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HQ 545662

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February 20, 1998

RR:IT:VA 545662 RSD

Category: VALUATION

Port Director
United States Customs Service
610 S. Canal Street
Chicago, Illinois 60607

RE: Internal Advice Request 62/93 concerning payments made for the right to make a pharmaceutical product; Proceeds

Dear Director:

This is in response to your memorandum dated July 16, 1993, concerning the request for internal advice 62/93 on the dutiability of certain payments made in connection with the importation of pharmaceutical products. The Chief, Food & Chemicals Branch of the National Import Specialist Division prepared a memorandum dated May 23, 1994, outlining his views on this matter. A meeting was held with counsel at our office on February 22, 1996, to discuss the internal advice request. Counsel made several submissions on this matter. Counsel's request for confidential treatment of the supply agreement has been granted. We regret the delay in responding.

FACTS:

The imported merchandise is a pharmaceutical product called Lupron Depot (hereinafter LD). LD is a sustained released formulation of the pharmaceutically active compound called leuprolide acetate (hereinafter LA). It is used in the treatment of conditions such as endometriosis, prostate cancer, and precocious puberty. TAP Pharmaceutical, a joint venture of a U.S. company, Abbott Laboratories (hereinafter Abbott), and a Japanese company, Takeda Chemical (hereinafter Takeda), under a 50/50 partnership arrangement, imports the LD into the United States.

The active pharmacological agent, which produces the physiological effect of LD is a chemical called leuprolide. LA is a salt of leuprolide, enabling the product to be stored and transported in bulk powder form. Unlike most pharmaceutical products, the leuprolide protein is digested and thus rendered inactive if taken orally. Accordingly, it is like insulin and must be administered by injection. Abbott's Chemical and Agricultural Products Division manufactures LA in the United States. The LA is a powder packaged in individual vials sufficient for two weeks of daily injections.

Abbott sells and exports the LA powder produced for the daily injections to Takeda in Japan. Takeda encapsulates the drug into sterile micro- spheres consisting of a lactic acid/glycolic acid copolymer. When injected into the body, the microsphere releases the leuprolide over a period of approximately one month. The purpose of microencapsulation is only to modify the delivery rate of the drug into the body from the daily dosage form. The physiological action of the microencapsulated version is identical to that of the LA marketed by TAP in the daily injectable form. Takeda packages the sterile microspheres (which appear visually as a powder) into vials containing one of four different dosages of leuprolide and then sells and reexports the vials to TAP together with ampules of a diluent also produced by Takeda. TAP subcontracts to Abbott for labeling the vials of leuprolide microspheres with ampules of diluent and packaging them into kits with instructions. TAP then markets the kits as LD in the United States and Canada.

TAP and Takeda entered into a licensing agreement on March 6, 1989 related to the sale of LD in the United States. Article II describes the licenses. Under Article IIA, Takeda grants TAP an exclusive license to make, have made, use, and sell the product (defined as LD) in the territory under the Patent Rights. Under Article IIB, Takeda grants TAP an exclusive license to make, have made, use and sell the Product (i.e. LD) in the Territory using technical information. TAP pays two category of royalties in connection with its U.S. sales of the LD kits. Article III of the license agreement describes the royalties that TAP pays Takeda for patents covering LD and LA. The first category of royalties is described in Article III.A of the license agreement. Under Article III.A, TAP pays Takeda royalties associated with patents described in exhibit B of the license agreement which relate to the processes that Takeda uses in Japan to microencapsulate bulk LA. These patents do not relate to the production of the LA itself. The royalties are calculated as a sliding percentage based on the level of TAP's U.S. sales of LD (i.e. 5% of the first ten million dollars in annual net sale, as defined in license agreement; 4% of the next ten million dollars in annual sales; and 3% of all annual net sales above twenty million dollars.) The dutiability of the royalties regarding the production of LD that TAP pays to Takeda under Article III.A is not raised as an issue in the request for internal advice.

What is at issue in this case is the dutiability of the license fees paid under Article III.B of the license agreement. This provision requires TAP to pay license fees to Takeda associated with patents described in Exhibit C of the license agreement. These patents also owned by Takeda relate to processes used to produce LA and to certain intermediate products leading to the production of final LA. Counsel points out that Abbott owns the actual product patent on LA. License fees under Article III.B of the agreement are paid in the same percentages as apply to license fee paid under Article III.A. Thus, half of the royalty payments that TAP pays to Takeda relate to patent rights in making LA and the other half relate patent rights for producing the LD. The internal advice request only concerns royalties paid for the use of patents involved in making the LA in the United States.

Takeda and TAP entered into a supply agreement relating to LD on October 20, 1989.

ISSUE:

Whether the payments that TAP makes to the seller for patents used in making the domestically produced active ingredient of the imported pharmaceutical product, LD, are dutiable as part of transaction value?

LAW AND ANALYSIS:

As you know, 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. In this instance the buyer and the seller are related parties. Section 402(b)(2)(B) of the TAA (19 U.S.C. 1401a (b)(2)(B)) sets forth two conditions under which a transaction value between related parties will be deemed acceptable. The first is where an examination of the circumstances of sale indicates that the relationship between the parties did not influence the price actually paid or payable. The second is where the transaction value closely approximates certain "test" values. In your memorandum you state that you have accepted that transaction value as the means of appraisement based on the circumstances of the sales. Accordingly, we have assumed for purposes of this ruling that transaction value is the appropriate basis of appraisement.

Section 402(b)(1) of the TAA provides for five additions to the price actually paid or payable. Sections 402(b)(1)(C) (D) and (E) which provide for additions to the price actually paid or payable for:

(C) the value, apportioned as appropriate of any assist;

(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.

While an analysis of the dutiability of the concerned payments could be made under either section 402(b)(1)(C) and/or (D), we have concluded that the most conclusive analysis would be under section 402(b)(1)(E).

With regard to proceeds, the Statement of Administrative Action (SAA), H.R. Doc. No. 153, (96 Cong., 1st Sess., pt. 2 (1979)) reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 at 49, (October 1981) provides that:

[a]dditions for the value of any part of the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrues 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.

In a notice published in the Customs Bulletin on February 10, 1993, commonly referred to as Hasbro II, at page 13, Customs referred to the definition of proceeds in analyzing whether certain payments were proceeds within the meaning of section 402(b)(1)(E). The decision states:

Proceeds are defined as "issues or income; yield; receipts; produce; money or articles of other thing of value arising or obtained by the sale of property; the sum, amount, or value of property sold or converted into money or into other property.
Notice, p. 13 cited Black's Law dictionary, 6th ed., 1990 at p.
1204. Another definition of proceeds is "what is produced by or derived from something (as a sale investment, levy, business) by way of total revenue: the total amount brought in ***." Webster's
Third New International Dictionary 1986.

In applying this definition in the context of 402(b)(1)(E) the income produced from the subsequent resale, disposal, or use of the imported merchandise that accrues directly, or indirectly, to the seller is added to the price actually paid or payable for the imported goods.

In Hasbro II, the payments at issue accrued to the seller upon the resale of the imported merchandise. Specifically, the seller received 7% of income from the subsequent resale of the imported merchandise. Customs ruled that such payments constituted proceeds of the subsequent resale of the imported merchandise and were to be added to the price actually paid or payable for the imported merchandise. See also Headquarters Ruling Letter (HRL) 544800, May 17, 1994 (regarding proceeds of a subsequent resale).

In this instance, the royalty payments accrue to the seller, Takeda, directly based on the resale in the United States of the imported merchandise, LD. Article III B provides that Licensee shall pay a royalty equivalent to a specified percentage of all annual net sales... for seven years from the date of the first commercial sale of the product in each country of the territory. Product is defined as the injectable dosage from composed of microcapsules (in other words, the imported product). Thus upon the sale of each imported product, TAP must pay the seller a specified percentage of the net sales. Counsel contends that the royalties should not be dutiable as proceeds because they are paid for the rights for a product made in the United States. Counsel points to several rulings where Customs has held that payments are not dutiable because a substantial part of the payments were not based on components that were imported. For example, in HRL 544656, issued June 19, 1991, published as C.S.D. 92-12, 26 Cust. Bull. 424 (1992), royalties were paid on the invoice sales price of machines made from both imported and domestic components. In that decision, Customs determined, with regard to the issue of proceeds, that the payments were not based on the resale of the imported product, but, instead, were based on the resale of a finished product that included U.S. components. Because Customs found that a substantial portion of the payments were based on components that were not imported, the payments were not dutiable as proceeds. See also HRL 545770, dated June 21, 1995.

We believe that this case is distinguishable from C.S.D. 92-12 and other similar rulings. In C.S.D. 92-12 the imported product was processed with U.S. made components after importation to make the finished product and the royalties were paid based on the sale of that finished product. Accordingly, we were unable to determine what part of the royalties related in the imported product and what part related to the domestic components. In contrast, in this case the royalty payments are determined solely on sales of the imported product, which is not further processed in the United States after importation. The amount of the royalty payment is based on a percentage of the net sales of LD. In the case of any product in a kit presentation, the royalty is based only on the cost of the LD. See Article I.I. We believe that once the LA is processed overseas into the LD, it becomes a separate and distinct product, and it is the LD which is being resold in the United States. Although the active ingredient may be produced in the United States prior to importation, under Article III.B of the license agreement, royalties are paid to the seller of the imported merchandise based on the resales of the imported product in the United States, not on the sales of the active ingredient. In other words, in determining whether fees paid to the seller are dutiable as proceeds, section 402(b)(1)(E) does not require an analysis of why the fees are paid. If fees accrue directly or indirectly to the seller from the subsequent resale, disposal, or use of the imported merchandise, they would be dutiable as proceeds under section 402(b)(1)(E). Therefore, we conclude therefore that the royalty payments are income which accrues to the seller upon the subsequent resale of the imported LD that should be added to the price actually paid or payable under section 402(b)(1)(E) provided there is sufficient information to determine the amount.

HOLDING:

Based on the information provided, the royalty payments made by the importer to its related party seller, made pursuant to Article III.B of the license agreement would be added to price actually paid or payable as proceeds under section 402(b)(1)(E).

The Office of Regulations and Rulings will take steps to make a version of this decision, with the confidential information deleted, available to Customs personnel and via the Customs Ruling Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act and other public access channels 60 days from the date of this decision. Sincerely,

Acting Director

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