HQ 546034 - IA 15/95; transaction value; ?402(b)(1)(D); royalties; General Notice, Dutiability of Royalty Payments; SAA; HRLs 545321 and 545776; proceeds of subsequent resale; insufficient information; ?402(h)(5); HRL 545504 - United States International Trade Commision Rulings

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HQ 546034

May 6, 1997

RR:IT:VA 546034 KCC

CATEGORY: VALUATION

Port Director
U.S. Customs Service
JFK Airport
Building #77, Room 228
Jamaica, New York 11430

RE: IA 15/95; transaction value; ?402(b)(1)(D); royalties; General Notice, Dutiability of Royalty Payments; SAA; HRLs 545321 and 545776; proceeds of subsequent resale; insufficient information; ?402(h)(5); HRL 545504

Dear Port Director:

This is in regard to your memorandum of March 14, 1995, under cover of which you forwarded a request for internal advice (IA 15/95), dated February 9, 1995, submitted by Ross and Hardies on behalf of CIBA-GEIGY Corporation ("the Company"), concerning whether certain payments constitute non-dutiable charges under submitted with the internal advice request. We regret the delay in responding.

FACTS:

The royalty payments at issue are made pursuant to a Licence Agreement between CIBA-Geigy Limited ("Limited") and Henkel KGaA ("Henkel") executed by both parties in early 1990. Pursuant to includes the Company, acquired from Henkel the exclusive worldwide "...license to make, use and sell the Compound and the Product(s) under the Patent Rights in the Field." The Compound is defined in ?1(a) of the License Agreement as "1-hydroxy -3 aminopropane-1, 1-diphosphonic acid, "ADP" and its N substituted derivatives and its salts respectively (e.g. di-sodium pamidronate)...." ?1(e) of the License Agreement defines the term Product(s) as any pharmaceutical product containing the Compound as the only Active Substance or in combination with other Active Substances (and ready for sale to third parties)."

The imported product at issue is Aredia, put up in vials for intravenous administration, which is the trade name for a medicament containing the active ingredient pamidronate disodium (the "Compound"), a drug used to inhibit the resorption of bone. Although the use of the Compound in humans was developed by Limited, Henkel is the owner of the patent rights. However, Limited and Henkel have joint patent protection. The imported product was manufactured by Limited under the patent held by Henkel. The Company purchased Aredia from Limited and imported it into the U.S.

In exchange for the exclusive license, Limited is required to pay Henkel a royalty based on a percentage of the net sales value. ?3 of the License Agreement. The net sales value is defined in ?1(h) of the License Agreement as "the value which results from the gross sales of the Product(s) by [Limited] or its Affiliates to third parties in finished specialty form, i.e. ready for sale to patients, less trade, cash, or, volume discounts and the legal added value tax separately shown." The royalty is accounted for on a semi-annual basis and payment is due within two months after the end of the half-year. ?5 of the License Agreement.

The purchase of the product is governed by a Supply Agreement between the Company and Limited dated April 1, 1994. The Supply Agreement was written because the Company desired to purchase and Limited desired to sell certain "Agreement Products." Henkel is not a party to the Supply Agreement and is not related to Limited or the Company. Limited and the Company are related and as defined by the License Agreement, the Company is considered an affiliate of Limited. The Supply Agreement states that "the proprietary rights, including patent rights, trademarks, etc. with respect to such products within the Untied States are owned by or licensed to [Company]...." ?2(b) of the Supply Agreement states that "[Limited] will use its best efforts to fill all [Company's] orders for Agreement Products placed hereunder..." for a set price as determined by ?3 of the Supply Agreement. The term "Agreement Products" is defined in ?1(a) of the Supply Agreement as "specialty chemicals or other products, including compounds, composititions and formulations thereof, and raw materials, intermediates and components for the manufacture or formulation thereof, which shall be supplied by [Limited] to [Company]."

Additionally, ?3(e) of the Supply Agreement states that "[u]nless it is otherwise impractical or precluded from doing so by reason of the agreement with the third party, all royalty payments due to third parties on account of the Agreement Products shall be paid by [the Company] to such third party." However, Counsel for the Company states that the royalty payments are actually made from the Company to Limited, who then remits the payments to Henkel. Counsel states that the royalty payments from the Company to Henkel are transmitted through Limited only as a matter of convenience, a mere pass through. Henkel relies on Limited to ensure that the payments from the Affiliates are correct. Counsel contends that the substance of the payments, as opposed to the form, is that the payments are made to Henkel.

You contend that the royalty payments constitute "proceeds" from the subsequent resale of the imported product that accrue, directly or indirectly, to the seller (Limited) and are to be added to the price actually paid or payable pursuant to the royalty payments are not dutiable as proceeds because they do not directly relate to the imported product. Additionally, citing ?402(b)(1) of the TAA, Counsel states that, if the payments are dutiable as proceeds, transaction value is an unacceptable method of appraisement because of the lack of sufficient information.

ISSUE:

1. Whether the royalty payments made by the Company to Henkel are included in the transaction value of the imported product under ?402(b)(1)(D) of the TAA.

2. Whether the royalty payments made by the Company to Henkel are included in the transaction value of the imported product as proceeds of subsequent resale under ?402(b)(1)(E) of the TAA.

3. Whether there is sufficient information to determine the amount of the royalties.

LAW AND ANALYSIS:

The preferred method of appraising merchandise imported into the U.S. is transaction value pursuant to ?402(b) of the TAA, codified at 19 U.S.C. 1401a. ?402(b)(1) of the TAA provides, in pertinent part, that 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. ?402(b)(1) of the TAA provides 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.

1. Royalty Payments

With regard to royalties, the Statement of Administrative Action ("SAA"), adopted by Congress with the passage of the TAA, provides 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 (October 1981), at 48-49.

In General Notice, Dutiability of Royalty Payments, 27 Cust. Bull. 12 (1993), 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 related to the imported merchandise and a condition of sale and, therefore, dutiable as royalty payments.

Regarding the first factor, the imported product was manufactured under patent held by Henkel. The Licence Agreement indicates that Henkel is the owner of the patent rights relating to the "Compound", and as Limited developed the Compound for use in humans, it obtained joint patent protection with Henkel. Therefore, Limited and its affiliates hold and/or were granted the right to use any patents that exist for the Compound and its Products in the designated territorial area.

Next, it has been submitted that the royalty payments are not involved in the production or sale of the imported Aredia vials, since the royalty payments become due only after the Company sells the product to third parties. We disagree. It is our opinion that the royalty payments are involved in the production and sale of the imported product. The Licence Agreement grants both Limited and the Company, "an exclusive license in the Territory to make, use, and sell the Compound and the Product(s) under the Patent Rights..." held by Henkel. Limited legally carried forth this obligation in the Supply Agreement by stating that the Company was to pay all royalty obligations to third parties which in this case is Henkel. It is our understanding that the imported product, manufactured by Limited, is manufactured using the patent rights referred to in the License Agreement for which the royalties are paid. In effect, the royalty payment relates to the technical information involved in the patented process to manufactured the imported Product. As such, the royalty, which is paid upon the sale of the imported product is involved in its production of the imported product. See, HRL 545321 dated June 30, 1995.

Additionally, it is our position that the payment of the royalties is closely related to the sale of the imported product. As previously stated, the Licence Agreement grants Limited "an exclusive license in the Territory to make, use, and sell the Compound and the Product(s) under the Patent Rights..." held by Henkel. By definition in the License Agreement, the "Compound" is the active ingredient found in the "Product" Aredia which is the imported product at issue. In executing the Licence Agreement Limited obligated its affiliates to the terms of the license agreement, including the obligation to make royalty payments. Thereafter, the Company and Limited entered into the Supply Agreement which obligated Limited to supply all of Company's product needs. In ?3(e) of the Supply Agreement Limited legally carried over the royalty payment stating that "[u]nless it is otherwise impractical or precluded from doing so by reason of the agreement with the third party, all royalty payments due to third parties on account of the Agreement Products shall be paid by [the Company] to such third party" i.e., Henkel. As stated by Counsel, pursuant to an arrangement with Henkel, the royalty payments are made to Limited, who thereafter remits them to Henkel. Without paying the royalty fee to Limited pursuant to the Licence and Supply Agreements, as well as the informal royalty payment agreement between all three parties, Company could not import the merchandise into the U.S. for sale to third parties. Thus, we find that the royalty payments pertain to the sale for exportation of the imported product.

With regard to the third question, i.e., could the importer buy the product without paying the fee, Customs acknowledged that the answer goes to the heart of whether a payment is considered to be a condition of sale. In this case, pursuant to the License Agreement, the royalty is to be paid by Limited on "the Net-Sales Value" which is defined as "the value which results from the gross sales of the Product(s) by [Limited] or its affiliates [the Company] to third parties...." Pursuant to ?3(e) of the Supply Agreement, the Company is obligated to pay the royalty on the sale of the imported product to Henkel. However, as stated by Counsel, the Company pays the royalty to Limited who remits the royalty payment to Henkel. The Supply Agreement obligates the Company to pay the royalty fee for the imported product. Although the Supply Agreement states that the Company is to pay third parties any necessary royalty payments, the Company pays Limited the royalty fees. Thus, Company can not import the merchandise unless it pays the royalty fees. Pursuant to the License and Supply Agreements, as well as the informal royalty payment agreement between all three parties, royalty payments are due on each item that is purchased, imported and sold. Thus, the answer to question three is that the Company could not purchase the imported product without paying the royalty fee.

Additionally, we have held that royalty payments made directly to, or indirectly to patent holders, who were not the seller or related to the seller, were additions to the price actually paid or payable as royalties pursuant to ?402(b)(1)(D) of the TAA when such payments were related to the imported merchandise and were a condition of their sale. In HRL 545321 dated June 30, 1995, the importer had purchased merchandise from a related seller. The importer's parent company paid certain royalties to two licensors and the importer reimbursed its parent for such payments. In HRL 545776 dated September 1, 1995, the importer purchased merchandise from an unrelated seller and was making royalty payments to its parent which the parent paid to the licensor. In both of these cases, the importer paid royalty fees for the right to use patented technologies in the manufacture of the imported merchandise. Without the licensing agreements with their corresponding royalty payments the imported merchandise could not have been produced by the manufacturer. Both cases determined that royalty payments were related to the imported merchandise and a condition of sale of the imported merchandise for purposes of ?402(b)(1)(D) of the TAA.

Based on the above considerations, we find that the royalty payments are included in the transaction value of the imported product under ?402(b)(1)(D) of the TAA. The payments are related to the imported merchandise which the buyer is required to pay as a condition of sale.

2. Proceeds of Subsequent Resale

The next issue is whether the royalty payments constitute proceeds of subsequent resale, disposal or use, pursuant to proceeds of subsequent resale as follows:

Additions for the value of any part of the proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue directly or indirectly to the seller, do not extend to the flow of dividends or other payments from the buyer to the seller that do not directly relate to the imported merchandise. Whether an addition will be made must be determined on a case-by-case basis depending on the facts of each individual transaction.

The instant case involves the type of situation described by Congress where "certain elements called 'royalties' may fall within the scope of the language under either new section 402(b)(1)(D) or 402 (b)(2)(E) or both." See, The General Notice on the Dutiability of "Royalty" Payments.

In this case, Counsel for the Company states that the royalty payment is made to Limited and then is passed through to Henkel. Pursuant to the Supply Agreement, Counsel states that the Company is contractually obligated to pay the royalties to Henkel. Counsel maintains that payment of the royalties through Limited is solely done as a collection agent for Henkel. Based on the information submitted, the royalty payments accrue directly to Limited, the seller. In the Licence Agreement, Limited and its affiliates are obligated to pay royalties. The Company, through the Supply Agreement, agreed to pay these royalties. However, in spite of the contract, the Company makes the royalty payments to Limited. It is not necessary to establish whether the seller, Limited, benefits. The SAA states that the payments must only accrue directly or indirectly to the seller. See also, Generra Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990). The proceeds of the subsequent resale clearly inure to the benefit of the seller.

There is no dispute that the royalty payment becomes due upon the Company's resale of the imported product. The amount of the royalty payments is based on the "Net-Sales Value" which is defined as the gross sales of the Aredia vials to third partes. Counsel for the Company contends that the payment made is not proceeds of subsequent resale because, pursuant to the Licence Agreement, the payments are made on the sale of any royalty product whether imported or not. However, the Supply Agreement obligated Limited to supply all of Company's product needs. ?2 of the Supply Agreement. The Company is acquiring all of its product needs from Limited and thereafter making the royalty payments to Limited for the sold imported merchandise. Therefore, the proceeds of the subsequent resale apply to the imported product. The royalty payments in this situation directly relate to the imported product and, thus, are statutory additions to the price actually paid or payable as proceeds of a subsequent resale pursuant to ?402(b)(1)(E) of the TAA.

3. Sufficient Information

The next issue to be addressed is whether there is sufficient information to determine the amount of the royalties. This issue arises because the continuing royalties are not due until the Aredia is sold in the U.S.

?402(b) of the TAA provides that the price actually paid or payable for imported merchandise shall be increased by the amounts attributable to the enumerated items only to the extent that such amount is based on sufficient information. If sufficient information is not available, for any reason, the transaction value of the imported merchandise concerned shall be treated, for purposes of ?402(b) of the TAA, as one that cannot be determined. The term "sufficient information" is defined as "information that establishes the accuracy of such amount, difference, or adjustment." See, ?402(h)(5) of the TAA.

In Headquarters Ruling Letter (HRL) 545504 dated May 4, 1995, involving proceeds under ?402(b)(1)(E), counsel argued that there was a lack of sufficient information to establish transaction value because the proceeds cannot be quantified in a reasonable period of time. In that case, the buyer was required to account for sales on a quarterly basis, with an accounting and payment due 30 days after the end of the quarter. Customs rejected counsel's argument noting the following:

The TAA is designed to accommodate situations in which a purchase price is established, but not paid, at the time merchandise is imported into the United States. For purposes of the transaction value provision, a bona fide sale may be found to exist even though actual payment has not been made for goods at the time of importation, provided that the purchase agreement includes fixed terms which make the purchase price either determined or determinable at that time.

Two situations in which a buyer and a seller have potentially agreed to a price without full payment being made prior to or at the time of importation involve royalties and proceeds of subsequent resale, disposal or use of the imported merchandise. In both of these instances, Customs must determine whether payments - which inure to the benefit of a foreign seller after importation has occurred -- should be added to the "price actually paid of payable" for purposes of calculating the duty owed. Such amounts should be added provided there is sufficient information upon which to determine the amounts therefor.

...we do not find that such a payment arrangement indicates, prima facie, that the proceeds cannot be quantified in a reasonable period of time and, hence, that there is a lack of sufficient information. It is our position that the term "subsequent resale," by its very nature, implies that proceeds may not be paid, or even quantifiable, for some time after importation of the merchandise. Furthermore, we do not believe the payment structure agreed to by the parties is uncommon in such transaction. To hold otherwise could render transaction value unacceptable in numerous cases in which proceeds subsequently accrue to the seller. Cf. HRL 542701, TAA No. 47, issued April 28, 1982, and HRL 542746, issued March 30, 1982.

In this case, even though the amount of the royalty addition is not known at the time of importation, we believe that there is sufficient information to determine the amount of the addition. The License Agreement clearly specifies how the royalties are to be calculated. As such, there is information that establishes the accuracy of such amount.

Additionally, we note that there is a rebuttable presumption that all payments made by a buyer to a seller, or party related to a seller, are part of the price actually paid or payable. See, Headquarters Ruling Letter (HRL) 545663 dated July 14, 1995. This position is based on the meaning of the term "price actually paid or payable" as addressed in Generra Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990). In this case, as the payments are made to the seller, Limited, they could be viewed as part of the total payment for the goods and, therefore, part of the price actually paid or payable in determining transaction value.

HOLDING:

Based on the information submitted, the payments made to Limited are included as a statutory addition to the price actually paid or payable under ?402(b)(1)(D) of the TAA, or under

This decision should be mailed by your office to the internal advice requester no later than 60 days from the date of this letter. On that date the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels.

Sincerely,

Acting Director
International Trade Compliance

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