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HQ 545536

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September 21, 1995

VAL R:C:V 545536 er
CATEGORY: VALUATION

District Director
Norfolk, Virginia

RE: Request for Internal Advice Regarding the Dutiability of Royalty Payments; Related Parties.

Dear Sir:

This is in response to your memorandum dated January 19, 1994, forwarding the request for internal advice dated November 30, 1993, which was submitted to you by counsel on behalf of their client UCB Radcure Inc. ("Radcure"). The request concerns the dutiability of certain royalty payments made by Radcure to a related foreign company and to two unrelated foreign companies. We regret the delay in responding.

FACTS:

Radcure is a U.S. company that is engaged principally in the manufacture of chemical products in the U.S. Approximately ninety percent (90%) of the products are manufactured in the U.S. and the remaining ten percent (10%) are imported. Products imported are solvent-free polymer resins in liquid form: polyester resins for powder paints; resins curable by ultraviolet light or by accelerated electron beams (UB/EBC); and polyurethane resins for coatings. These resins are found in inks, varnishes, adhesives, and decorative and protective coatings. It is our understanding that the imported products are the licensed products which are the subject of the various licensing agreements and manufacturing processes described in these licensing agreements which are discussed below.

The three foreign sellers of the products are: (1) UCB, S.A. ("UCBSA), the Belgian parent corporation; (2) Quimica Iberica, SA ("UCB Spain"), a wholly-owned Spanish subsidiary of UCBSA; and Daicel UCB Company LTD ("UCB Japan"), a joint venture between UCBSA and an unrelated Japanese company.

Radcure makes royalty payments to its related party, UCBSA, and to two unrelated parties which were involved in the early development of the products, Rhone-Poulenc, Inc. ("Rhone-Poulenc") and Alcolac, Inc. ("Alcolac"). Rhone-Poulenc and Alcolac are not related to Radcure, UCBSA, UCB Spain, or UCB Japan.

The royalty payments are calculated and paid quarterly based on a set percentage of net sales of the products in the U.S. Depending on the particular type of product sold, Radcure will make a royalty payment to either UCBSA alone, or both UCBSA and Rhone-Poulenc or Alcolac. These royalty payments are made on the basis of the sale of the products whether domestically manufactured or imported. Thus, approximately 10% of the royalty payments paid to UCBSA and Rhone-Poulenc or Alcolac are related to merchandise that has been manufactured abroad by UCBSA (seller/licensor), UCB Spain (seller) or UCB Japan (seller) and imported by Radcure.

The royalty payments are made pursuant to the terms of three licensing agreements between: Radcure and UCBSA, Radcure and Rhone-Poulenc and Radcure and Alcolac. The agreement between Radcure and UCBSA is a cross-licensing agreement under which Radcure obtains rights to certain proprietary and other information held by UCBSA, and UCBSA obtains rights to certain proprietary and other information held by Radcure (obtained by Radcure under its licensing agreements with Rhone-Poulenc and Alcolac, described below) "which would be useful or necessary for the manufacturing, the marketing, the using and the sale" of the products.

   The information supplied to Radcure by Rhone-Poulenc and Alcolac and in turn supplied by Radcure to UCBSA represents research and development activities undertaken in the U.S. and thus does not constitute an assist under 19 U.S.C. 1401a(h)(1)(A)(iv). The licensing agreement also grants to Radcure an exclusive license to manufacture and sell the products in a defined territory.

Like the Radcure and UCBSA agreement, the Radcure/Rhone-Poulenc and the Radcure/Alcolac licensing agreements also provide that Radcure is entitled to obtain information "which would be useful or necessary for the manufacturing, the marketing, the using and sale" of the products. As stated above, neither Rhone-Poulenc nor Alcolac is a seller of the products to Radcure; nor is either party related Radcure, UCBSA, UCB Spain or UCB Japan.

ISSUE:

Whether the subject royalty payments are dutiable as either part of the price actually paid or payable for the imported merchandise or as a statutory addition to that price?

LAW AND ANALYSIS:

The preferred method of appraising merchandise imported into the U.S. is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 ("TAA"), codified at 19 U.S.C.a 1401a. Section 402(b)(1) of the TAA 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 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. (Section 402(b)(1)(D)). For purposes of this decision, we have assumed that transaction value is the appropriate method of appraisement.

There is a rebuttable presumption that all payments made by a buyer to a seller, or a party related to a seller, are part of the price actually paid or payable. See HRL 545663 dated July 14, 1995. Thus, with regard to the payments made by Radcure to UCBSA for merchandise purchased from UCBSA or from its related parties UCB Spain and UCB Japan, the presumption is that the payments are part of the total payment made for the imported merchandise. See Section 402(b)(4)(a). The information submitted by counsel does not rebut the presumption that the royalty payments are part of the total payment made for the imported merchandise.

This presumption does not apply to the royalty payments made to Alcolac and Rhone-Poulenc because neither Alcolac nor Rhone-Poulenc is related to the sellers of the merchandise. Accordingly, these payments are not presumed to be part of the price actually paid or payable for the merchandise and must instead be analyzed from the perspective of whether they constitute a statutory addition to the price actually paid or payable.

Regarding the royalty payments made to UCBSA, even if we were presented with evidence which persuades us that the such payments are separate from the price actually paid or payable, the payments would, nonetheless, constitute royalties under section 402(b)(1)(D) of the TAA. 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 at 48-49 (1981).

In the General Notice, Dutiability of Royalty Payments, Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993), Customs articulated three factors, based on prior court decisions, for determining whether a royalty was dutiable. These factors are 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 are a condition of sale and, therefore, are dutiable as royalty payments.

Regarding the first factor, it is undisputed that much of the merchandise imported by Radcure from UCBSA is manufactured under patent rights held by UCBSA. However, according to counsel, neither Rhone-Poulenc nor Alcolac hold patent rights on any of the merchandise imported by Radcure which is purchased by Radcure from UCBSA, UCB Spain or UCB Japan. Thus, the imported merchandise is manufactured under patent rights held by UCBSA but is not manufactured under patent rights held by Rhone-Poulenc or Alcolac.

Regarding the second factor, the information submitted indicates that the royalty paid to UCBSA is involved in production of the imported merchandise. The licensing agreement grants to Radcure "an exclusive license ... to practice the process and to manufacture and sell the products anywhere in the territory ...". Under the agreement, the term "process" means "such process as has been developed by either party and/or which may, during the term of this Agreement, be developed by either party as it relates to the manufacture of Products (i.e., the chemical products defined in section 1.1 of the Agreement.)" As indicated above, it is our understanding that the imported merchandise, whether manufactured by UCBSA, UCB Spain or UCB Japan, is manufactured using the process referred to in the licensing agreement for which royalties are paid. As such, the royalty, which is paid upon the sale of the imported product, is involved in the production of the imported merchandise.

Since no purchase agreements relating to the imported merchandise have been submitted, we cannot determine whether the royalties are expressly involved in the sale of the imported merchandise. However, based on the information provided, we conclude that it is unlikely that UCBSA or its related companies would have sold the imported products manufactured in accordance with the licensed process, unless Radcure also agreed to pay the royalties in question.

With regard to the royalties paid by Radcure to Rhone-Poulenc and to Alcolac, the license agreements provide that Radcure is entitled to obtain the following:
all unpatented trade secrets, proprietary and confidential information, specifications, compositions, formulas, manufacturing methods, application methods, testing methods, computer programs, technical information data and drawings, as well as any improvements thereto, which would be useful or necessary for the manufacturing, the marketing, the using and sale of the products as shall have been developed or acquired by either party prior to the termination of this Agreement, and
all patents and patent applications on any of the foregoing.

In support of its position that the payments made to Rhone-Poulenc and Alcolac are not dutiable additions to transaction value, counsel states that while the licensing agreements provide that Radcure is entitled to patents and patent applications held by Rhone-Poulenc and Alcolac, Rhone-Poulenc and Alcolac do not hold patents relating the products imported by Radcure. Rhone-Poulenc holds patent rights on one product, but this product is manufactured in the U.S by Radcure. Thus, the royalty payments made to Rhone-Poulenc and Alcolac by Radcure for imported products represent payment for the use of unpatented information only. Counsel also points out that the information supplied to Radcure by Rhone-Poulenc and Alcolac represents research and development activities undertaken in the U.S. by Rhone-Poulenc and Alcolac, and thus does not constitute an assist under 19 U.S.C. 1401a(h)(1)(A)(iv) even if provided free of charge, or at a reduced rate, to one of the foreign sellers.

While we agree, based on the information submitted by counsel, that the research and development is not an assist, we are not persuaded that just because the imported merchandise is manufactured without the use of any patented information held by Rhone-Poulenc and Alcolac that the royalty payments made to those parties are not related to the production of the imported merchandise. The licensing agreements between Radcure and these two parties provide that the royalties paid to Rhone-Poulenc and Alcolac are paid for the exclusive license "to practice the process and to manufacture and sell the products...". The term "process" means "such process as has been developed and used by [Alcolac or Rhone-Poulenc] or which may ... be developed by [Alcolac or Rhone-Poulenc] as it relates to the manufacture of the products..." (emphasis added). The licenses set forth that Alcolac and Rhone-Poulenc have the right to grant the licenses for the manufacture, use and sale of the products and for the use of the process by Radcure to manufacture the products. The licensing agreements thus tie the payment of the royalties to the production of the merchandise. In addition, in the cross-licensing agreement between Radcure and UCBSA, UCBSA obtains rights to information held by Radcure (obtained by Radcure under its licensing agreements with Rhone-Poulenc and Alcolac) "which would be useful or necessary for the manufacturing, the marketing, the using and the sale of the Products." The language in these agreements demonstrates that the royalty payments are related to the production of the imported merchandise. Therefore, as regards the royalty payments made to Rhone-Poulenc and Alcolac, the response to the second factor is in the affirmative.

In prior decisions, including the General Notice, supra, Customs acknowledged that the "answer to question three goes to the heart of whether a payment is considered to be a condition of sale." Because Radcure does not incur the obligation to make the royalty payment for goods purchased from UCBSA until the products are resold in the U.S. counsel believes that the royalties are not a condition of the sale of the imported merchandise. Counsel cites to HRL 544061, dated May 27, 1988, and HRL 544129, dated August 31, 1988, in support of its position. As pointed out in the General Notice, in these two decisions one of the major factors for determining whether the royalty was not dutiable was whether the royalty payments were calculated on the basis of sales that occurred subsequent to the importation of the merchandise. This line of reasoning was specifically rejected in the General Notice where Customs 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.

The royalty is paid to UCBSA on each imported item purchased from UCBSA, UCB Japan or UCB Spain which is resold in the U.S. As Congress stated in the SAA "an addition will be made for any royalty or license fee paid by the buyer to the seller, unless the buyer can establish that such payment is distinct from the price actually paid or payable for the imported merchandise, and was not a condition of the sale of the imported merchandise for exportation to the United States." As regards the payments made by Radcure to UCBSA for merchandise purchased from UCBSA, the information submitted fails to establish that the payments were not a condition of sale. As indicated previously we conclude that it is unlikely that UCBSA or its related companies would have sold the imported licensed products unless Radcure agreed to pay it the royalties relating to such products. Accordingly, we find that the payments made to UCBSA for merchandise purchased from UCBSA is dutiable under section 402(b)(1)(D).

Royalty payments made to Alcolac and Rhone-Poulenc for merchandise purchased from UCBSA or its related parties, UCB Japan and UCB Spain, are also dutiable royalties under section 402(b)(1)(D). In the General Notice Customs discussed certain court cases decided under export value, a means of appraisement under a previous valuation statute, which involved the dutiability of royalty payments. One of the cases, Imperial Products, Inc., 65 CCPA 38, C.A.D. 1203, 570 R.2d 337 (1978), contained the following language:

A royalty fee may or may not be part of the dutiable value. When a royalty is paid on each and every importation and is inextricably intertwined with the imported merchandise such fee is part of the dutiable value. BBR Prestressed Tanks, Inc. v. U.S., 64 Cust. Ct. 787, A.R.D. 265 (1970); Erb & Gray Scientific, Inc. v. U.S., 53 CCPA 46, C.A.D. 875 (1966). When the fee is not inextricably intertwined with the production of the imported merchandise or is optional or is paid for the exclusive right to manufacture and sell in a designated area it is not dutiable. U.S. v. Rohner Gehrig & Co., 9 Cust. Ct. 591, R.D. 5724 (1942).

In addressing the third factor regarding whether the importer can buy the product without paying the royalty Customs, in the General Notice, looked to the principles set forth in the above-quoted language and determined that where the fee had to be paid on each imported article, the fee was not optional and would be dutiable. In the instant case the licensing agreement between UCBSA and Radcure under which Radcure pays UCBSA royalties for products purchased from UCBSA, UCB Japan and UCB Spain is a "cross-license" agreement which incorporates the royalty agreements between Radcure/Alcolac and Radcure/Rhone-Poulenc. The UCBSA/Radcure agreement provides that Radcure and UCBSA consider the UCB, Rhone-Poulenc and Alcolac technologies to be complementary and that the parties are desirous of combining their respective technologies for the purpose of improving the production, developing more efficiently new applications and better serving and competing in the expanding world-wide market for the products. Although neither Alcolac nor Rhone-Poulenc is related to UCBSA, their collaboration with regard to the production of the imported merchandise is evident from the cross-license agreement and the Radcure/Alcolac and Radcure/Rhone-Poulenc agreements. From the cross-licensing agreement it is apparent to us that the royalties paid to Alcolac and Rhone-Poulenc are "inextricably intertwined" with the production of the imported merchandise. The conclusion that the royalties are "inextricably intertwined" with the imported merchandise is also supported by the fact that the provisions in the Radcure/Alcolac and Radcure/Rhone Poulenc agreements that pertain to notice requirements, require Alcolac and Rhone-Poulenc to give notice not only to Radcure, but also to its related-party seller, UCBSA. Thus, under the circumstances, we find that Radcure could not purchase the imported merchandise without also paying royalties to Rhone-Poulenc and Alcolac.

HOLDING:

Royalty payments made by Radcure to UCBSA for merchandise purchased from UCBSA, UCB Japan and UCB Spain are dutiable either as part of the price actually paid or payable for the imported merchandise or as royalties under section 402(b)(1)(D).

Royalty payments made by Radcure to Rhone-Poulenc and Alcolac for merchandise purchased from either UCBSA, UCB Spain or UCB Japan are also dutiable as royalties under section 402(b)(1)(D).

Sincerely,

John Durant, Director
Commercial Rulings Division

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