HQ 546159 - Internal advice concerning royalties and proceeds of subsequent resale made to party related to seller; Transaction Value; ?402(b)(1)(D) of the TAA; Hasbro II; HRL 544991 - United States International Trade Commision Rulings

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HQ 546159

July 18, 1997

VAL RR:IT:VA 546159 LPF

CATEGORY: VALUATION

Assistant Field Director, Regulatory Audit U.S. Customs Service
P.O. Box 19207
Charlotte, NC 28219

RE: Internal advice concerning royalties and proceeds of subsequent resale made to party related to seller; Transaction Value; ?402(b)(1)(D) of the TAA; Hasbro II; HRL 544991

Dear Director:

This is in response to your memorandum dated October 11, 1995, requesting internal advice concerning the dutiability of royalties paid by [* * * * * * * *] (Importer) of Research Triangle Park, NC. This request emanates from an audit conducted by your office. We have granted counsel's request for confidentiality in accordance with his July 25, 1996 letter. Additionally, we have excised, in the public version of this decision, the bracketed confidential information below. A meeting was held with counsel, which included telephonic participation from the Importer, on February 10, 1997.

FACTS:

Importer is a wholly owned subsidiary of [* * * * * * * *] (Parent Company A), who in turn is wholly-owned by [* * * * * * * *]. Their parent company is [* * * * * * * *] (Parent Company B). Importer purchases merchandise from both foreign and domestic sources. Although its suppliers are both related and unrelated companies, Importer primarily sources its products from owns these corporate subsidiaries through Parent/Licensor, the only direct subsidiary of Parent Company B.

Products sold to Importer include active ingredients, bulk intermediates and finished pharmaceutical/medicinal products. [* * * * * * * *] owns the patent and trademark rights to the products covered by the license agreement entered into between [* list of the products, in their various forms, subject to the license agreement was submitted. These same products are subject to the submitted supply agreements entered into between [ *

Importer pays royalties to [ * * *

Although counsel explains that [* * * * * * * * *] purchases its products from manufacturing companies whose process know-how was self-developed, it is our understanding that these are related to Parent/Licensor and, hence, Importer. [* * * * * * * *] is a customer of these same manufacturing companies as well as of a company who paid [* * * * * * * *] for the necessary process know-how.

Counsel also states that the price at which goods are sold to Importer covers both the manufacturers' costs as well as the costs of the reseller, and that price would include research and development costs to the extent incurred. This is also the case where a product undergoes primary and secondary production prior to its sale to Importer. Counsel provides that primary manufacturing is the production of chemically complex active ingredients, which give a medication its efficacy and potency, from simpler raw materials. Secondary manufacturing involves blending active ingredients with excipients and further manufacturing in order to create a bulk stage product which then is packaged and labeled as a finished product.

Counsel adds that whenever Importer uses an intangible asset that is owned by another related entity in the production of a product in the U.S., Importer ordinarily would make an appropriate payment to the owner for the use of that intangible.

It is counsel's position that the payments at issue cannot constitute royalties or proceeds to be added to the price pursuant to ?402(b)(1)(D) and (E) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. 1401a. With regard to royalties, counsel provides that the imported merchandise is not manufactured under a patent for which Importer is obligated, directly or indirectly, to make payment, the royalty does not relate to the production of the imported merchandise, and the importer could purchase the imported merchandise without paying a fee.

Specifically, counsel points out that the license agreement provides that it is the parties' express intention that no royalty be payable from Importer on the importation of such raw materials, bulk or finished products but only on the net sales of the product in the U.S. Counsel explains the payments only are tied to technological know-how used in U.S. production as well as trademark utilization in the U.S. Counsel also stresses that the license agreement provides that Importer shall not be required to pay any royalty or license fee as a condition of the sale of merchandise exported to the U.S. by [* * * * * * * *]. Rather, counsel submits that the license agreement provides that such merchandise shall be priced in accordance with a separate agreement between the parties without regard to royalties.

Counsel stresses that [* * * * * * * *], although the holder of certain intellectual property rights, is not the seller of the merchandise for exportation to the U.S. Hence, with regard to proceeds, counsel submits that the payments made by Importer are not shared directly or indirectly with the foreign sellers nor are used in any way to offset costs of production. Producers and sellers of the products, counsel explains, have their own obligations to [* * * * * * * *] and those responsibilities are not borne by Importer. Thus, counsel provides that if any product is manufactured under patent, it is the obligation of the producer, not Importer, to pay any applicable patent fees.

Your office disagrees and believes the payments may be dutiable as assists, royalties or proceeds of a subsequent resale, disposal or use of the imported merchandise.

ISSUE:

Whether the royalties or fees at issue, paid by Importer to [* * * * * * * *], are included within the transaction value of the imported merchandise as royalties or proceeds of subsequent sale.

LAW AND ANALYSIS:

As you are aware, the preferred method of appraising merchandise imported into the U.S. is transaction value pursuant to ?402(b) of the TAA. Section 402(b)(1) provides, in pertinent part, that the 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, including the value of any royalty or license fee related to the imported merchandise that the buyer is required to pay as a condition of the sale for export to the U.S. (?402(b)(1)(D)) and the proceeds of any subsequent resale, disposal or use of the imported merchandise that accrue to the seller (?402(b)(1)(E)). Although the buyer and seller of the merchandise at issue are related parties pursuant to ?402(g), for purposes of this decision we have assumed that transaction value is the appropriate method of appraisement.

The Statement of Administrative Action (SAA), adopted by Congress with the passage of the TAA, explains 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 at 48-49 (1981).

In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), commonly known as "Hasbro II," 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 a condition of sale and, therefore, dutiable as royalty payments.

When analyzing the Hasbro II factors, Customs, in its more recent ruling decisions, has taken several considerations into account which follow from the language set forth in the SAA. These include, but are not limited to: i) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture imported merchandise generally will be dutiable); ii) to whom the royalty is paid (e.g., payments to the seller or party related to the seller more likely are dutiable than payments to an unrelated third party); iii) whether the purchase of the merchandise and payment of royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the merchandise and payment of royalties; license agreement refers to, or provides for, the sale of the imported merchandise or requires the buyer's purchase of the merchandise from the seller/licensor; termination of either the purchase or license agreement upon termination of the other or termination of the purchase agreement due to failure to pay royalties); and iv) payment of royalties on each and every importation. See Headquarters Ruling Letter (HRL) 544991, issued September 13, 1995, and cases cited therein.

Based on the information provided, we find the subject payments to constitute royalties comprising part of the transaction value of the merchandise. First, we find the imported merchandise to be manufactured under patent, insofar as we understand that the patented applications or "know-how" are utilized in the manufacturing process of the merchandise. Although counsel submits that the royalty payments are tied to technological know-how used in U.S. production (as well as trademark utilization in the U.S.), we note that the license agreement provides for the patented manufacture by [* * * * * * * *]. We understand [* * * * * * * *] to include the foreign sellers/manufacturers of the imported products. Hence, the patented manufacture does not pertain exclusively to Importer's U.S. production.

Second, we find that the royalty is involved in the production or sale of the imported merchandise. It is our understanding that the patented know-how granted to Importer relates to the manufacture of the products in their various forms, as imported. Without the licensing agreement and the attendant royalty payments, the imported merchandise as such could not have been produced by the foreign suppliers. Specifically, we note that in accordance with the supply agreements, the [ * * * * this, in our opinion, suggests that the intellectual property already received from [* * * * * * * *] via the license agreement also is a necessary and integral part of the production or sale of the imported merchandise. In other words, it would appear that both types of know-how are indispensable to the production and sale of the imported goods; without either one, production and sale could not occur.

Finally, it is our position that Importer could not buy the imported merchandise without paying the fee. A thorough review of the license and purchase agreements reveals that taken as a whole they do not support the language included in the license agreement which counsel highlights, to wit, that Importer shall not be required to pay any royalty or license fee as a condition of the sale of merchandise exported to the U.S. To the contrary, the license agreements provide for the payment of royalties by Importer and that [ * *
* ]. In particular, this is supported by the language included in the license agreement stating that when [ Although counsel claims that the price of related products already includes the appropriate payment made to the related owner of an intangible asset for the use of such assets, it is apparent through the license agreement that in numerous cases when Importer uses such assets in the production of a product it is incumbent on Importer to make the appropriate royalty payments since they are not already included in the price of the imported merchandise itself.

Furthermore, we find that the purchase of the merchandise and payment of royalties are inextricably intertwined. For instance, as stated above, the license agreement in some cases provides for Such language suggests that the payment of the royalties is closely tied to the purchase of the goods. It is our position that this remains the case regardless of the frequency in which this actually occurs. In addition, the license agreement provides that [ * *
* * * *.] No evidence has been submitted indicating that Importer has the autonomy to purchase such merchandise other than from [* * * * * * * *]. Finally, the fact that the payments are made to [* * * * * * * *], a party related to the foreign sellers, is further indication that the royalties are closely tied to the purchase of the goods and, therefore, a condition of sale. While we appreciate counsel's position that the fact royalty payments are made to parties related to the seller only should create a rebuttable inference, as opposed to serve as prima facie evidence, of a condition of sale, the submitted evidence does not warrant a finding of non-dutiability.

We note that based on the information provided, we cannot conclude that a substantial portion of these payments are based on materials that are not imported. From the information available, we cannot meaningfully distinguish the royalty payments tendered for the imported raw materials, intermediary products, and finished products. Further, counsel has not provided any meaningful distinction separating the amount of the payments attributable to the patent rights from the exclusive trademark rights. Thus, we find both types of payments to constitute a "condition of sale" and to "relate to the imported merchandise" for purposes of the royalties analysis.

In consideration of the information currently available and the fact that it has been concluded that the subject royalty payments constitute royalties in accordance with ?402(b)(1)(D), we find it unnecessary for purposes of this decision to consider whether these payments alternatively may be dutiable as assists or proceeds of a subsequent resale in accordance with

HOLDING:

The royalty payments or fees paid by Importer to [* * * * * * * *] are included within the transaction value of the imported merchandise as royalties in accordance with ?402(b)(1)(D).

This decision should be mailed by your office to the internal advice requester no later than sixty 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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