VAL RR:IT:VA 546159 LPF
Assistant Field Director, Regulatory Audit
U.S. Customs Service
P.O. Box 19207
Charlotte, NC 28219
RE: Internal advice concerning royalties and proceeds of
subsequent resale made to party related to seller;
Transaction Value; 402(b)(1)(D) of the TAA; Hasbro II; HRL
544991
Dear Director:
This is in response to your memorandum dated October 11,
1995, requesting internal advice concerning the dutiability of
royalties paid by [* * * * * * * *] (Importer) of Research
Triangle Park, NC. This request emanates from an audit conducted
by your office. We have granted counsel's request for
confidentiality in accordance with his July 25, 1996 letter.
Additionally, we have excised, in the public version of this
decision, the bracketed confidential information below. A
meeting was held with counsel, which included telephonic
participation from the Importer, on February 10, 1997.
FACTS:
Importer is a wholly owned subsidiary of [* * * * * * * *]
(Parent Company A), who in turn is wholly-owned by [* * * * * * *
*]. Their parent company is [* * * * * * * *] (Parent Company
B). Importer purchases merchandise from both foreign and
domestic sources. Although its suppliers are both related and
unrelated companies, Importer primarily sources its products from
related companies such as [* * * * * * * *] (Seller 1), [* * * *
* * * *] (Seller 2), and [* * * * * * * *]. Parent Company B
owns these corporate subsidiaries through Parent/Licensor, the
only direct subsidiary of Parent Company B.
Products sold to Importer include active ingredients, bulk
intermediates and finished pharmaceutical/medicinal products. [*
* * * * * * *] owns the patent and trademark rights to the
products covered by the license agreement entered into between [*
* * * * * * *]. Under the license agreement [ * * * * * * * * *
* * * * ** * * * ]. A
list of the products, in their various forms, subject to the
license agreement was submitted. These same products are subject
to the submitted supply agreements entered into between [ *
* * * * *
* * * * *
* * * * *
* * * * *
* * * * *] .
Importer pays royalties to [ * * *
* * * * *
* * * * *
* * * * *
* * * * *
* * * * *
* * * *].
Although counsel explains that [* * * * * * * * *] purchases
its products from manufacturing companies whose process know-how
was self-developed, it is our understanding that these
manufacturing companies, [* * * * * * * *] and [* * * * * * * *]
are related to Parent/Licensor and, hence, Importer. [* * * * *
* * *] is a customer of these same manufacturing companies as
well as of a company who paid [* * * * * * * *] for the necessary
process know-how.
Counsel also states that the price at which goods are sold to
Importer covers both the manufacturers' costs as well as the
costs of the reseller, and that price would include research and
development costs to the extent incurred. This is also the case
where a product undergoes primary and secondary production prior
to its sale to Importer. Counsel provides that primary
manufacturing is the production of chemically complex active
ingredients, which give a medication its efficacy and potency,
from simpler raw materials. Secondary manufacturing involves
blending active ingredients with excipients and further
manufacturing in order to create a bulk stage product which then
is packaged and labeled as a finished product.
Counsel adds that whenever Importer uses an intangible asset
that is owned by another related entity in the production of a
product in the U.S., Importer ordinarily would make an
appropriate payment to the owner for the use of that intangible.
[ * *
* * * * *
* * * * *
* * * * *
* * * * *].
It is counsel's position that the payments at issue cannot
constitute royalties or proceeds to be added to the price
pursuant to 402(b)(1)(D) and (E) of the Tariff Act of 1930, as
amended by the Trade Agreements Act of 1979 (TAA), codified at 19
U.S.C. 1401a. With regard to royalties, counsel provides that
the imported merchandise is not manufactured under a patent for
which Importer is obligated, directly or indirectly, to make
payment, the royalty does not relate to the production of the
imported merchandise, and the importer could purchase the
imported merchandise without paying a fee.
Specifically, counsel points out that the license agreement
provides that it is the parties' express intention that no
royalty be payable from Importer on the importation of such raw
materials, bulk or finished products but only on the net sales of
the product in the U.S. Counsel explains the payments only are
tied to technological know-how used in U.S. production as well as
trademark utilization in the U.S. Counsel also stresses that the
license agreement provides that Importer shall not be required to
pay any royalty or license fee as a condition of the sale of
merchandise exported to the U.S. by [* * * * * * * *]. Rather,
counsel submits that the license agreement provides that such
merchandise shall be priced in accordance with a separate
agreement between the parties without regard to royalties.
Counsel stresses that [* * * * * * * *], although the holder
of certain intellectual property rights, is not the seller of the
merchandise for exportation to the U.S. Hence, with regard to
proceeds, counsel submits that the payments made by Importer are
not shared directly or indirectly with the foreign sellers nor
are used in any way to offset costs of production. Producers and
sellers of the products, counsel explains, have their own
obligations to [* * * * * * * *] and those responsibilities are
not borne by Importer. Thus, counsel provides that if any
product is manufactured under patent, it is the obligation of the
producer, not Importer, to pay any applicable patent fees.
Your office disagrees and believes the payments may be
dutiable as assists, royalties or proceeds of a subsequent
resale, disposal or use of the imported merchandise.
ISSUE:
Whether the royalties or fees at issue, paid by Importer to
[* * * * * * * *], are included within the transaction value of
the imported merchandise as royalties or proceeds of subsequent
sale.
LAW AND ANALYSIS:
As you are aware, the preferred method of appraising
merchandise imported into the U.S. is transaction value pursuant
to 402(b) of the TAA. Section 402(b)(1) provides, in pertinent
part, that the transaction value of imported merchandise is the
"price actually paid or payable for the merchandise when sold for
exportation to the United States" plus enumerated statutory
additions, including the value of any royalty or license fee
related to the imported merchandise that the buyer is required to
pay as a condition of the sale for export to the U.S.
(402(b)(1)(D)) and the proceeds of any subsequent resale,
disposal or use of the imported merchandise that accrue to the
seller (402(b)(1)(E)). Although the buyer and seller of the
merchandise at issue are related parties pursuant to 402(g), for
purposes of this decision we have assumed that transaction value
is the appropriate method of appraisement.
The Statement of Administrative Action (SAA), adopted by
Congress with the passage of the TAA, explains that:
[a]dditions for royalties and license fees will be limited to
those that the buyer is required to pay, directly or
indirectly, as a condition of the sale of the imported
merchandise for exportation to the United States. 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.
Statement of Administrative Action, 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 at 48-49 (1981).
In the General Notice, Dutiability of Royalty Payments, Vol.
27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), commonly
known as "Hasbro II," Customs articulated three factors, based on
prior court decisions, for determining whether a royalty was
dutiable. These factors were whether: 1) the imported
merchandise was manufactured under patent; 2) the royalty was
involved in the production or sale of the imported merchandise;
and 3) the importer could buy the product without paying the fee.
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.
When analyzing the Hasbro II factors, Customs, in its more
recent ruling decisions, has taken several considerations into
account which follow 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 imported merchandise generally will be
dutiable); ii) to whom the royalty is paid (e.g., payments to the
seller or party related to the seller more likely are dutiable
than payments to an unrelated third party); iii) whether the
purchase of the merchandise and payment of royalties are
inextricably intertwined (e.g., provisions in the same agreement
for the purchase of the merchandise and payment of royalties;
license agreement refers to, or provides for, the sale of the
imported merchandise or requires 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 failure to pay
royalties); and iv) payment of royalties on each and every
importation. See Headquarters Ruling Letter (HRL) 544991, issued
September 13, 1995, and cases cited therein.
Based on the information provided, we find the subject
payments to constitute royalties comprising part of the
transaction value of the merchandise. First, we find the
imported merchandise to be manufactured under patent, insofar as
we understand that the patented applications or "know-how" are
utilized in the manufacturing process of the merchandise.
Although counsel submits that the royalty payments are tied to
technological know-how used in U.S. production (as well as
trademark utilization in the U.S.), we note that the license
agreement provides for the patented manufacture by [* * * * * * *
*]. We understand [* * * * * * * *] to include the foreign
sellers/manufacturers of the imported products. Hence, the
patented manufacture does not pertain exclusively to Importer's
U.S. production.
Second, we find that the royalty is involved in the
production or sale of the imported merchandise. It is our
understanding that the patented know-how granted to Importer
relates to the manufacture of the products in their various
forms, as imported. Without the licensing agreement and the
attendant royalty payments, the imported merchandise as such
could not have been produced by the foreign suppliers.
Specifically, we note that in accordance with the supply
agreements, the [ * * * *
* * * * *
* * * * *
* * * * *]
this, in our opinion, suggests that the intellectual property
already received from [* * * * * * * *] via the license agreement
also is a necessary and integral part of the production or sale
of the imported merchandise. In other words, it would appear
that both types of know-how are indispensable to the production
and sale of the imported goods; without either one, production
and sale could not occur.
Finally, it is our position that Importer could not buy the
imported merchandise without paying the fee. A thorough review
of the license and purchase agreements reveals that taken as a
whole they do not support the language included in the license
agreement which counsel highlights, to wit, that Importer shall
not be required to pay any royalty or license fee as a condition
of the sale of merchandise exported to the U.S. To the contrary,
the license agreements provide for the payment of royalties by
Importer and that [ * *
* * * * *
* * * *
* ]. In particular, this is supported by the language included
in the license agreement stating that when [
* * * * *
* * * * *.]
Although counsel claims that the price of related products
already includes the appropriate payment made to the related
owner of an intangible asset for the use of such assets, it is
apparent through the license agreement that in numerous cases
when Importer uses such assets in the production of a product it
is incumbent on Importer to make the appropriate royalty payments
since they are not already included in the price of the imported
merchandise itself.
Furthermore, we find that the purchase of the merchandise and
payment of royalties are inextricably intertwined. For instance,
as stated above, the license agreement in some cases provides for
the [ * * * *
* * * * *.]
Such language suggests that the payment of the royalties is
closely tied to the purchase of the goods. It is our position
that this remains the case regardless of the frequency in which
this actually occurs. In addition, the license agreement
provides that [ * *
* * * * *
* * * *.] No evidence has
been submitted indicating that Importer has the autonomy to
purchase such merchandise other than from [* * * * * * * *].
Finally, the fact that the payments are made to [* * * * * * *
*], a party related to the foreign sellers, is further indication
that the royalties are closely tied to the purchase of the goods
and, therefore, a condition of sale. While we appreciate
counsel's position that the fact royalty payments are made to
parties related to the seller only should create a rebuttable
inference, as opposed to serve as prima facie evidence, of a
condition of sale, the submitted evidence does not warrant a
finding of non-dutiability.
We note that based on the information provided, we cannot
conclude that a substantial portion of these payments are based
on materials that are not imported. From the information
available, we cannot meaningfully distinguish the royalty
payments tendered for the imported raw materials, intermediary
products, and finished products. Further, counsel has not
provided any meaningful distinction separating the amount of the
payments attributable to the patent rights from the exclusive
trademark rights. Thus, we find both types of payments to
constitute a "condition of sale" and to "relate to the imported
merchandise" for purposes of the royalties analysis.
In consideration of the information currently available and
the fact that it has been concluded that the subject royalty
payments constitute royalties in accordance with 402(b)(1)(D),
we find it unnecessary for purposes of this decision to consider
whether these payments alternatively may be dutiable as assists
or proceeds of a subsequent resale in accordance with
402(b)(1)(C) and (E), respectively.
HOLDING:
The royalty payments or fees paid by Importer to [* * * * * *
* *] are included within the transaction value of the imported
merchandise as royalties in accordance with 402(b)(1)(D).
This decision should be mailed by your office to the internal
advice requester no later than sixty 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