• HQ H100056
• Nov 15, 2010

• Type : Valuation • HTSUS :
•  Related:   225357; 231255; 548574; 546602; 545755; 547532; 546478; 546038; 545380; 544436; 544991; 545361; 545710; 545998; 545307; 545114; H012659; H092448; H024566   

OT:RR:CTF:VS H100056 GG

Port Director
U.S. Customs and Border Protection
610 S. Canal St., 3rd Floor
Chicago, IL 60607

RE: 19 U.S.C. § 1401a(b)(1)(D) and (E); Dutiability of Royalty Payments; 19 U.S.C. § 1484; Right to Make Entry

Dear Port Director:

This is in response to your memorandum of September 11, 2007, which forwarded the request for internal advice submitted on behalf of [Company A] (the “requester”), with respect to the dutiability of certain royalty payments. Counsel for the requester made additional submissions dated January 23, 2008, July 9, 2008, and April 1, 2010.

The requester has advised that the disclosure of certain information relative to this matter could potentially cause substantial harm to the competitive position of the parties involved. Based on our review of the matter we have concluded that the information in question is eligible for confidential treatment under 19 C.F.R. § 103.12; accordingly, we have granted the request for confidentiality. Appropriate steps will therefore be taken to ensure that the information remains confidential and, to this end, the bracketed portions of this decision will be redacted from any published versions of this decision. A public version of this decision is enclosed for your files.

FACTS:

The requester is the importer of record of an active pharmaceutical ingredient (“API”), [Bulk]. This product is licensed by the parent company, [Company B]. The foreign supplier of the API is [Company C], also a wholly-owned subsidiary of [Company B]. The requester is not the purchaser of the API from [Company C]; rather, its function is to import and store the API at its facility in a foreign trade zone (“FTZ”) until such time that it is shipped to [XX Holding Partnership] (the “Partnership”) in Puerto Rico for use in the manufacture of a finished product, [XXX].

The requester performs its importation and storage services pursuant to a formal Services Agreement entered into with another subsidiary of [Company B], [Company D]. The Services Agreement requires the requester to provide a variety of services in addition to those related to the importation and storage of pharmaceutical active ingredients. The covered services are listed in Appendix A to the Services Agreement, and include business-related activities such as the provision of accounting, financial, tax, legal, human resources, and information management services. In addition, the requester agrees to provide services that relate to: the marketing, advertising and commercial support of products; the regulatory, medical and drug safety of marketed products; the research and development of products, including preparation of regulatory filings and management of contract research organizations; the environmental waste disposal of hazardous materials or reactive chemical waste products; the distribution of samples; the oversight of third party manufacturing relationships; and, of most consequence here, the importation of pharmaceutical active ingredients and finished products. The Services Agreement specifies that the requester will be paid for the services that it provides.

The Partnership is the purchaser of the API from [Company C]. It is a joint venture that is owned by an affiliate of [Company E], the [Company F], and [Company D]. [Company F] owns 50.1 percent of the Partnership and [Company D] owns 49.9 percent of the Partnership. [Company F] is a separate legal entity from and unrelated to the [XX] group of companies referenced above (i.e., [Company B and Company C] and the requester). The overall arrangement is such that the purchaser of the imported API, i.e., the Partnership, is related to both the supplier, [Company C], and the licensor [Company B].

The terms of sale between [Company C] and the Partnership are typically “CIP,” i.e., “carriage and insurance paid [to named place of destination].” Under CIP sales terms, risk of loss passes from the seller to the buyer when the merchandise is placed on board the exporting carrier. Although the Partnership assumes risk of loss of the API at the time of exportation, title to the API only transfers from [Company C] to the Partnership when the API is withdrawn from FTZ inventory. Throughout this process, the requester never holds title to, or assumes risk of loss for, the imported API. On average, the API remains in the requester’s inventory for three months or less.

The Partnership is required to pay [Company C] for the supply of the imported API within 60 days upon shipment from the FTZ. The commercial invoice price for the imported API is factored into annual negotiations between the unrelated joint venture partners, [Company B and Company E]. To date, this purchase price has remained unchanged from the time the API is imported into the United States until approximately three months later when it is withdrawn from inventory. Therefore, the actual purchase price paid by the Partnership is the exact amount that is reflected on the commercial invoice that is presented to U.S. Customs and Border Protection (“CBP”) at the time of entry.

In addition to the separate supply payment that the Partnership makes to [Company C] for the supply of the imported API, the Partnership also pays various royalties to the licensor of the API, [Company B]. The terms and conditions giving rise to the supply of the API, and to the supply and royalty payments, are set forth in two separate agreements.

The Product Know-How License Agreement (the “Product Know-How Agreement”) was entered into between [Company B] and [Company E] (jointly referred to as “licensors”) and the Partnership (“licensee”), on January 1, 1997. Its stated purpose is to enable the Partnership to commercialize finished products in Territory B, which includes the United States. Article 2.1 grants the Partnership an exclusive license, under the “Developed Know-How,” to make, have made, sell, offer for sale and import the [Bulk] products in Territory B; to develop [Bulk] products for Territory B; and to make, have made and export the products outside of Territory B.

The following definitions apply under the Product Know-How Agreement:

“Developed Know-How” means any and all technical data, information, material and other know-how that relate to the formulation of the Products, including, without limitation, any analytical methodology, chemical, toxicological, pharmacological and clinical data, formula, procedures, protocols, techniques and results of experimentation and testing, developed by [Company B] and [Company E] under the Development Agreement. “[Bulk] Product” means the product or products having as an active ingredient [Bulk] or any salt, ester, metabolite or pro-drug thereof. “Product” means a [Bulk] product.

In consideration of the license grant, the Partnership agrees to pay a development royalty of [XX]% of the net sales of [Bulk] products in Territory B.

The second agreement, known formally as the [Bulk] Intellectual Property License and Supply Agreement (the “License and Supply Agreement”) was entered into between [Company B] (“licensor”) and the Partnership (“licensee”), also on January 1, 1997. This agreement makes provision for the grant of a license under the Product Intellectual Property to use certain patents, trademarks and know-how for the commercialization of [Bulk] products in Territory B, as well as for the supply of the imported API. The license rights are substantially the same as those granted in the Product Know-How Agreement. Article 2.1(i) grants the Partnership an exclusive license under the Product Intellectual Property to make, have made, sell, offer for sale and import the [Bulk] products in Territory B; to develop [Bulk] Products for Territory B; and to make, have made, and export the Products outside of Territory B. An additional license grant, found in 2.1(ii), makes provision for the production of [Bulk] after the “Exclusive Supply Period.” The Exclusive Supply Period is the period of time during which the licensor or its affiliates is the exclusive supplier of the API to the Partnership. Counsel advises that the License and Supply Agreement is currently within the Exclusive Supply Period, and asks that the internal advice decision address only the dutiability of royalties incurred within that period. This decision is structured accordingly.

The following definitions apply under the License and Supply Agreement:

“Product Intellectual Property” means the Product Know-How, the Licensed Trademarks and that part of the Licensed Patents relating to [Bulk] Products. “Product Know-How” means any and all technical data, information, material and other know-how that relate to the formulation of [Bulk] Products, including, without limitation, any analytical methodology, chemical, toxicological, pharmacological and clinical data, formulae, procedures, protocols, techniques and results of experimentation and testing, solely owned, developed or acquired by Licensor as of the date hereof.

The terms common to the two agreements, e.g., “Territory B”, “Product”, “[Bulk] Product” share the same definition.

The supply provision of the License and Supply Agreement is found in Article 3. Article 3.1 provides as follows:

3.1 Supply during the Exclusive Supply Period

During the Exclusive Supply Period, Licensor shall supply, or shall cause one or more of its Affiliates to supply, as exclusive supplier to the Partnership, the [Bulk] required for the development, clinical testing and manufacturing of [Bulk] Products for Territory B. The price to be paid by the Partnership for the [Bulk] shall be based on the Cost of Bulk and shall be paid to Licensor pursuant to Article 6 hereof.

Article 3.2 provides that the Partnership will be able to purchase the API from other parties in the event of rising production costs of the bulk or increased competition. This would signify the end of the Exclusive Supply Period. Article 3.3 specifies that parties to the agreement shall agree on the other terms and conditions for the supply of the API during the Exclusive Supply Period, including the payment mechanism for the imported bulk API. In consideration of the license rights granted and the services provided under the License and Supply Agreement, Article 6.1 requires the Partnership to make a “Discoverer’s Remuneration” equal to [XX] percent of net sales of [Bulk] products in Territory B. This consists of two separate components: (i) a discovery royalty; and (ii) a supply payment for the supply of the [Bulk]. The Agreement also provides that the price paid for [Bulk] shall be based on the cost of the [Bulk]. Under this arrangement, in order to calculate the discovery royalty, the cost of the API Bulk is not included in the remuneration figure [xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx]. It is undisputed that the supply payment made by the Partnership to [Company C] is part of the price actually paid or payable for the imported API. ISSUE:

Whether the requester, [Company A], has the right to enter the imported API;

Whether the subject royalty payments are dutiable as part of the price actually paid or payable for the imported merchandise;

Whether the royalty payments are an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D) and/or 1401a(b)(1)(E).

LAW AND ANALYSIS:

Right to Make Entry

Section 484(a)(1) of the Tariff Act of 1930, as amended (19 U.S.C. § 1484(a)(1)) provides that only parties qualified as the “importer of record” may make entry. Those qualified parties are identified in § 484(b)(2)(B) as the owner or purchaser of the merchandise, or, when appropriately designated by the owner, purchaser, or consignee of the merchandise, a licensed customs broker.

The terms “owner” and “purchaser” are further defined in Customs Directive 3530-002A, dated June 27, 2001. Sections 5.3.1 and 5.3.2 of the directive provide:

5.3.1 The terms “owner” and “purchaser” include any party with a financial interest in a transaction, including, but not limited to, the actual owner of the goods, the actual purchaser of the goods, a buying or selling agent, a person or firm who imports on consignment, a person or firm who imports under loan or lease, a person or firm who imports for exhibition at a trade fair, a person or firm who imports goods for repair or alteration or further fabrication, etc. Any such owner or purchaser may make entry on his own behalf or may designate a licensed Customs broker to make entry on his behalf and may be shown as the importer of record on the CF 7501. The terms “owner” or “purchaser” would not include a “nominal consignee” who effectively possesses no other right, title, or interest in the goods except as he possessed under a bill of lading, air waybill, or other shipping document.

5.3.2 Examples of nominal consignees not authorized to file Customs entries are express consignment operators (ECO), freight consolidators who handle consolidated shipments … and Customs brokers who are not permitted to transact business in Customs ports where a shipment is being entered.

The requester asserts that it has the right to make entry because it imports the API on consignment. It claims that it is required to fulfill a role beyond that of a nominal consignee, because it imports and stores and maintains the product in inventory. It also claims to have a financial interest in the API, because it receives a quarterly service fee for the services it performs under the formal Service Agreement with [Company D], including services relating to the importation of the API. The requester considers Headquarters Ruling Letter (“HQ”) 225357, dated December 22, 1994, to be supportive of its position that it may serve in the role of importer of record.

In HQ 225357, British Aerospace, Inc. (“BA”) received and held aircraft spare parts that had been consigned to it by Airbus Service Company. The arrangement was made pursuant to a consignment agreement entered into between the two companies. In upholding BA’s right to make entry, the ruling focused on the fact that the company had a right to possess the spare parts after importation apart from a transportation document such as a bill of lading or air waybill.

In another ruling, HQ 231255, dated March 28, 2006, CBP determined that a company did not have a sufficient financial interest to make entry, when its sole function was to store imported merchandise belonging to several related companies in a FTZ that it operated. There is no suggestion in that ruling that the importer received any financial remuneration from the related companies for its storage services, or performed under a formal agreement. Rather, it was noted that the FTZ operator did not benefit financially from the goods stored in the warehouse and had no interest in them other than as a custodian.

In the case under review, the requester has a right, as conferred by the Services Agreement, to possess the API after importation. In consideration for the services rendered under the agreement with respect to the API, i.e., importing, handling, storage and inventory management, it receives a fee. This arrangement appears to be similar to the BA situation described in HQ 225357. The requester is also required under the Services Agreement to perform a variety of other services, some of which may also indirectly relate to the imported active ingredient. For example, the requester provides services concerning marketing and samples distribution, which is an indication that the requester’s interest in the imported API extends beyond the time of importation and storage, all the way to the subsequent manufacture and distribution of the finished product made with the imported API. Other covered services relate to the regulatory, medical and drug safety of marketed products; the research and development of products, including preparation of regulatory filings and management of contract research organizations; and the environmental waste disposal of hazardous materials or reactive chemical waste products. As indicated above, the requester is remunerated under the Services Agreement for its provision of these services. These factors, taken together, demonstrate that the requester has a sufficient financial interest to enter the API.

Appraisement of Imported API

Sale for Exportation

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. The 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.

As a preliminary matter, we must determine whether the API was sold for exportation to the United States. Although the API is sold by [Company C] to the Partnership, the requester indicates that the sales occur after importation, following placement and storage in the requester’s inventory. The arrangement is characterized in the internal advice request as importation on consignment. Under a typical consignment arrangement, the sale occurs after the goods are already in the consignee’s possession. If this type of situation involves imported merchandise, the sale is considered a domestic sale instead of a sale for exportation, thus ruling out the use of transaction value. See, e.g., HQ 548574, dated March 17, 2005; HQ 546602, dated January 29, 1997; HQ 545755, dated May 18, 1995.

In certain situations, however, there may be a sale for exportation to the United States even though a transaction is described as, or has attributes of, a consignment. For example, in HQ H012659, dated November 14, 2007, imported automotive components were delivered to a designated logistics service provider, and were held in inventory until they were transferred to the buyer for production into transmissions. The contract between the seller and buyer required the buyer to issue payment to the seller on the 63rd day after the issuance of the pro forma invoice, regardless of whether the parts had been placed in production or remained in inventory. Title transferred from the seller to the buyer either when the parts were delivered to the buyer or on the 63rd day, whichever occurred earliest. The buyer assumed risk of loss of the parts when they were placed on board the exporting carrier for shipment to the United States. In determining that the sales were sales for exportation to the United States, CBP considered the following factors: the buyer was obligated to purchase the imported merchandise and to pay within a specified time frame; the price paid conformed to the prices on the pro forma and commercial invoices; and risk of loss transferred at the place of shipment. See also HQ H092448, dated May 4, 2010.

Applying the factors in HQ H012659, [Company C] cannot sell the imported API to any buyer other than the Partnership; the price of the imported API is agreed to prior to importation based upon past negotiations between the parties; the Partnership is obligated to purchase the API from [Company C] until such time that [Company C] may no longer supply the API to the Partnership; the price declared on the pro forma invoice at the time of entry is the same price the Partnership pays to [Company C]; and risk of loss passes from [Company C] to the Partnership when the API is handed over to the outbound carrier. There are enough parallels between this case and HQ H012659 for us to conclude that the sale of the API is a sale for exportation to the United States.

Price Actually Paid or Payable

The next issue is whether the royalty payments are included in the price actually paid or payable for the imported API. 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). In this particular case, the royalty payments are made by the Partnership to [Company B], the parent company of the seller of the API. 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 Sportswear Company v. United States, 905 F.2d 377(CAFC 1990), and Chrysler Corporation v. United States, 17 CIT 1049 (CIT 1993).

We note that the Product Know-How Agreement and the License and Supply Agreement were signed on the same day; that their preambles make reference to each other; and that a supply provision with respect to the imported active ingredient is an integral part of the License and Supply Agreement. Thus, the question arises as to whether the license and supply provisions are inextricably intertwined such that the Partnership paid for the capabilities to manufacture the finished product and at the same time became obligated to purchase bulk ingredient to manufacture the finished product.

Counsel for the importer takes the position that the royalty payments are not part of the price actually paid or payable because they are for the right to certain technical data, know-how, and intellectual property related to finished products containing the active imported ingredient; they are made based on a percentage of the sales of the finished products rather than a percentage of a resale of the imported API; the arrangement to purchase the imported API exists independently of the arrangement to pay the royalties, notwithstanding its inclusion in the License and Supply Agreement; and the value of the imported API is not considered when calculating the royalty. Counsel also maintains that the independence of the sales of the API from the royalty payments is further demonstrated by the fact that the Partnership can purchase the API indefinitely without paying any royalties, because the obligation to pay the royalties arises only upon the manufacture and sale of the finished products. If there are no sales of the finished products, no royalties will be due. On this basis, and citing to Headquarters Ruling Letter (“HQ”) 547532, dated November 2, 2001, counsel argues that the royalty payments are not related to the imported API, and thus are not part of the price actually paid or payable for the API.

In HQ 547532, an automobile manufacturer imported components, known as “KD Kits,” from its parent company pursuant to a Component Supply Agreement, and manufactured automobiles in a foreign trade subzone using both the imported and domestic components. The importer had also entered into a non-exclusive license agreement with the parent company, under which it acquired rights to certain technical information or patents for use in connection with the manufacture of the vehicles. In exchange for these rights, the importer paid the parent company a royalty based on the net sales of the finished automobiles. Although the Component Supply Agreement had a provision requiring the importer to purchase all of the KD Kits from the parent company, the importer indicated that it was entitled to source some or all of the elements of the KD Kits from other suppliers, and on occasion had done so for reasons of cost, quality, or availability. The Component Supply Agreement also contained no reference to the license agreement. Under a Generra and Chrysler analysis, CBP determined that the royalty payments were unrelated to the purchase of the KD Kits. The basis for its determination was that the importer had demonstrated that the rights for which royalties were paid related solely to the use of technical knowledge in the manufacture in the United States of licensed products made in part with the imported KD kits. It was also noted that the value of the imported merchandise was not included in the royalty calculation. CBP further observed that the independence of the sales from the royalty payments was established by the following factors: the importer could purchase parts from its parent company indefinitely without paying royalties; the obligation to pay arose only upon the manufacture and sale of the vehicles; no royalty payment was due if the vehicles containing the imported KD kits were not sold; and the importer was free under certain circumstances to purchase the KD kits from other suppliers.

There are significant distinctions between HQ 547532 and the situation under review. Rather than being separate from, and containing no reference to, the license agreements, the supply provision in this case is an integral part of the License and Supply Agreement. The Product Know-How Agreement, in turn, refers to the License and Supply Agreement in its preamble, thus conceivably linking the payment of the development royalty to the supply of the API. Also, during the Exclusive Supply Period, on which this internal advice decision focuses, the importer is required to purchase the API from the Licensor or its affiliates. Because of these differences, we cannot rely on HQ 547532 alone in determining whether the royalty payments are included in the price actually paid or payable for the imported goods.

A more recent ruling, HQ H024566, dated October 15, 2008, also addressed royalty payments made in association with the importation of KD packs. In that case, the importer manufactured turbochargers using technology developed and licensed by the foreign seller of the KD packs. The turbochargers were assembled using the imported KD packs and other parts either manufactured or procured elsewhere by the importer. A provision in the license agreement required the importer to purchase the KD packs from the licensor. The royalty amount, which was based on the net invoiced value of the manufactured turbochargers sold by the importer, specifically excluded the cost of the KD packs. CBP determined that the royalty payments were not part of the price actually paid or payable for the imported KD packs, but instead were for the right to manufacture and sell a finished product in the United States using the licensor’s patents and technical information.

In HQ 546478, dated February 11, 1998, it was determined that royalties relating to marketing-related intellectual property rights associated with the distribution of product in a territory and based only on the percentage of the importer’s mark-up (excluding the value of the imported product) were not part of the transaction value of the imported merchandise. The imported merchandise in that case was not further manufactured in the United States but was sold in the condition as imported. The sublicense agreement in HQ 546478 contained only a brief reference to the importer’s purchase of the imported merchandise. In HQ 546478, our decision included the assumption that there were no supply agreements or other contracts between the parties that linked the royalty payments with the purchase of the imported merchandise.

In HQ 546038 dated July 19, 1996, the importer entered into a license agreement with the supplier of pharmaceutical tablets. Under the agreement, the importer acquired know-how and U.S. trademark and patent rights for the tablets, which were a prerequisite to the importer obtaining U.S. Food and Drug Administration (“FDA”) approval to market the tablets in the United States. Once such approval was secured, the importer was required to make initial payments and continuing royalties under the license agreement. On the same day that the importer and supplier entered into the license agreement, they signed a supply agreement which obligated the importer to purchase the tablets from the supplier. CBP determined that the royalty payments were closely related to the imported merchandise. It based this conclusion in part on the fact that on the same day the importer signed the license agreement granting it rights to manufacture the tablets, it also signed the supply agreement which obligated it to purchase the imported product from the supplier. Thus, it was found that the two agreements were “intrinsically intertwined” because at the same time that the importer paid for the capability to manufacture the tablets, it forfeited that right by entering into the supply agreement. Also, the license agreement allowed the importer to obtain FDA approval, thus enabling it to import the product pursuant to the supply agreement. In HQ 545380, March 30, 1995, the imported merchandise consisted of components for a mainframe computer system. The importer used the imported components to manufacture the computer system. At issue were royalties the importer paid to the seller pursuant to a licensing agreement for the use of technical information and know-how related to the development of the computer system. Under the terms of the agreement, the technical know-how was not limited to that which was required for the manufacture of the computer system but also pertained to technical know-how regarding the manufacture and development of the imported components. Under the terms of the licensing agreement, the importer was required to purchase the components for the computer system from the seller. Customs determined that under these circumstances the royalty was related to the production or sale of the imported merchandise.

In comparing these rulings, it appears that the case under consideration more closely resembles HQ H024566 and HQ 547532. Those rulings and this case share the following attributes: the license agreements bestow rights in connection with the manufacture in the United States of licensed products made in part with the imported merchandise; the licensed know-how is with respect to the finished products, not the imported merchandise; the supply agreements pertain to merchandise that is incorporated in the finished product, and not to the finished products; separate payments apart from the royalties are made for the imported merchandise; and the value of the imported merchandise is excluded from the royalty calculation. In contrast, in HQ 546038 and HQ 545380, the licensed know-how relates in at least some respects to the manufacture and development of the imported merchandise, thus providing a clearer linkage between the royalty payments and the imported merchandise. There is also no mention in either case of the royalty excluding the cost of the imported merchandise. Upon review of the submitted information, we agree that the license fees are not an element of the price actually paid or payable for the imported API. Since the licensed rights for which the license fees are paid relate solely to the manufacture and sale of the finished products in the United States, and the value of the imported API is not taken into account when determining the amount of the license fees, we find that such fees do not relate to the sale for exportation of the imported merchandise.

Addition to the Price Actually Paid or Payable as a Royalty

We must next consider whether the royalty payments constitute additions to the price actually paid or payable for the imported merchandise. 19 U.S.C. § 1401a(b)(4)(A). Under 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." Under section 19 U.S.C. § 1401a(b)(1)(E), an addition to the price actually paid or payable is made for “the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller.”

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 provides:

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: (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 for the United States.

After reviewing the language of the statute along with the legislative history and prior case law, Customs and Border Protection (“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 1 and 2 and a negative answer to question 3 suggest that the payments are dutiable; negative answers to questions 1 and 2 and an affirmative answer to question 3 suggest that the payments are nondutiable. Question 3 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 the “Hasbro II ruling”), which stated these questions in discussing previously-issued HQ 544436, dated February 4, 1991.

In the General Notice (the Hasbro II ruling where HQ 544436 was discussed), CBP determined that the royalty paid to the seller in the matter under consideration 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 HQ 544991 of September 13, 1995, CBP held that a royalty was involved in the sale of the imported merchandise because 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 HQ 545380, supra, where CBP found the royalty to be related to the production or sale of the imported merchandise where, under the terms of the licensing agreement, the importer was required to purchase components from the seller. Some factors which CBP 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 HQ 544991, HQ 545380; HQ 545361, dated July 20, 1995; and the General Notice.

The first question concerning the dutiability of the payments made under the Product Know-How and License and Supply agreements is whether the imported merchandise is manufactured under patent. The answer to this question is “yes.” However, counsel for the requester emphasizes that the imported API is not one of the licensed products covered by either agreement. As such, it argues that this question does not bear much weight here since the patent for the manufacture of the API is unrelated to the royalty for the intellectual property and technical know-how to make the finished product [XX]. In considering this argument, we make note of the fact that in HQ 547532, supra, CBP also questioned the relevancy of the first question when the royalties concerned the assembly of vehicles in the United States, and not the imported components. With regard to the second question, i.e., whether the royalties are involved in the production or sale of the imported product, counsel argues that the facts of its case are substantially similar to those of HQ H024566, supra. As discussed previously, in HQ H024566 the importer had a non-exclusive license to manufacture turbochargers in the United States using imported KD packs and other parts, and to sell the turbochargers to related and unrelated customers. A provision in the license agreement required the importer to purchase the KD packs from the licensor. The cost of the imported merchandise was subtracted from the final royalty amount. CBP determined that the royalty payments were not involved in the production or sale of the imported merchandise, noting that “the royalty payment is for the use of various patents in the production of merchandise in the United States which incorporates the imported merchandise, but is not for the imported merchandise itself…” In reaching this conclusion, CBP took into consideration the fact that the cost of the imported KD Packs was subtracted from the final royalty amount.

In HQ 545710, dated October 30, 1998, a buyer imported a patented pharmaceutical compound that was used as the active ingredient in a finished pharmaceutical product. By the terms of a license agreement, the buyer was granted the right under licensed patents and know-how to make, use and sell the licensed compound, and to make, have made, use and sell licensed product from licensed compound. As consideration for these rights, the buyer agreed to pay the patent holder a royalty based on a specified percentage of the net sales of the licensed finished pharmaceutical products sold by the buyer or its sub-licensees or subsidiaries. In addressing the second question, CBP found that the royalties paid related to the production and sale of the imported licensed compound, because the compound was specifically covered by the license agreement. See also HQ 545998, dated September 13, 1996.

In HQ 544991, dated September 13, 1995, the importer entered in a license agreement with its parent company, which granted the importer the right to use licensed technology and a trademark in the manufacture, marketing and use of machines in the United States. The parent company supplied certain parts for the manufacture of the machines. The terms and conditions pertaining to the supply of the parts required the importer to forecast its supply needs, to place purchase orders no later than three months before the scheduled shipment date, and to pay for the parts as prescribed by the supplier’s price list. In consideration for the licensed technology and technical assistance provided by the parent company and for the use of the trademark, the importer also paid royalties based on net sales of finished machines. CBP determined that the payment of the royalties was closely tied to the purchase of the imported parts, and as such was a condition of the sale for exportation of the imported parts.

In analyzing these cases, we find that there is a clear parallel between the requester’s situation and H024566, and obvious distinctions between the facts of this case and HQ 545710 and HQ 544991. In HQ 545710, the licensed know-how applied to the imported active ingredient as well as to the finished product, whereas the intellectual property granted to the Partnership in both agreements pertains only to the manufacture of the finished pharmaceutical goods. This indicates that the royalty payments made by the Partnership are involved in the production of the finished product [XX], as opposed to the production of the imported API. And while the royalty calculations in the instant case and in HQ H024566 specifically exclude the cost of the imported merchandise, there is no mention of a corresponding exclusion in HQ 545710 and HQ 544991. The omission [xxxxxxxxxx] of the cost of the API from the royalty amount suggests that the royalties are paid in respect of post-importation activities, and are not involved in the sale for exportation to the United States of the API. The answer to the second question is, therefore, “no.”

The third question is whether the purchaser may buy the imported [Bulk] without paying the subject license fees. Counsel for the requester cites to HQ 545307, dated February 3, 1995, which involved the dutiability of certain royalty payments involving scientific and technical information in connection with the manufacture and sale of a finished pharmaceutical product. In that ruling, CBP held that the royalty payments at issue were not a condition of sale of the imported active pharmaceutical ingredient and therefore did not constitute an addition to the price actually paid or payable under 19 U.S.C. § 1401a(b)(1)(D). HQ 545307 is distinguishable from the present matter in a number of respects. First, unlike in HQ 545307, the imported merchandise here is manufactured under patent. Second, the parties in HQ 545307 were unrelated, whereas a relationship exists here. And third, the imported active ingredient in HQ 545307 was not imported pursuant to a supply agreement. Taking these differences into consideration, we do not find HQ 545307 to be particularly persuasive here.

Again, we find HQ H024566 to be more applicable to the case at hand. There, it was determined that the importer could buy the imported KD packs without paying the royalty, because the activity triggering the obligation to pay the royalty was not the importation of the KD packs, but rather, the production and sale of the turbochargers in the United States. The situation under review is similar, in that the requirement to pay the royalties only arises when the finished product [XX] is manufactured and sold in the United States. Counsel for the requester also points out that the finished product [XX] that contains the imported API is frequently used in clinical research, or provided as samples or donations through the requester’s extensive needy patient program, and that none of those situations would trigger the obligation to pay royalties. Taking all of these factors into consideration, it is our determination that the Partnership could buy the API without paying the license fees. Therefore, the response to the third question is “yes.”

Pursuant to the analysis above, we find that the royalty payments made under the Product Know-How and License and Supply Agreements are not additions to the price actually paid or payable for the imported merchandise under 19 U.S.C. § 1401a(b)(1)(D).

Addition to the Price Actually Paid or Payable as a Proceed

Nevertheless, it still must be ascertained whether the payments are to be added to the price actually paid or payable as proceeds pursuant to 19 U.S.C. §1401a(b)(1)(E). This provides that "the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller," are to be added to the price actually paid or payable. Counsel for the requester contends that the royalty payments are not dutiable as proceeds because as a result of the processing in the United States, the imported API undergoes substantial processing and manufacturing which leads to the creation of a new, distinct product on which the royalty payments are based.

Counsel points to an interpretative note in the Customs Regulations in support of the argument that the royalties are not dutiable. Specifically, 19 CFR § 152.103(b)(3) provides:

A royalty is paid on the basis of the price in a sale in the United States of a gallon of a particular product imported by the pound and transformed into a solution after importation. If the royalty is based partially on the imported merchandise and partially on other factors which have nothing to do with the imported merchandise (such as 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 seller), it would be inappropriate to attempt to make an addition for the royalty. However, if the amount of this royalty is based only on the imported merchandise and can be readily quantified, an addition to the price actually paid or payable will be made.

In HQ 545114, dated September 30, 1993 (C.S.D. 93-26), an imported chemical was used in connection with the manufacture under license in the United States of a pharmaceutical product. Royalty payments were made by the importer for the right to use a patented process and know-how necessary to manufacture the finished product, and were based on the resale of the finished product. In holding that the payments were not dutiable as proceeds under 19 U.S.C. § 1401a(b)(1)(E), we observed that the manufacturing involved more than simple mixing and finishing. Moreover, once the finished product was produced, it was no longer possible to isolate the imported merchandise.

In HQ 545307, supra, the imported merchandise underwent a chemical reaction resulting in the formation of a new chemical complex. The processing in the United States constituted much more than simple mixing and finishing, creating a new product, which was substantially different from the imported merchandise. CBP determined that since the royalty payment was based in part on materials that were not imported and other factors (mixing the imported merchandise with U.S. ingredients so it was no longer separately identifiable), the payment did not constitute an addition to the price actually paid or payable as a proceed.

Counsel for the requester indicates that the imported API is combined with several necessary excipients, which creates a new product, the finished product [XX]. A copy of a label for the finished product was provided, which shows at least eight other ingredients besides the imported API. After the manufacture of the finished product, the API is no longer separately identifiable from the other ingredients that are used in the manufacturing process. We agree that the manufacture of the finished product constitutes more than simple mixing and finishing, that a new product is created, and that the finished product upon which the royalty payment is based is substantially different from the imported merchandise. Consequently, the royalty payments do not constitute proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly, to the seller.

HOLDING:

The requester, [Company A], has the right to make entry;

The subject royalty payments are not dutiable as part of the price actually paid or payable for the imported merchandise; and

The royalty payments are not an addition to the price actually paid or payable for the imported API under 19 U.S.C. § 1401a(b)(1)(D) or (E).

Please promptly provide a copy of this ruling to counsel for the requester. Sixty days from the date of this ruling 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 methods of public distribution.

Sincerely,

Monika R. Brenner
Chief
Valuation and Special Programs Branch