely unrelated to the imported merchandise or pertain to construction, assembly, or technical assistance provided with respect to the merchandise after its importation. See, HRL 546012; HRL 548331; Chrysler Corp., 17 C.I.T. 1049; and 19 U.S.C. § 1401a(b)(3). As stated above, the Importer claims the development payments are for services provided with regard to the finished product, not the imported product. The Importer also argues that this is supported because the payments under the Development Agreement" are not triggered by importation but are- paid annually.

With regard to the timing of the payment, this is not necessarily a relevant concern. In HRL 548331, CBP acknowledged that R&D payments may not result in the exportation of merchandise for a number of years but decided that the issue of timing was an accounting issue and did not affect the dutiability of the payments. Additionally, in HRL 545998, the payments for the pre-clinical studies were due 60 days after receiving the results, not at a point related to an importation, and yet these payments were still considered dutiable as part of the total payment for the price actually paid or payable. Therefore, it is irrelevant that the development payments are not triggered by importation. ·

The Importer also argues against dutiability because the Supply Agreement and Development Agreement are unrelated. The Development Agreement and License Agreement were entered into on December 15, 1998, and the Supply Agreement was entered into on June 29, 2000. While it is true the Development Agreement does not reference the Supply Agreement, the License Agreement, executed on the same day as the Development Agreement, does provide for the possible future creation of a supply agreement and the price that will be set should a supply agreement be entered into. However, the fact that the Agreements do not reference each other is not sufficient proof that the development payments are completely unrelated to the imported merchandise or pertain to construction, assembly, or technical assistance provided with respect to the merchandise after its importation. Additionally, the Supply Agreement provides that either party may terminate the Supply Agreement in the event of nonpayment of any monies due to it by the other party, which would include development payments due under the Development Agreement.

The Development Agreement covers four types of services: (1) General Development Work, (2) Manufacturing Development Work, (3) Regulatory Development Work, and (4) General Services.

General Development Work covers carrying out the development plan, modifying the development plan, and creating procedures for an adverse event in relation to the Product. Contrary to the Importer's statement that HRL 545998 may be distinguished because “[a]t issue in [HRL 545998] were pre-clinical studies on the active ingredient to be imported, however, as opposed to the services here, which are clinical studies on the finished goods[,]" the Development schedule includes pre-clinical studies and clinical studies, in addition to the manufacture of the product. The Development Agreement also states, like the License Agreement, that it relates to the Compound. Additionally, the name of the Compound is printed on every page of the Development Schedule. While some of the General Development Work does appear to be related to the Licensed Product, it is not completely unrelated to the imported Compound. Therefore, as in HRL 546012, where some categories of services related to the imported product and other related to domestic work, the payments under General Development Work will be dutiable as they are not completely unrelated to the imported product.

Manufacturing Development Work covers assistance and technical support for the manufacture of the finished Product, and we find is therefore considered to fall under 19 U.S.C. § 1401a(b)(3) as services provided for the construction, erection, assembly, or maintenance of, or the technical assistance provided with respect to, the merchandise after its importation into the United States. Therefore, payments allocable to Manufacturing Development Work will not be dutiable if they can be allocated separately from dutiable development payments. 19 U.S.C. § 1401a(b)(3) (Amounts are not dutiable "... if identified separately from the price actually paid or payable ... ").

Regulatory Development Work covers approval of the clinical trial program, agency meetings, review of documentation, project management and strategy input, management of the emergent dossier, reprographies, certification/inspection, samples, labeling, and preclinical data. This covers the bulk drug, formulated product, pharmacology, toxicology, ADME, and clinical. The review of documentation covers both preclinical and clinical reports. As the imported Compound and the Licensed Product both have the same chemical formula, and the Regulatory Development Work covers work for both the Compound and the Licensed Product, the development payments allocable to the Regulatory Development Work will be dutiable. The Importer has not sufficiently proven that the Regulatory Development Work is completely unrelated to the imported product or provided solely for post-importation development.

"General Services," listed in part "D" of the development schedule, covers liaising with the foreign company for disclosure of know-how to the Importer necessary for the development of the Licensed Product, as required by the License Agreement, and using the materials referred to in a provision of the License Agreement (mainly amounts of the Compound). The cost of the latter provision is acknowledged to be born by the Importer under the License Agreement. The former is also enumerated in the License Agreement. Therefore, no part of the Development payments should be allocated to the General Services provided for in part "D", as payment for these provisions is provided for elsewhere.

Development payments made pursuant to the Development Agreement, except to the extent the Importer and the Office of Regulatory Audit are able to agree on an allocation for Manufacturing Development Work to be excluded from the total payment, are dutiable as part of the price actually paid or payable.

Milestone Payments and Royalty Payments

In consideration for the rights granted under the License Agreement, the Importer agreed to pay both milestone payments and a royalty. The milestone payments are (1) a payment due 30 days after the execution of the Agreement, (2) all costs already incurred by

the Parent in relation to the product up to the date of execution (minus milestone payments to the foreign third party), (3) a payment due 20 days after the initiation of the first phase Ill clinical trial of the licenses product, (4) a payment due 20 days after the first application for the licensed product is accepted for review by the appropriate health authority for any country, and (4) a payment due 20 days after the first launch of the licensed product in any country.

Royalty payments are also paid by the Importer to the Parent at a rate based on the royalty payments made by the Parent to the foreign third party under the Head License Agreement plus a percent mark-up. The payment is due within 21 days of the Parent's payment to the foreign third party, and must continue to be paid until that obligation is extinguished.

The Parent's royalty to the foreign third party is calculated based on a percentage of net sales of the Licensed Products. However, CBP has held that the method of calculating the royalty is not relevant to determining the dutiability of a royalty payment. See HRL 545710, dated October 30, 1998 (citing "Hasbro 11”, infra).

Commercialization milestone payments such as the ones at issue are considered royalty payments. See 19 U.S.C. § 1401a(b)(1)(D). As stated above, 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. These additions include "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 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) and (E). These additions apply only if they are not already included in the price actually paid or payable. Royalty payments may properly be included as part of the price actually paid or payable, or an addition thereto. As milestone payments are considered royalties, and both these payments by the Importer are in consideration for the same rights, these will be analyzed together.

1. Price Actually Paid or Payable

The first issue is whether the royalty payments are included as part of the price actually paid or payable. As discussed above, it is CBP's position that payments made by the buyer to a party related to the seller are indirect payments made to, or for the benefit of, the seller. All such payments are included in transaction value unless it is established that they were made in exchange for something other than the imported goods. See, Generra, 905 F.2d 377, and Chrysler, 17 CIT 1049. In this case, the royalty payments are made by the buyer to the seller of the API, the Parent. The evidence also does not clearly establish that the license fees are unrelated to the imported merchandise. The license agreement clearly covers the technical know-how related to the imported Compound under Article 2.1.

Although the initial bulk Compound may not be physically separately identifiable, the Compound creates the chemical composition of the finished drug. As stated in the Prescribing Information for the drug, the other ingredients are inactive ingredients and the chemical formula is that of the Compound. The formula given for the active ingredient in the Prescribing Information is the same as that of the Compound in the License Agreement, and the name given

to the formula of the Compound in the Prescribing Information is listed below the drug name on every page of the Prescribing Information and in parenthesis next to the drug name in the description of the drug.

The Importer takes the position that this case is like HRL H128018, dated April 6, 2011, in which CBP determined that the royalties were not part of the price actually paid or payable. In that case the royalties were not dutiable as part of the price actually paid or payable, as royalties, or as proceeds because the imported merchandise was not manufactured under patent and the know-how provided was only for domestic manufacturing using the imported merchandise as raw materials, among other factors. These two factors, however, are significant differences from the case at hand. In this case, the imported merchandise is manufactured pursuant to the licensed patent, and the license covers not only the domestic manufacturing, but also the know-how to manufacture the imported Compound. As such, CBP does not consider HRL H128018 analogous in this situation.

The Importer also states that "[n]o royalty is paid on the API, even though it is used up and may have been incorporated into a finished product." However, this statement is not supported by the Agreements. The royalty payments are made by the Importer to the Parent at a rate equal to the royalty paid by the Parent, plus a certain percent mark-up, and the Parent's royalty to the foreign third party is calculated based on a percentage of net sales of the Licensed Products. There is no indication the cost of the API is backed out of this amount. In contrast, in HRL H100056, dated November 15, 2010, the amount paid for the imported merchandise was backed out of the royalty calculations, and therefore, CBP determined that the royalty was not paid for the imported merchandise. Additionally, in HRL H100056, as in HRL H128018, the license only covered the know-how for the domestic manufacturing, not the imported product.

Unlike the above cited cases where the license only covered the know-how for the domestic manufacturing, in this case the know-how for the imported product is licensed to the Importer under the License Agreement. As such, these payments are not unrelated to the imported merchandise and should be included in the transaction value of the imported merchandise as part of the price actually paid or payable.

2. Royalties

Although CBP believes that the royalty 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. With regard to royalties, the Statement of Administrative Action (SAA), which forms part of the legislative history of the TAA, provides in relevant part:

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

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.

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 to the United States.

Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., Pt II, at 443- 444 (1979) [hereinafter SAA].

After reviewing the language of the statute along with the legislative history and prior case law, CBP looks to the following three questions as 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? Affirmative answers to questions one and two and a negative answer to question three suggest that the payments are dutiable; negative answers to questions one and two and an affirmative answer to question three suggest that the payments are nondutiable. Question three goes to the heart of whether the payment is considered to be a condition of sale. See General Notice entitled "Dutiability of "Royalty" Payments," published in the Customs Bulletin and Decisions on February 10, 1993 (the "General Notice"; also, sometimes referred to as "Hasbro 11”) (stating these questions in discussing previously issued HRL 544436, dated February 4, 1991).

In analyzing these factors, CBP has taken into account certain considerations that flow from the language set forth in the SAA These include, but are not limited to:

(i) the type of intellectual property rights- at issue (e.g., patents covering processes to manufacture the imported merchandise will generally be dutiable);

(ii) to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated third party);

(iii) whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g.., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require the buyer's purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other, or termination of the purchase agreement due to the failure to pay the royalties); and

(iv) payment of the royalties on each and every importation.

HRL W548649 (citing HRL 546478, dated February 11, 1998; see also, HRL 546433, dated January 9, 1998; HRL 544991, dated September 13, 1995; and HRL 545951, dated February 12, 1998).

In this case, the answer to the first question, was the imported merchandise manufactured under patent, is “yes.” In the License Agreement itself, the imported Compound is defined as “all compounds encompassed by the PATENTS ... and the free acid forms of such compounds and all other pharmaceutically acceptable salts of such free acid forms." Additionally, in the Supply Agreement, it is stated that the Importer has rights under patents and know-how on a worldwide basis in respect to the Compound and that it wishes for the Parent to supply it with its requirements of the Compound. Thus, the Compound being imported is manufactured under patent.

The Importer argues that the imported Compound is not manufactured under patent, even though it is a patented compound, because it is not manufactured by a party with a right to manufacture it. The Parent manufactures the Compound; however, the Importer argues it does this as a contract manufacturer because the Parent sold its rights to the Importer. This argument has no merit. Question one does not concern if the party manufacturing the compound is the one with the rights to do so under the patent, only if a patent covers the compound. The Importer also claims the patent does not cover the process to manufacture the Compound, only the composition of the Compound. It argues that the Statement of Administrative Action deals exclusively with “process patents" and not “composition patents” because of the language used: “patents covering processes to manufacture.” This same argument was made by Pfizer in HRL 545998. CBP held that a composition patent covering the chemical composition of a compound is “the type of patent that was intended to come within the purview of question one.” Therefore, we conclude that the imported Compound is manufactured under patent, and question one should be answered in the affirmative.

The second question is whether the royalty is involved in the production or sale of the imported merchandise. The Importer argues that the royalty payments are not dutiable because the payments are primarily for intangible rights, like the right to sell the finished product. In making this argument, the Importer ignores the fact that rights connected with the Compound are also granted under the Agreement, and the Compound is the imported product. The Importer also cites, and attempts to analogize, the example provided in 19 C.F.R. § 152.103(f), which states:

A foreign producer sold merchandise to an unrelated U.S. importer. The U.S Importer pays a royalty to an unrelated third party for the right to manufacture and sell a product made in part from the imported merchandise. The royalty is based on the selling price of the further manufactured product in the U.S.

The regulations state that this payment would not be dutiable. The Importer argues that this is analogous except for the fact that the payments are being made indirectly to a third party. We do not agree. The payments made under the License Agreement are made from the Importer to its Parent company. The Parent company owes a foreign third party a royalty on the same rights; however, this is a separate agreement, and the Parent is the seller in this situation. Additionally, the Parent keeps a percentage of the payments made to it by the Importer, as the royalty is a marked-up amount of what the Parent owes the foreign third party. This example is also not on point to the situation here because the example only covers the rights to domestic manufacturing; the License Agreement at issue also covers rights to the imported Compound.

The Importer attempts to argue that the "profit” made by the Parent in selling their rights under the Head License Agreement should not be considered a benefit to the seller of the Compound because it is only conducted for tax purposes to create an "arms length transaction" that would be acceptable to the tax authorities in the country where the Parent is located. This bears no impact on the analysis for duty purposes. Additionally, the "profit is not the only benefit to the Parent-seller; the Parent sold their rights under the Head License Agreement for a royalty that is greater than what they owe. The fact that the Parent must also pay the unrelated foreign party for the rights they sublicensed is not significant in determining if the payment is dutiable. The Parent sold rights they possessed for a royalty.

The Importer also argues that the royalties are not dutiable because the payments are accounted for by the Importer as costs of the U.S. end product. This same argument was made by Pfizer in HRL 545998 and was rejected. HRL 545998 stated that "[t]he royalties are involved in the production of the imported merchandise because as discussed above such product is "manufactured under patent" and the license for which royalties are paid specifically covers those patent rights." This is the same as in the situation at issue. Additionally, in HRL 545998, CBP looked at the fact that the supply agreement required Pfizer to purchase all of its requirements of the imported API from the licensor's Parent. It was irrelevant for the purpose of determining that the agreements were interrelated that the supply agreement was entered into four years after the license agreement, similar to the situation at issue. In HRL 545998, the supply agreement and the license agreement were also coterminous, and while the agreements in the situation at issue are not coterminous, the Supply Agreement may be terminated if the royalties due under License Agreement are not paid. The Supply Agreement provides that either party may terminate the Supply Agreement in the event of nonpayment of any monies due to it by the other party, which would include royalties due under the License Agreement. Additionally, a supply agreement did not even exist in HRL 545710, which analyzed a similar license agreement.

In HRL 545710, the patent holder granted to Merck an "exclusive license ... 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.” The Compound, the imported product, was used as the active ingredient in two pharmaceutical preparations. Merck claimed the answer to question two was "no” because the royalties were involved only in the production or sale of the licensed products produced by Merck in the U.S. Its argument was based in part on the fact that the royalty payments were based on the sale of licensed products. CBP stated that this is not relevant in determining the dutiability of the royalty payments. See HRL 545710 (citing Hasbro II). Also, CBP held that the answer to the second question was "yes” because despite the further processing of the imported licensed compound, the imported licensed compound was specifically covered by the license agreement.

HRL 545710 and HRL 545998 are closely analogous to the case at issue. In this case, as in HRL 545710 and HRL 545998, the imported Compound is used in the production of a finished pharmaceutical product. Also, as in HRL 545710 and HRL 545998, both the Compound and the final product are covered by the License Agreement. The Compound is specifically covered by the license for which the royalty is owed. Additionally, in the situation at issue, the royalty is paid to the party selling the imported product. Therefore, as in HRL 545710 and HRL 545998, we conclude that the royalty was involved in the production or sale of the imported Compound and the answer to the second question is "yes.”

The third question, can the importer buy the product without paying the fee, goes to the issue of whether the payment of the royalty is a condition of the sale for exportation of the imported

product. As in HRL 545710, the royalties covered by the License Agreement are paid to the seller of the imported Licensed Compound, the Parent. It is more likely that the royalty will be dutiable when the licensor and the seller are one and the same and the royalty is paid directly to the seller, as is the case here. See SAA ( 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....”); HRL 545710 (citing HRL 545361, dated July 20, 1995, stating trademark royalties dutiable when paid to the seller/licensor but not when paid to a third party unrelated to the seller). The Importer has not established that these payments are distinct from the price actually paid or payable for the imported merchandise and were not a condition of sale of the imported merchandise. See SAA.

Under substantially similar circumstance in HRL 545710, discussed above, CBP concluded that there would be no sale of the imported product unless Merck agreed to pay the royalties provided for in the license agreement. CBP came to this conclusion in spite of Merck's arguments that there were instances in which no royalty would be owed, such as the importer failing to produce the final product, as the royalty was calculated based on the sales of the finished product. Merck also stated because the royalty owed was calculated based on sales of the finished products, no royalty would accrue simply because Merck manufactured the licensed compound without selling the licensed product. CBP concluded this argument was without merit. The third question was answered in the negative, primarily because the royalties were paid to the seller of the licensed compound.

In HRL 545998, Pfizer also argued that there would be situations in which the royalty would not be owed because the royalty was paid based on sales of the finished products and the finished product may not be sold, and conversely, there would be times when nothing was imported, such as when Pfizer manufactured both the compound and the finished product. As in HRL 545710, CBP determined the fact that there might be times that no royalty accrued was immaterial. Additionally, CBP pointed out the fact that while Pfizer could manufacture the API itself, this did not change the conclusion because if Pfizer manufactured the API in the U.S., nothing would be imported and no duties would be owed, including royalties. The Importer has made the same arguments as those made by Merck and Pfizer about the possibility of no royalty being owed or no importation occurring.

The Importer argues that because it could domestically source the Compound and the royalty would still be due, it cannot be related to the imported merchandise. The Importer cites HRL W548649, dated September 5, 2006, for this proposition. However, in HRL W548649, the fact that there were instances where no royalty was due was only one factor in the decision that the royalty was not dutiable. The other factors included the fact that the royalty calculation did not include amounts paid to the importing company as a result of reselling materials without further processing and the fact that the license agreement clearly indicated that it was only for the use of intellectual property in the domestic manufacturing and marketing of products. To the contrary, the License Agreement at issue in this situation continually references the imported Compound, and states in the preamble that the Parent is granting a sublicense to the Importer to ". . . develop, manufacture, use, distribute, and sell [the Compound] on a worldwide basis.” The License Agreement itself uses the Compound in the title. If the Compound were manufactured in the U.S., there would not be a dutiable importation, and therefore, there would be no value for which the royalty would be an addition. However, as long as the compound is imported under the circumstances at issue, we find the license fee is a condition of sale.

In Pfizer, the supply agreement was coterminous with the license agreement. Therefore, if royalties were no longer paid, the supply agreement would no longer exist. Similarly, in the situation at issue, while the agreements are not coterminous, the Supply Agreement allows for termination by either party in the event of nonpayment of any monies due to it by the other party. Therefore, as discussed above in question two, should the Importer cease payment under the License Agreement, the Parent may terminate the Supply Agreement. This provides the same effect as coterminous agreements; if the royalty is not paid, the Parent-seller may cease to supply the imported Compound. In addition, the Importer argues that the milestone payments are not tied to events related to the imported product and could occur in another jurisdiction. However, as discussed above, CBP has held that the method of calculating the royalty is not relevant to determining the dutiability of the royalty payment. See HRL 54571O. Additionally, if the milestone occurred in another jurisdiction, and no compound was being imported into the U.S., no duty would be owed because nothing would be imported. See HRL 545998. Based on the above, we find that the Importer cannot buy the licensed Compound without paying the milestone payments or the royalty payments.2

Accordingly, we find that the royalties and milestone payments at issue are additions to value under 19 U.S.C. § 1401a(b)(1)(D). As such, it is unnecessary to determine if the royalty or milestone payments could constitute additions to value as proceeds under 19 U.S.C. § 1401a(b)(1)(E).

HOLDING:

We conclude that the development payments are dutiable as part of the price actually paid or payable, except to the extent the Importer and the Office of Regulatory Audit are able to agree on the allocations discussed above. We also find that the milestone and royalty payments are dutiable either as part of the price actually paid or payable or as an addition to value under 19 U.S.C. § 1401a(b)(1)(D).

You are directed to mail this decision to the internal advice applicant, no later than 60 days from the date of this letter. On that date the Office of Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page on the World Wide Web at www.CBP.gov, by means of the Freedom of Information Act, and other public methods of distribution.

Sincerely,

Monika R. Brenner, Chief
Valuation and Special Programs Branch

2 The importer also cites Canada v. Mattel Canada Inc., [2001) 2 S.C.R. 100, 2001 sec 36 for the proposition that the phrase “condition of sale”, used in the Canadian Customs Act, should be interpreted the same as in sales law. This is not the interpretation that was taken by the U.S. in Hasbro II. Additionally, Mattel was about a trademark royalty paid to a third party. These are distinct differences.