HQ 545728 - Payments for the right to use trademarks, trade names on a pharmaceutical product; royalties; condition of sale; related parties - United States International Trade Commision Rulings

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HQ 545728

November 30, 1995
R:IT:V 545728 RSD

CATEGORY: VALUATION

Sandra Friedman, Esq.
Barnes, Richardson & Colburn
475 Park Avenue South
New York, New York 10016

RE: Payments for the right to use trademarks, trade names on a pharmaceutical product; royalties; condition of sale; related parties

Dear Ms. Friedman:

This is in response to your letter dated July 24, 1994, on behalf of the [XXXXXXXX] Corporation (hereinafter the buyer), in which you request a ruling on the dutiability of royalty and license fee payments made for the right to use a trademark, a trade name, and know how in selling the imported product. A copy of the license agreement was forwarded to our office on January 20, 1995. On March 27, 1995, a meeting was held at our offices with you and in-house counsel of the buyer to discuss this matter. Subsequently, you made two additional submissions. A submission dated May 10, 1995, concerned the relationship between the buyer and the seller. The submission dated July 13, 1995, contained a copy of a recent royalty invoice. In your letter of January 20, 1995, you requested that we give confidential treatment to the information contained in the licensing agreement. In a telephone conversation with you on November 30, 1995, you indicated that it would be satisfactory if we kept the names of the parties, the name of the product, the chemical ingredients, the quantity of the product distributed, the pricing information, the amount of the royalties and license fees, and the country of origin confidential. This information is bracketed and will not be disclosed in copies of this ruling made available to the public.

FACTS:

The buyer is a U.S. company which makes and sells pharmaceutical products. It imports [XXXXXXXXXXXXX] (hereinafter the licensed product), a pharmaceutical product in a controlled released dosage form, made by the foreign company [XXXXXXXX] (hereinafter the seller). The licensed product was developed by [XXXXXXXXX] (hereinafter the licensor) and bears the trademark [XXXXX] (hereinafter the licensed trademark) owned by the licensor. The licensor is the parent company of the seller.

In June of 1989, the buyer entered into a license agreement with the licensor regarding licensed products. The license agreement also contains provisions regarding the supply of the license product. The preamble to the agreement indicates that the licensor owns and controls certain proprietary information with respect to the licensed product and that the buyer wishes to market the licensed product in the territory during the term of the agreement, and the licensor wishes to supply the buyer with the licensed product for use and sale in the territory during the term of the agreement. The licensed product is defined in section 1 of the agreement as the pharmaceutical product in a controlled released dosage form developed by the licensor having as its sole active ingredient [XXXXXXXXXXXXXXXXXXXXXXXX] and marketed under the licensed trademark in [XXXXXX]. Under the agreement, the licensor grants to the buyer and the buyer accepts from the licensor the exclusive right and license to use and sell the licensed product and to use the licensor's know-how for such purposes. The buyer agrees to use and sell the licensed product solely under the trademark in the territory.

Section 4 of the agreement provides that the licensor agrees to supply to the buyer and the buyer agrees to purchase from the licensor, the buyer's total requirements of the licensed product in the form of [XXXXXXXXXXXXXXXXXXXXXX] as described and set forth in Enclosure 1 attached to the agreement. In addition, the licensor agrees to provide to the buyer [XXXXXXXXXXXXXXXXXXXXX] free of charge for use as samples during the first year of sale of the product. In exchange for the exclusive license rights, the buyer agrees to pay the licensor a royalty of [XXXX] percent of its net sales in the United States and Puerto Rico, and a non-creditable license fee in the amount of [XXXXXXXXXXXXXXXXXXXXX] payable in two installments. The buyer is unrelated to either the seller or the licensor.

Based on your submission, it appears that the licensor's obligation to supply the licensed product to the buyer is undertaken by the licensor's subsidiary, the seller.

ISSUE:

Whether royalty and license fee payments from the buyer to the licensor, a party related to the seller of the imported product, for various rights associated with the use and sale of the imported licensed product are dutiable?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA: 19 U.S.C. ? 1401a). The preferred method of appraisement is transaction value, which is defined as the "price actually paid or payable for merchandise when sold for exportation to the United States," plus certain enumerated additions. Although we have assumed for purposes of this ruling that transaction value is the appropriate basis of appraisement, no evidence has been provided to justify its use.

Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable. Two of the statutory additions to the price actually paid or payable are found in sections 402(b)(1)(D) and (E) which provide for additions to the price actually paid or payable for:

(D) any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly as a condition of the sale of the imported merchandise for exportation to the United States; and

(E) the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue, directly or indirectly to the seller.

In regard to the dutiability of royalties and license fees, the Statement of Administrative Action 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 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, where as royalties and license fees paid to third parties for use, in the United States, of copyrights and trademarks related 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 sale of the merchandise for exportation to the United States, an addition will be made.

Statement of Administrative Action , H.R. Doc. No. 153 96 Cong., 1st Sess., pt 2 reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981) at 48-49.

The question of whether the royalty payments are dutiable or not was analyzed in our notice on the dutiability of royalty payments, which was published in the Custom Bulletin on February 10, 1993, commonly referred to as "Hasbro II". In that notice we indicated that several questions must be answered in order to determine whether a royalty payment is related to imported merchandise and required as a condition of sale. As set forth in the notice the questions are: (1) was the imported merchandise manufactured under the 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? 27:6 Cust. B. & Dec. 1 at 9-11. Negative responses to the first and second questions, and an affirmative response to the third, suggest that a royalty payment is non-dutiable under section 402(b)(1)(D) of the TAA.

The first question posed by the notice is whether the imported merchandise was manufactured under patent. Although the information submitted with the ruling request does not indicate whether or not the imported merchandise was manufactured under patent, you claim that the product was not manufactured under patent.

The second question indicated in the notice, whether the royalty is involved in the production or sale of the imported merchandise, can be determined on information contained in the licensing agreement furnished with the ruling request. The agreement provides that the royalties and license fees are paid by the buyer, to the licensor, for the exclusive right and license to use and sell the imported product and to use licensor's know-how for such purposes. The agreement also provides that the licensed product is to be sold under the licensed trademark.

While it does not appear based on this language that payment of the royalty is in involved in the production of the merchandise, we conclude that such payment is involved in its sale. Even though the continuing royalties do not become due until the imported product is resold in the United Sates or Puerto Rico, the license agreement connects the payment of the royalties with the sale of the imported product to the buyer. Not only does the license agreement provide that buyer must purchase its total requirements for the product from the licensor, it specifies the terms of sale, including the purchase price. In addition, section 5 of the agreement provides in part that "if ... the Base price plus royalty payable by the buyer ... results in a cost-of-goods (including royalty) equal to or greater than [ ] percent of the buyer's Net Sales of Product in the Territory, the buyer shall have the right to manufacture or to have manufactured Product for its own account and the licensor shall deliver to the buyer the necessary technical information for such manufacture." These provisions closely tie the payment of royalties with the sale of the imported merchandise. Thus we find that the payment of royalties is involved in the sale of the imported licensed product.

The third question posed by the notice is whether the importer could buy the imported merchandise without paying the royalty fee i.e., whether the payments are a condition of sale. While royalties paid to third parties for use in the U.S., of a trademark related to the imported merchandise are generally not dutiable, the SAA provides that such payments will nevertheless be treated as dutiable if they represent a condition of the sale for exportation. SAA reprinted in, Dept. of Treas., Customs Valuation under the TAA at 49. Royalty payments are a condition of sale when they are paid on each and every importation and are inextricably intertwined with the imported merchandise; but if the payments are optional and not inextricably intertwined with the imported merchandise, or are paid solely for the exclusive right to manufacture and sell in a designated area, they are not a condition of sale. See Imperial Products, Inc. v. United States, 425 F.Supp. 852, 77 Cust. Ct. 66 (1976).

In this instance, the royalties and license fees are paid by the buyer, to a party related to the seller, for the use of the licensed trademark and for know-how in selling the licensed product. In HRL 545361, dated July 14, 1995, we ruled that certain trademark royalties were dutiable when paid to the seller or a party related to the seller, but not where they were paid to a third party unrelated to the seller. We noted that where the licensor and the seller are the same person, and the payment is made to the licensor/seller, we consider the royalty to be a condition of the sale of the merchandise for exportation to the U.S. The payment is not optional, but must be made to the licensor in its capacity as seller of the merchandise. We believe that the same principle must apply in this case because in order to buy the product, the buyer also had to agree to pay a royalty to the licensor and the royalty had to be paid on each and every importation. Our conclusion that the buyer had to pay royalties in order to buy the product is supported by the language of section 2 of the licensing agreement. In section 2.1, the licensor grants to the buyer the exclusive right and license to use and sell the product, and to use the licensor's know-how for such purposes. Section 2.2 states that the buyer agrees to use and sell the product solely under the licensed trademark in the territory. Furthermore, in the same agreement the licensor agrees to supply and the buyer agrees to purchase all the buyer's total requirements of the product. Therefore, it is evident that the royalty payment was not optional. In other words, in order to buy the licensed product, the buyer had to agree to pay the royalty and license fee on each and every importation of the license product. The licensor's obligation to supply the licensed product to the buyer is undertaken by the licensor's subsidiary, the seller. Under these circumstances, we find that payment of the royalties is a condition of sale of the of the imported product.

Based on the above considerations, we find that the royalty payments should be added to the price actually paid or payable under section 402(b)(1)(D) of the TAA. Having reached this conclusion, we do not address whether these payments could be considered dutiable proceeds under section 402(b)(1)(E) of the TAA.

HOLDING:

Pursuant to the foregoing, and assuming that transaction value is the appropriate method of appraisement, payments made by the buyer to the licensor constitute additions to the price actually paid or payable of the imported licensed product under section 402(b)(1)(D) of the TAA.

Sincerely,

Acting Director
International Trade Compliance

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