Price Actually Paid or Payable; Royalties; Pharmaceuticals

HQ 545998 November 13, 1996 VAL RR:IT:VA 545998 LR CATEGORY: Valuation Robert L. Eisen, Esq. Karen Bysiewicz, Esq. Coudert Brothers 114 Avenue of the Americas New York, N.Y. 10036-7703 RE: Price Actually Paid or Payable; Royalties; Pharmaceuticals Dear Mr. Eisen and Ms. Bysiewicz: This is in response to your letter dated May 9, 1995, on behalf of your client, Pfizer Inc. ("the importer/buyer"), requesting a ruling on the dutiability of payments to UCB Pharmaceuticals, Inc., now Pharma, Inc. ("the licensor") for royalties, research studies, and co-promotion fees relating to the imported product, cetirizine ("the imported product"). The arguments presented in the meeting on April 15, 1996, and summarized in your supplemental submission dated May 28, 1996 were also taken into account in rendering this decision. This ruling does not contain any of the information which you claim is confidential as set forth in your letters dated May 17, 1995 and May 28, 1996, and clarified in your November 11, 1996 fax. We regret the delay in responding. FACTS: The imported product is a pharmaceutical active ingredient. The importer/buyer purchases it in bulk form from UCB, S.A. ("the seller), an unrelated company located in Belgium. Upon importation, the importer/buyer combines the imported product with other ingredients of U.S. origin in the manufacture of Zyrtec ("the finished product"), an antihistamine available to consumers by doctor's prescription only. After receiving FDA approval in 1995, the finished product was launched commercially in the U.S. market in February, 1996. A portion of the imported product was also used to conduct research and to prepare samples of the finished product. There is one licensor-owned, U.S. patent for the imported product which will expire in 2002. This patent concerns the chemical composition of the imported product. You indicate that the imported product and the finished product have different forms, functions and physical characteristics. The former is a powdered, chemical bulk material which is not suitable for use as a pharmaceutical end-product because of its unpleasant taste and lack of reliable dosage form. In contrast, the finished product contains precise amount of the imported product in combination with other ingredients presented in the form of a film-coated tablet. You state that in this form, the finished product can be relied upon to achieve the desired antihistamine benefits for which it has been tested and approved by the FDA. You point out that FDA approval was required for both products. The importer/buyer has entered into five agreements with respect to the imported product: the "License Agreement," "Supply Agreement", "Combination Agreement", "Trademark Agreement" and a "Co-Promotion Agreement". Copies of these agreements were submitted. These agreements are summarized below. The various payments provided for in three of these agreements are the subject of this ruling. The Supply Agreement is between the importer/buyer and the seller. The other agreements are between the importer/buyer and the licensor, a party related to the seller. The License Agreement On August 15, 1983, the importer/buyer and the licensor, a U.S. subsidiary of the seller, entered into a license agreement ("the License Agreement"). Under its terms, the licensor granted the importer/buyer (1) the exclusive right under the imported product patent to sub-license, make, use and sell within the United States Licensed Products in the United States and (2) an exclusive license to use the licensor's Technical Information in connection with the manufacture, use and sale of the Licensed Products in the United States. These rights are subject to the licensor's own rights to make, use and Licensed Products in the U.S. The term "Licensed Products" is defined as "any of the Products the manufacture, use or sale of which would, in the absence of a license, infringe the Licensed Patents or which utilize the licensor's Technical Information. The term "Licensed Patents" is defined as all U.S. patents owned or acquired by the licensor or its affiliates related to the Products, or methods of use or intermediates or processes for the manufacture thereof. As noted above, you indicate that there is one licensor-owned, U.S. patent for the imported product which is currently in force pertaining to the composition of ceterizine. Thus, "Licensed Products" means the imported product, together with all pharmaceutical compositions and dosage units containing ceterizine as the sole therapeutically active ingredient. Under the License Agreement, the importer/buyer shall, at its own expense, take all steps and make all efforts necessary or desirable to obtain FDA approval to market Licensed Product for all appropriate indications as determined by the importer/buyer after consultation with the licensor and shall use its best efforts to promote and market the Licensed Products in the United States. The License Agreement further provides that the first commercial sale of Licensed Products will occur within six months from the date of FDA approval. In consideration of the licenses described above, the importer/buyer has agreed to pay the licensor advance royalties and continuing royalties based on the net sales of the Licensed Products in the U.S. (The advance royalties are to be credited against any continuing royalties). The License Agreement provides for the payment of minimum royalties. The continuing royalties begin to accrue on the date of the first commercial sale of the Licensed Products to third parties. Also, under the License Agreement the importer/buyer agreed to pay the licensor a fixed sum within sixty days of receiving the results of two preclinical studies conducted by the licensor. The two studies concerned the long-term toxicity of the imported product and were conducted in the early 1980's outside the United States. In addition, the licensor conducted two chronic (two-year) carcinogenicity studies and ten toxicology studies of the imported product which it conducted outside the United States. The importer/buyer reimbursed the licensor for the results of these studies. All fourteen studies concern the general safety of the imported product and were necessary in order to obtain FDA approval for the finished product. The Combination License Agreement On November 10, 1987, the importer/buyer and the licensor entered into a Combination License Agreement ("Combination Agreement,") in which the licensor granted to the importer/buyer the exclusive license under the Licensed Patents to make, use and sell combinations in the United States and an exclusive license to use the licensor's Technical Information in connection with the manufacture, use and sale of combinations in the United States. This agreement differs from the License Agreement in that the earlier agreement applies only to products containing the imported product as the sole active ingredient, whereas the Combination Agreement applies to products containing the imported product and at least one other active ingredient (the latter products will be referred to as "Combinations"). In exchange for the right to combine the imported product with other pharmaceutical active ingredients, the importer/buyer is obligated to pay a royalty to the licensor, a percentage of the importer/buyer's net sales of the Combinations in the U.S., which would infringe the licensor's licensed patent (for the imported product or the licensor-developed Combinations) and a percentage of net sales of Combinations whose manufacture, use or sale in the U.S. involves the licensor technical information. You indicate that to date, the importer/buyer has conducted research in the U.S. to develop Combinations, but presently has not obtained FDA approval for any such products. The Supply Agreement On the date the Combination Agreement was executed, the importer/buyer also entered into a supply agreement ("Supply Agreement") with the seller, the licensor's foreign parent. Under the Supply Agreement, the importer/buyer agreed to purchase its requirements of the imported product from the seller for five years from the date of the first commercial sale of a Licensed Product. Thereafter, the importer/buyer agreed to purchase all its requirements except for any bulk of the imported product produced by the importer/buyer itself. The price of the imported product is established in the Supply Agreement and is based on the seller's costs of production plus a specified percentage. The Supply Agreement provides that "all terms used herein that are defined in the License Agreement or in the Combination Agreement will have, unless otherwise specified herein, the meanings set forth in the License Agreement or the Combination Agreement." With regard to patents, the Supply Agreement provides that the seller represents and warrants that neither the manufacture, use or sale of the imported product to the importer/buyer nor the manufacture, use or sale by the importer/buyer of products incorporating the imported product will infringe any valid and subsisting United States patent other than any such patent licensed to the importer/buyer under the License Agreement or the Combination Agreement or owned by or licensed to the importer/buyer. The Supply Agreement provides that if the License Agreement and Combination Agreement are both terminated, the Supply Agreement will terminate. Co-Promotion Agreement The importer/buyer and the licensor entered into an agreement on June 20, 1995 (the "Co-Promotion Agreement") which permits the licensor to assist the importer/buyer in marketing the "Product" in the United States. The Co-Promotion Agreement defines the term "Product" as "cetirizine". Under the agreement, the licensor has the opportunity to make sales presentations to licensed prescribers of medications. In exchange for its marketing and promotion efforts in the U.S., the licensor will earn a fee ("Co-Promotion Fee") in accordance with a formula provided in the agreement. Trademark Agreement The importer/buyer and the licensor entered into a Trademark License Agreement ("Trademark Agreement") on June 20, 1996. Under the terms of the Agreement, the licensor grants the importer/buyer the use of its U.S. trademarks, "Zyrtec" and "Zirtek". You indicate that the grant of the exclusive right to use, and to license the use of, these trademarks is royalty-free and poses no customs valuation issues. ISSUES: Whether the following fees are part of the transaction value of the imported product: 1) initial and continuing royalties which the importer/buyer must pay the licensor under the license and combination agreements; 2) payments the importer/buyer must pay the licensor under the license agreement relating to the various clinical studies performed by licensor; 3) [payments the importer/buyer must pay the licensor under the Co-Promotion Agreement]. LAW AND ANALYSIS: For the purpose of this ruling, we assume that transaction value is the proper basis of appraisement. Transaction value, the preferred method of appraisement, is defined by 402(b)(1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA, 19 U.S.C. 1401a(b)) as "the price actually paid or payable for the merchandise when sold for exportation to the United States...." plus certain additions specified in 402(b)(1)(A) through (E). 1. Royalties Section 402(b)(1)(D) of the TAA provides for an addition 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. In a General Notice on the Dutiability of "Royalty" Payments (Vol. 27 Cust. Bull. No. 6, dated February 10, 1993) (hereinafter referred to as the "General Notice") Customs set forth a three-part analysis designed to provide importers and Customs with a uniform approach to determine whether certain payments constitute dutiable royalties. This analysis identifies the following three questions, the answers to which assist in determining whether a royalty payment is related to the imported merchandise and is a condition of sale: 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? General Notice at pages 9-11. Negative responses to the first two questions and a positive response to the third points to nondutiability. Question 1 In this case, there is one licensor-owned U.S. patent covering the imported product. It concerns the composition of ceterizine. Nonetheless, your contention is that based on the language in the Statement of Administration Action (SAA) adopted by Congress upon passage of the TAA, and as interpreted by Customs, the answer to question one is "no". You base this conclusion on the fact that the patent does not cover processes to manufacture the imported product. In this regard, you note that the SAA provides that royalties paid for patents covering processes to manufacture the imported merchandise will generally be dutiable (emphasis added). Statement of Administrative Action, H.R. Doc. No. 153, Reprinted in Customs Valuation Under the Trade Agreements Act of 1979, at pp.46-69 (1981). You also cite HRL 545379, July 7, 1995, which held that license fees paid for rights to use an ornamental design in connection with U.S. sales of hair bands were not dutiable as royalties or proceeds of subsequent resale. The decision notes that the design patent was linked more to the appearance of the article, and thus was not for rights associated with its manufacture. You indicate that the patent at issue merely protects the chemical structure of the compound much in the same way as the design patent protects the appearance of the hair bands in HRL 545379. We do not consider the patent covering the imported product to be comparable to the patent covering the hair bands in HRL 545379. The hair bands were covered by a design patent pertaining to "the ornamental design for a hair or foot band as shown and described". 35 U.S.C. 171, entitled Patents for Designs, provides for the patentability of "any new, original and ornamental design for an article of manufacture"(emphasis added). To be patentable, a design must be new, inventive, and ornamental; it must be the product of aesthetic skill and artistic conception. See Bliss v. Gotham Industries, Inc., 316 F.2d 848 ( 9th Cir., 1963). HRL 545379 concluded that the design patent at issue was akin to royalties and license fees paid for the right to use copyrights and trademarks. In contrast to the design patent covering the hair bands, the licensor-owned patent concerns the chemical composition of a pharmaceutical active ingredient. This is obviously not a design patent covering a product's ornamental design. Nor is the patent comparable to royalties and license fees paid for the right to use copyrights and trademarks. We find that the patent at issue is the type of patent that was intended to come within the purview of question one. Thus, even if this patent does not technically cover the process by which the imported product is manufactured, we find that in the circumstances presented, the imported product was "manufactured under patent" and that the answer to question one is "yes". Question 2 You indicate that the response to the second question, whether the royalty is involved in the production or sale of the imported merchandise, is "no." You base this conclusion on the fact that a portion of the royalties is paid for unpatented Technical Information necessary to manufacture the finished product in the United States. Thus, you argue the royalties are paid not for ownership rights to the imported product, but for the right to use the imported product in conjunction with other ingredients to make a finished end-product. You also indicate that the importer/buyer's internal accounting procedure requires that the royalties be booked as cost of U.S. sales, as opposed to costs of the imported product. Finally, you contend that the subject royalty payments are not inextricably intertwined with the imported product as demonstrated by the fact that the License Agreement was negotiated and signed nearly four years before the Supply Agreement for the imported product. You contend that the four-year time span indicates the lack of relationship between the royalty payments and the imported product. While the royalties are paid in part for the right to use the imported product in conjunction with other ingredients to make a finished end-product, they are also involved in both the production and sale of the imported merchandise. The royalties are involved in the production of the imported merchandise because as discussed above such product is "manufactured under patent" and the license for which royalties are paid specifically covers those patent rights. Under the License and Combination Agreements, the licensor granted the importer/buyer the exclusive right under the imported product patent to sub-license, make, use and sell within the U.S. Licensed Products in the U.S. The royalties are also involved in the sale of the imported product. We reach this conclusion on the basis of the various agreements discussed above. First, we note that the imported product is one of the Licensed Products as that term is defined in the License and Combination Agreements for which royalties are paid. As discussed above, the term "Licensed Product" includes any of the Products the manufacture, use or sale of which would, in the absence of a license, infringe the Licensed Patents. Also, the Supply Agreement covering the imported product requires the importer/buyer to purchase its requirements of the imported product from the licensor's parent, except for any of the product produced by the importer/buyer itself. In addition, the Supply Agreement specifically provides that "if the License Agreement and Combination Agreement are both terminated, this Agreement will terminate." These facts demonstrate that the royalties are involved in the sale of the imported merchandise. See HRL 545331, January 19, 1996 (Royalties are involved in the sale of the imported merchandise because the supply agreement provides that it is only in effect as long as the license agreement is in effect, and there would be no sale for exportation to the importer without the license agreement). The fact that the Supply Agreement was executed four years after the License Agreement does not negate the fact that the agreements are inter-related. We also note that the Supply Agreement and the Combination Agreements were executed on the same date. Question 3 You indicate that the response to the third question, whether the buyer could purchase the product without paying the fee, is "yes." According to the General Notice, this question goes to the heart of whether a payment is considered a condition of sale. You take the position that the answer to this question is "yes" because the importer/buyer's royalty payments to the licensor only accrue on the commercial sale of the finished products. You indicate further that the imported product differs in material ways, and possesses different properties than the finished products. Unlike the imported product, the finished product is