HQ 545381 - IA; diagnostic kits; pharmaceutical products; transaction value; price actually paid or payable; related parties; License and Supply Agreements; indirect payment; related to imported merchandise; HRL 546038; Generra Sportswear Co.; Chrysler Corporation; royalties; ?402(b)(1)(D); General Notice, Dutiability of Royalty Payments; SAA; HRLs 544129, 544061, 545361; 542844, 545998 and 544991; proceeds of any subsequent resale, disposal or use; ?402(b)(1)(E) - United States International Trade Commision Rulings

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HQ 545381

May 4, 1998

RR:IT:VA 545381 KCC

CATEGORY: VALUATION

Port Director
U.S. Customs Service
#1 La Puntilla
San Juan, Puerto Rico 00901

RE: IA; diagnostic kits; pharmaceutical products; transaction value; price actually paid or payable; related parties; License and Supply Agreements; indirect payment; related to imported merchandise; HRL 546038; Generra Sportswear Co.; Chrysler Corporation; royalties; ?402(b)(1)(D); General Notice, Dutiability of Royalty Payments; SAA; HRLs 544129, 544061, 545361; 542844, 545998 and 544991; proceeds of any subsequent resale, disposal or use; ?402(b)(1)(E)

Dear Port Director:

This is in response to your memorandum (APP-6-08-DD:CO:IA CT452) dated June 24, 1993, which forwarded an internal advice request initiated by Boehringer Mannheim America, Ltd., Puerto Rico Branch, now known as Corange International, Limited, Puerto Rico Branch ("Corange") regarding royalty payments made to Boehringer Manheim GMBH ("BMG"). We are in receipt of Corange's submission dated June 10, 1993, and supplemental submissions dated February 21, 1995, and November 25, 1997. Information contained in Consumption Entry Audit Report No. 412-93-CEO-001 dated January 17, 1995, and information presented at a meeting on July 1, 1997, was taken into consideration in reaching this decision. We regret the delay in responding.

The information furnished in connection with this IA will be treated as confidential pursuant to ?177.2(b)(7), Customs Regulations (19 CFR ?177.2(b)(7)), and 5 U.S.C. ?552, as set forth in a letter to Counsel dated December 12, 1997.

FACTS:

The subject issues arose in the context of an audit of the importer, Corange, which is a branch office of Boehringer Mannheim America, Ltd. ("BMAL"), a Bermuda corporation. BMAL is legally domiciled in Bermuda. As an exempt company, BMAL is authorized to operate anywhere in the world except Bermuda. Corange manufactures rapid diagnostic test kits and dipstick kits ("diagnostic kits") for sale to Boehringer Manheim Corporation ("BMC"), a related U.S. company. BMC then sells the diagnostic kits to unrelated customers. BMAL owns and controls BMC. BMC is affiliated with BMG. Counsel notes that Corange, BMC, BMAL and BMG are related companies pursuant to ?402(g)(1) of the TAA. Imported materials, as described below, used in the manufacture of the diagnostic kits are purchased by Corange from BMG, BMC and other unrelated suppliers.

The diagnostic kits are used by patients, by medical personnel in doctor's offices, and by technicians in medical laboratories, for the detection of various substances in the blood or urine. A diagnostic kit contains a packaged vial of dipsticks with instructions, color code label and may include a barcode calibration slip.

In its submissions, Corange describes the processing involved in manufacturing the diagnostic kits. Corange receives rolls of plastic elvax foil, protective foil, logo foil and reagent foil. The initial step of the manufacturing process consists of using the rolls of material to permanently bond the reagent material to a plastic backing and sealing or enmeshing (depending on the type of kit being made) the reagent material to protect the integrity of the reagent chemistry. After sealing and enmeshing, the enmeshed or sealed rolls are cut into individual dipsticks and the requisite number are placed in a vial. The vial is then sealed with a stopper assembly. Next, "bar code" strips are developed which are used to calibrate the electric meter which reads the diagnostic dipstick during the test procedure. A separate bar code is developed for each lot of dipsticks manufactured, in accordance with the exact color changes produced by that lot of dipsticks. The lot specific bar codes are based on Corange's testing of each dipstick lot. The bar code strips are packaged with each vial. The final step is the labeling and boxing operation for each vial. The labels contain lot specific color codes which can be used for comparison purposes, to provide a visual reading of the dipsticks. Pictures of the 300 meter rolls of reagent material in their condition as imported by Corange from BMG, samples of reagent material cut from a imported roll showing the condition of the reagent material as imported, and samples of the diagnostic kits manufactured by Corange and sold to BMC were submitted for our examination.

Prior to 1979, the diagnostic kits were manufactured in Germany by BMG and sold to BMC. No royalties were paid under this arrangement. On July 26, 1979, BMG and BMC entered into a License Agreement covering the manufacture of the diagnostic kits in the U.S. Under Article 2.1 of the License Agreement, BMG grants BMC a non-exclusive license ("the license") under BMG's patent rights, and agrees to make available all technical information necessary "to make, to have made, use and sell" the "products" in the U.S. Article 1.1 of the License Agreement defines "products" as "the diagnostic test kits and rapid diagnostic dipsticks sold under the label of BM[G] as listed in the Annex I and II to this Agreement to be amended from time to time for which BM[G] has granted patent licenses and/or made available TECHNICAL INFORMATION...."

In consideration of the license granted, BMC agrees to pay a "license and service fee" ("royalty fee") of a percentage of net sales of all "products" manufactured by BMC and sold or otherwise disposed of by BMC. BMC has construed this clause to include all "products" manufactured for BMC by Corange. BMC pays BMG the royalty fee on a quarterly basis. In a letter to BMAL dated July 6, 1988, BMG granted BMAL and, thus Corange, a non-exclusive license to manufacture the "products", as defined in the License Agreement between BMG and BMC, for sale of such "products" to BMC. Additionally, Article 3.3 of the License Agreement states that BMC agrees not to sell the "products" unless having received quality control (QC)-release by BMG QC-laboratory.

Pursuant to Corange's June 10, 1993 submission, it manufactures 30 types of diagnostic kits out of the 139 products covered by the License Agreement, listed in Annex I to the License Agreement. The remainder are manufactured by BMC in Indiana. Corange notes in its November 27, 1997 submission that the individual products are constantly improving. Thus, changes are regularly made in the types and numbers of diagnostic kits manufactured for sale by BMC. However, Corange notes that these changes are monitored and the License Agreement is regularly modified. Corange submitted the July 3, 1996 amendment to the License Agreement, a revised Annex I. Corange notes that a comparison of the product numbers on the 1996 Annex I with the product numbers on the 1979 Annex I shows that none of the products covered by the 1979 License Agreement remain on the 1996 License Agreement.

Additionally, Corange states that since the submission of the internal advice request, a new family of diagnostic kits is being manufactured in the U.S. for BMC. These new diagnostic kits, which contain a greater percentage of imported components than the diagnostic kits subject to the 1979 License Agreement, are based upon the use of technology wholly developed in the U.S. Therefore, they are neither subject to the 1979 License Agreement between BMC and BMG, nor are they subject of any royalty payments. Corange states that if the royalty paid by BMC was for imported component materials from BMG, then the diagnostic kits should not only be subject to a royalty, but should carry a higher royalty than the diagnostic kits which have fewer imported components.

The materials used by Corange in manufacturing the diagnostic kits are supplied by both foreign and domestic companies, of which BMG and BMC are the only related suppliers. BMG primarily supplies reagent materials. However, BMG has supplied elvax foil, protective foil, aluminum bags and glue to Corange. The remaining supplies are from the U.S., Germany and Belgium. Corange also purchases reagent material, which is manufactured in Indiana using BMG's technical information, from BMC. Corange states that BMC is free to have the licensed products completely manufactured in the U.S. from materials and components which are wholly of U.S. origin and the identity of the suppliers of materials used by Corange has no effect on BMC's obligation to pay the royalties.

A Supply Agreement, dated July 26, 1979 between BMC and BMG requires that BMG supply all of BMC's commercial requirements of the listed bulk material for specified products manufactured by BMC. Article 3 of the Supply Agreement, specifically reads:

Supply. In order to enable BMC a continuous manufacture of FINAL PRODUCTS of a constant quality BM[G] shall, subject to the terms and conditions set forth herein, supply all of BMC's commercial requirements of BULK MATERIALS, in as far as this concerns products made by BM[G], and BMC shall purchase such BULK MATERIAL from BM[G].

There is no separate Supply Agreement between BMG and Corange. However, as stated above, one of Corange's supplier is BMC. Article 4 of the Supply Agreement states that to facilitate BMG's planning or production, BMC shall submit to BMG, four months prior to the beginning of each calendar year, "an annual estimate of BMC's requirements of the BULK MATERIAL."

Final Products is defined in Article 1.1 of the Supply Agreement as "..any and all test kits or regent systems and rapid diagnostic dipsticks manufactured by BMC o the basis of BULK MATERIAL." Bulk Materials is defined in Article 1.2 of the Supply Agreement as "[t]he products as specified in the Annexes to this Agreement." Annex I of the Supply Agreement lists twenty-five components. Corange states that it has never purchased any of the twenty-five components in Annex I. Additionally, Corange states that most of those components are no longer used by BMC.

Annex II of the Supply Agreement covers "[r]olls, tubes, stoppers and labels for the manufacture of..." ten Chemstrip products which are identified by identification number and product name. Corange states that none of the identification numbers listed in Annex II of the Supply Agreement currently corresponds to a product manufactured by Corange, and only three of the ten named Chemstrip products are still manufactured by Corange, although under different identification numbers which reflect an improved version. Corange states that unlike the License Agreement, the Supply Agreement was never amended. Thus, Corange contends that the Supply Agreement is effectively obsolete; it does not cover component materials used in any products currently made by Corange or component materials of any of the products which are currently subject to the License Agreement.

Moreover, Corange states that the products listed in Annex II of the Supply Agreement, i.e., rolls, tubes, stoppers and labels for the manufacture of ten Chemstrip products, which were to be purchased from BMG are actually purchased from other unrelated German companies. Corange states that the only component material purchased from BMG are "rolls" of reagent material, none of which are mentioned in the Supply Agreement.

Article 9 of the Supply Agreement indicates that the agreement "shall be valid as long as BMC manufactures FINAL PRODUCTS." Corange states that none of the "final products" specified by identification number in Annexes I and II of the Supply Agreement are still manufactured by BMC. Corange contends that since these Annexes have never been updated by amending the Supply Agreement, the Supply Agreement is said to have expired by its own terms. Corange states that the Supply Agreement was effectively obsolete no later that January 1, 1993. As evidence of the expiration of the Supply Agreement, Corange submitted a letter from the Corporate General Counsel of BMG, Dr. Bernhard Jurisch. Dr. Jurisch negotiated, drafted and signed both the License Agreement and Supply Agreement on behalf of BMG. Dr. Jurisch stated that the License Agreement "was designed to facilitate the orderly and gradual transfer of certain manufacturing operations from Germany to the United States.... The Supply Agreement also served to facilitate production planning by BMG because it committed BMC to providing estimates of its needs and submitting orders in advance."

Additionally, Dr. Jurisch described the relationship between the License Agreement and the Supply Agreement as follows:

It was never the intention of BMG to create, by this [Supply] Agreement, a captive market for certain materials manufactured by BMG. On the contrary, the practice between the two companies has been to shift the sourcing of materials to BMC or to other companies, without penalty, as BMC has gained manufacturing experience. This course of conduct has, over the years, made the original 1979 Supply Agreement an obsolete document that has never been amended or updated to reflect the current practice of the two companies with regard to component sourcing.

Additionally, Dr. Jurisch addressed the royalty issue stating:

The royalty paid under the License Agreement is for the technology transferred by BMG to BMC which is necessary to make, use and cell [sic] certain products in the United States. The royalty is not dependent upon or otherwise related to BMC's use of any imported components whether obtained from BMG or elsewhere. The royalty is never mentioned or reference in the 1979 Supply Agreement, because BMG is entitled to its royalty payments on certain finished products manufactured and sold in the United States, regardless of where or from whom the components are sourced.

You submitted this internal advice request for a determination regarding the dutiable status of the subject royalty fees in light of Headquarters Ruling Letter ("HRL") 544436 (C.S.D. 91-6) dated February 4, 1991, and General Notice, Dutiability of Royalty Payments, 27 Cust. Bull. 12 (February 10, 1993), which is effective for all entries made after May 11, 1993. As of this date the entries at issue are those made after May 11, 1993. You inquire as to the royalty fees paid with respect to merchandise imported by BMC from BMG, by Corange from BMG and any other BMAL related company having the same type of royalty contract with BMG. The Audit report concludes that the royalty fees may be included in the transaction value of the imported merchandise. There is a particular concern raised in the audit report that the terms of the licensing agreement remained the same despite changing relationships between BMC and Corange in corporate reorganizations.

Corange takes the position that the royalty fee paid by BMC to BMG is not included in the appraised value of materials imported by Corange because 1) the royalty fees are not related to the imported merchandise, 2) the buyer of the imported merchandise is not required to pay the royalty fees, either directly or indirectly, 3) the royalty fees are not a condition of the sale of the imported merchandise for exportation to the U.S. and 4) the royalty fees do not represent the proceeds of any subsequent resale, disposal or use of the imported merchandise.

ISSUE:

1. Whether the royalty fees paid by the BMC to BMG are part of the price actually paid or payable for the merchandise imported by Corange, BMC or any other BMAL related company.

2. Whether the royalty fees paid by the BMC to BMG are included in the transaction value of the merchandise imported by Corange, BMC or any other BMAL related company having the same type of royalty contract with BMG under ?402(b)(1)(D) of the TAA.

3. Whether the royalty fees made by the BMC to BMG are included in the transaction value of the merchandise imported by Corange, BMC or any other BMAL related company having the same type of royalty contract with BMG, as proceeds of subsequent resale, disposal or use under ?402(b)(1)(E) of the TAA

LAW AND ANALYSIS:

Transaction value is the preferred method of appraisement. Transaction value is defined in ?402(b), Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. ?1401a(b); TAA), as the "price actually paid or payable for the merchandise when sold for exportation to the United States." ?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.

Imported merchandise is appraised under transaction value only if the buyer(s) and seller are not related, or if related, the transaction value is deemed to be acceptable. In this situation, Corange, BMC, BMAL and BMG are related pursuant to transaction value between related parties is acceptable only if an examination of the circumstances of the sale indicates that the relationship between the parties does not influence the price actually paid or payable, or the transaction value of imported merchandise closely approximates the transaction value of identical or similar merchandise in sales to unrelated buyers in the U.S. or the deductive or computed value for identical or similar merchandise. This ruling does not address the acceptability of transaction value. We assume for purposes of this ruling that transaction value is the proper method of appraisement for the imported merchandise.

1. Price Actually Paid or Payable

The "price actually paid or payable" is defined in indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise...) made, or to be made for the imported merchandise by the buyer to, or for the benefit of, the seller."

There is a rebuttable presumption that all payments made by the buyer(s) to the seller, or party related to the seller, are part of the price actually paid or payable. See, 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 Generra, the court considered whether quota charges paid to the seller on behalf of the buyer were part of the price actually paid or payable for the imported goods. In reversing the decision of the lower court, the appellate court held that the term "total payment" is all-inclusive and that "as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods." The court also explained that it did not intend that Customs engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, were for the merchandise or something else.

Additionally, we note that in Chrysler Corporation v. United States, CIT Slip Op. 93-186 (September 22, 1993), the Court of International Trade applied the Generra standard and determined that although tooling expenses incurred for the production of the merchandise were part of the price actually paid or payable for the imported merchandise, certain shortfall and special application fees which the buyer paid to the seller were not a component of the price actually paid or payable. With regard to the latter fees, the court found that the evidence established that the fees were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller and not a component of the price of the imported engines. Therefore, this presumption may be rebutted by evidence which clearly establishes that the payments, like those in Chrysler, are completely unrelated to the imported merchandise.

In this case, the party to whom the royalties are paid is the seller/licensor. A buyer of the materials, Corange, is not the party directly paying the royalty fee. BMC, a related company, pays the royalty fee. However, it is our position that the parties' relationships creates a situation where Corange is indirectly paying the royalty fee through BMC to BMG. As stated in its request for internal advice, Corange is related to BMC. Corange is a branch office of BMAL which owns and controls BMC. As previously stated, BMAL is legally domiciled in Bermuda, however, it is an exempt company which is authorized to operate anywhere in the world except Bermuda. Thus, BMAL, with its operating branch Corange, indirectly pays the royalties through its subsidiary BMC.

Although the License Agreement between BMC and BMG and the non-exclusive License Agreement between BMG and BMAL-Corange rights are separate and distinct from one another, we find that the License Agreements are closely tied together. In the July 6, 1988 letter to BMAL, BMG grants a "non-exclusive license as of January 1, 1988 to manufacture Products, as that term is defined in the non-exclusive License Agreement dated September 19, 1979 by and between" BMG and BMC. Thus, all the parties, BMG, BMC, BMAL-Corange are fully aware of the terms and conditions of the original License Agreement.

Thus, the royalty fees paid by BMC to BMG, the seller/licensor, are presumed to be part of the price actually paid or payable for the merchandise imported by Corange and BMC. Now, the importers must establish that the royalty fees are completely unrelated to the imported merchandise. Counsel maintains that these payments are not part of the price actually paid or payable because they are made irrespective of the imported product. Counsel states that the royalty fees are not "for the imported merchandise", but rather, are for the right to "to make, to have made, use and sell" the diagnostic kits in the U.S. with the use of the BMG's technical information related to the domestic manufacturing operation which was transferred to BMC and Corange.

We agree with Counsel that the royalty fees are not related to the imported merchandise. The royalty fees paid BMC are for the right to make, use and sell the diagnostic kits in the U.S. with the use of technical information made available by BMG to BMC and Corange. The technical information transferred under the License Agreement relates to the manufacture, quality control and marketing of the diagnostic kits in the U.S., not to the manufacture or production of any of the imported components. As evidence, Corange refers to the new family of diagnostic kits manufactured in the U.S. for BMC. These new diagnostic kits, which contain a greater percentage of imported components than the diagnostic kits subject to the 1979 License Agreement, are based upon the use of technology wholly developed in the U.S. Therefore, they are neither subject to the 1979 License Agreement between BMC and BMG, nor are they subject of any royalty payments. Corange states that if the royalty fees paid by BMC were for imported component materials from BMG, then the diagnostic kits should not only be subject to a royalty, but should carry a higher royalty than the diagnostic kits which have fewer imported components.

We note that on the same day that BMC signed the License Agreement to acquire the manufacturing capabilities, it also signed the Supply Agreement which obligated BMC to purchase all of its requirements of bulk material from BMG as defined in the Supply Agreement. Thus, the question arises whether the License Agreement and the Supply Agreement are inextricably intertwined such that BMC paid for the capabilities to manufacture the diagnostic kits and at the same time that it became obligated to purchase bulk material to manufacture the diagnostic kits.

In HRL 546038 dated July 19, 1996, we found that royalty payments made to gain U.S. trademark rights, patent rights, and manufacturing capabilities for a pharmaceutical product were part of the price actually paid or payable and were also considered an addition to the price actually paid or payable as a royalty pursuant to ?402(b)(1)(D) of the TAA. In this situation, on the same day the unrelated parties entered into the royalty agreement, they signed a supply agreement which obligated the licensee/buyer to purchase all of its requirements of the royalty product from licensor/seller. Thus, we held that the royalty and supply agreements were inextricably intertwined such that the licensee/buyer paid for the capability to manufacture the product at the same time that it forfeited that right by entering into the supply agreement.

It is our position that in the instant case, even though the License Agreement and the Supply Agreement were signed on the same day, the two agreements are not inextricably intertwined such that the royalty fees are related to the imported merchandise. In HRL 546038 the supply agreement obligated the licensee/buyer to purchase all of its requirements of the royalty product from licensor/seller. In this case, Article 3 of the Supply Agreement states that BMG agrees to supply BMC "[i]n order to enable BMC a continuous manufacture of FINAL PRODUCTS of constant quality...." Final Products is defined in Article 1.1 of the Supply Agreement as "..any and all test kits or regent systems and rapid diagnostic dipsticks manufactured by BMC on the basis of BULK MATERIAL." Bulk Material is defined in Article 1.2 of the Supply Agreement as "the products as specified in the Annexes to this Agreement. Thus, BMC was not obligated to purchase the royalty product, but some components used to manufacture the royalty products as listed in the Annexes to the Supply Agreement.

Additionally, there is no language in either agreement which links the License Agreement and the Supply Agreement together. Moreover, Corange has submitted compelling evidence that the Supply Agreement is effectively obsolete as it no longer reflects the actual course of the transactions between BMG and BMC. We note Dr. Jurisch's statements regarding the License Agreement and the Supply Agreement which are verified by the BMC and Corange's manufacturing operations and purchase transactions with BMG and other unrelated companies. None of the "final products" specified by identification number in Annex I and II of the Supply Agreement are still manufactured by BMC and Corange. Additionally, the only bulk materials purchased by BMC are reagent rolls. However, none of the rolls listed in Annex II of the Supply Agreement are currently purchased and imported by BMC or Corange. Moreover, Corange submitted evidence showing that the other bulk materials listed in Annex II of the Supply Agreement, i.e., tubes, stoppers and labels are actually purchased from other unrelated German companies. Unlike the License Agreement, the Supply Agreement was never amended. Thus, we agree with Corange that the Supply Agreement has expired by its own terms.

Without a connection between the License Agreement and the Supply Agreement, there is no evidence that the royalty fees are related to the imported merchandise. Therefore, we conclude that the royalty fees are not part of the total payment made or to be made by the buyer(s), directly or indirectly, to the seller for the imported merchandise.

2. Royalties

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.

SAA, 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.

After reviewing the language of the statute along with the legislative history and prior case law, Customs determined that the following three questions are relevant in determining whether a royalty is dutiable:

1) Was the imported merchandise manufactured under patent? 2) Was the royalty involved in the production or sale of the imported merchandise?
3) Could the importer buy the product without paying the fee?

See, General Notice, Dutiability of Royalty Payments, 27 Cust. Bull. 12 (1993) (hereinafter referred to as the "General Notice"). 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.. The General Notice includes a review of HRL 544436 (C.S.D. 91-6) dated February 4, 1991, commonly known as the "Hasbro ruling." The analysis set forth in the General Notice is applicable to entries of imported merchandise on or after May 11, 1993.

Prior to Customs' issuance of the General Notice, a major factor for determining that royalties were not dutiable under the "royalties" provision, was that the royalty payments were calculated on the basis of sales that occurred subsequent to the importation of the merchandise. See, HRL 544129 dated August 31, 1988; HRL 544061 dated May 27, 1988; and HRL 542844 dated June 17, 1982. However, Customs has since concluded that the method of calculating the royalty--e.g. on the resale price of the goods--is not relevant to determining the dutiability of the royalty payment. General Notice, at p.12. Instead, Customs must now look to the answers to the above three questions for assistance in determining whether the royalty fees are related to the merchandise and were a condition of sale.

Although the SAA provides that determinations about the dutiability of royalty payments are to be made case-by-case, it is more likely that the royalty will be dutiable when the licensor and seller are one and the same and the royalty is paid directly to the seller. Under these circumstances, payment of the royalty is more likely to be a condition of the sale for exportation of the imported merchandise than when the royalty is paid to an unrelated third party. See, HRL 545361, July 20, 1995, which held that trademark royalties are dutiable when paid to the seller/licensor but not when paid to a third party unrelated to the seller.

In this case, the party to whom the royalties are paid is both the seller and the licensor. According to the SAA, any royalty or license fee paid to the seller is part of transaction value unless the importer can establish that it is distinct from the price actually paid or payable for the imported merchandise and that such payment was not a condition of the sale of the imported merchandise for exportation to the United States. In other words, there is a presumption that royalties paid to the seller are dutiable unless the importer can show otherwise. See also, HRL 544991 dated September 13, 1995.

As previously stated, a buyer of the materials, Corange, is not the party directly paying the royalty fee. However, it is our position that the parties relationships create a situation where BMAL, with it operating branch Corange, is indirectly paying the royalty fee through BMC to BMG. Additionally, it is our position that the License Agreements are closely tied together. The rights set forth in the License Agreement between BMC and BMG and the non-exclusive License Agreement between BMG and BMAL-Corange are separate and distinct from one another. However, all the parties involved, BMG, BMC, BMAL-Corange are fully aware of the terms and conditions of the original License Agreement. In the July 6, 1988 letter to BMAL, BMG granted a "non-exclusive license as of January 1st, 1988, to manufacture Products, as that term is defined in the non-exclusive License Agreement dated September 19, 1979 by and between" BMG and BMC. Thus, the royalty fees are paid to the seller directly by BMC or, by BMAL with its operating branch Corange, indirectly through BMC.

With respect to the first question, Corange states that most of the component materials purchased from BMG are not produced under patent. However, there are some reagent rolls used in the manufacture of Chemstrip products which are covered by unexpired process patents. Although the imported merchandise was manufactured under patent, the License Agreement at issue does not cover the patented imported products. The License Agreement provides for the technical information necessary "to make, to have made, use and sell" the "products" in the U.S. Article 2.1 of the License Agreement. The "products" are defined in Article 1.1 of the License Agreement as "the diagnostic test kits and rapid diagnostic dipsticks sold under the label of BM[G] as listed in the Annex I and II to this Agreement...." The patented imported products are not listed in the Annexes and are, therefore, not covered by the License Agreement. Cf. HRL 545998 dated November 13, 1996, which held that, based on the License Agreement, the royalties were paid in part for the patent concerning the composition of the imported pharmaceutical product.

Second, we find that the royalty fees are not involved in the production or sale for exportation of the imported products, whether imported by Corange or BMC. BMG, the seller of the imported products and licensor, agrees to make available to BMC and the related Corange all technical information necessary "to make, to have made, use and sell" the licensed diagnostic kits in the U.S. Corange manufactures the diagnostic kits pursuant to a non-exclusive license, as defined in the License Agreement between BMG and BMC, for sale of such products to BMC. Thus, Corange's manufacturing rights are linked to the License Agreement between BMG and BMC. In consideration, BMC agrees to pay a royalty fee based on the percentage of net sales of all products manufactured by BMC and sold or otherwise disposed of by BMC. BMC has construed this to include all products manufactured for BMC by Corange. The rights granted BMC under the License Agreement are for the manufacture, use and sale of the completed diagnostic kits, not the materials imported by BMC or Corange.

In HRL 544991 dated September 13, 1995, royalty payments were paid in consideration of licensed technology and technical assistance provided by the parent, seller/licensor, to the importer/buyer. The imported merchandise (parts) from the licensor/seller was used to manufacture a finished product (machines) and the royalties were based on the selling price of the finished product. In that case, an agreement between the seller/licensor and the importer/buyer effectively linked the payment of the royalties to the purchase of the imported parts. Consequently, it was determined that as the importer/buyer could not buy the imported merchandise without paying the fee, the royalties were a condition of sale and, therefore, a proper addition to the price actually paid or payable of the imported merchandise under ?402(b)(1(D) of the TAA. See also, HRL 546038 dated July 19, 1996, supra.

It is our position that the above rulings are distinguishable from the present factual situation. As stated previously, unlike HRL 546038, BMC was not obligated to purchase the royalty product, but some components used to manufacture the royalty products as listed in the Annexes to the Supply Agreement. Additionally, unlike HRL 546038 and HRL 544991, we find that the License Agreement and Supply Agreement are not inextricably intertwined. As previously discussed, even though they were signed on the same day, Corange has submitted compelling evidence that the Supply Agreement is effectively obsolete as it no longer reflects the actual course of the transactions between BMG and BMC. See, Supra at ?1 The Price Actually Paid or Payable. Thus, we agree with Corange that the Supply Agreement has expired by its own terms.

Without a connection between the License Agreement and the Supply Agreement, our analysis focuses on the License Agreement and whether the royalty fees are involved in the production or sale for exportation of the imported products. It is our opinion that the royalty fees are not closely related to the imported merchandise, whether imported by BMC or Corange. The royalty fees are paid for BMG's technical information necessary to make, to have made, use and sell the diagnostic kits in the U.S. Thus, we find that the royalty fees do not pertain to the production or sale for exportation of the imported merchandise by either Corange or BMC.

With regard to the third question, i.e., could the importer buy the materials without paying the royalty fee, Customs acknowledged that the answer goes to the heart of whether a payment is considered a condition of sale. Both BMC and Corange may import the materials from BMG without paying the royalty fee. Corange represents that BMC's obligation to pay the royalty fee is not relieved by BMC's or Corange's purchase of materials from sources other than BMG. BMC must pay the royalty fee based on the resale price of the finished diagnostic kits regardless of where the component materials are sourced. As discussed above, Corange submitted evidence showing that there is no obligation to purchase bulk materials from the seller/licensor, BMG. Thus, it is our position that the BMC and Corange could purchase the imported bulk materials without paying the royalty fee.

Based on the above considerations, we find that the royalty fees are not considered royalties pursuant to ?402(b)(1)(D) of the TAA. The royalty fees, made in connection with BMC's and Corange's manufacture of the products in the U.S., are not related to the imported merchandise.

3. Proceeds of Subsequent Resale

The next issue is whether the royalty fees 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. 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).

There is no dispute that the royalty fees become due upon BMC's sale of the finished diagnostic kits. The amount of the royalty payments is based on the "Net-Sales" which is defined as the amount billed for sales of products to final users or wholesalers and/or distributors of labeled products. See, Article 1.6 of the License Agreement. However, the royalty fees do not arise from the resale of the imported components because, as described above, the imported components are not resold, they are manufactured into the diagnostic kits. This manufacturing operation is not a simple assembly or finishing operation. Corange purchases the reagent material for the urinalysis test strips from BMG. The manufacturing operations performed by Corange involve enmeshing, defect marking, cutting, testing, bar and color code preparation, packaging and labeling, which transform the imported reagent material into a finished product. Since the royalty fees are partially based on the imported product and partially on other factors, the royalty fees in this situation are not statutory additions to the price actually paid or payable as proceeds of a subsequent resale, disposal or use of the imported merchandise pursuant to ?402(b)(1)(E) of the TAA.

The royalty fees are not dutiable whether the materials are imported by BMC or Corange. Under the facts submitted, we find that the changes in corporate structure do not affect the analysis pertaining to the royalties. However, without being provided with License Agreements between other related companies and BMG, we cannot make a determination with respect to those royalty fees.

HOLDING:

The royalty fees paid by BMC to BMG are not part of the price actually paid or payable for the merchandise imported by BMC or Corange. Additionally, the royalty fees made by BMC pursuant to the License Agreement between BMC and BMG are not included in the transaction value of materials imported by BMC or Corange, as royalties or proceeds of subsequent resale, disposal or use pursuant to ?402(b)(1)(D) and (E) of the TAA.

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
Division

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