Dutiability of certain royalty payments made to a third party; patent

HQ H064075 March 25, 2011 VAL-2 OT:RR:CTF:VS H064075 KSG CATEGORY: Valuation Port Director. Port of Washington-Dulles Airport 22685 Holiday Park Drive #15 Sterling, Virginia 20166 Re: Dutiability of certain royalty payments made to a third party; patent Dear Director: This is in response to a letter from Baker & McKenzie dated March 5, 2008, on behalf of their client (“ABC Company”), requesting Internal Advice on whether certain royalty payments must be included in the transaction value of certain imported products. This Internal Advice is a follow-up to a prior disclosure filed by counsel on December 28, 2007. We note that counsel requested confidentiality on certain information, which will not be included in the Internal Advice. At the request of counsel, a meeting was held on this matter at Headquarters on January 27, 2010. We regret the delay in responding. FACTS: This case involves four license agreements that ABC Company has with four unrelated companies. License #XXX ABC Company entered into this agreement with XXX Company to grants ABC Company and its affiliates a royalty bearing, irrevocable worldwide, non-exclusive license, with no right to sub license, to make, have made, import, use, sell and offer to sell ABC Company’s licensed products. XXX License was entered into to settle various intellectual property rights disputes and potential litigation. The license covers certain merchandise, which in the absence of the license agreement, would be an infringement of at least one claim of XXX Company’s patent rights. XXX Company received a royalty-free license for certain of ABC Company’s patent rights at the same time. The XXX Company does not produce the merchandise or sell it to ABC Company. ABC Company either manufactures the merchandise in the U.S. or a ABC Company related party manufactures it in Europe (“ABC-Europe”) under the XXX License and an internal license from ABC Company and then sells it to ABC Company. If the merchandise is used for clinical, charitable, promotional purposes, is destroyed, or is sitting in a warehouse, no royalty payments are due. At the time that the merchandise is sold be ABC-Europe to ABC, no royalties are paid The XXX license requires ABC Company to pay XXX Company on a quarterly basis a percentage of the net sales of ABC Company’s licensed products. The definition of “net sales” includes any sale or commercial disposition for value by ABC Company or an affiliate in an arm’s length transaction with any unaffiliated third party anywhere, the gross invoice price less certain discounts, allowances, credits, duties, plus a proportion of cooperative advertising. The phrase “net sales” does not include transfers without consideration for clinical trials, research, samples to promote sales or compassionate use, or sales to ABC Company’s affiliated companies. Prior to 2008, ABC Europe paid a flat rate to ABC Company to cover the XXX royalty, other technology developed by ABC Company and used by ABC Europe and the right to use the ABC Company’s logo on products produced by ABC Europe for the U.S. and foreign markets. Beginning in 2008, the related companies changed the manner in which these monies are handled. ABC Company Europe pays a sliding technology fee to ABC Company based on net sales outside the U.S. and a separate fee to use the ABC Company logo on third-party sales outside the U.S. The technology fee paid to ABC Company by ABC Europe covers royalties on all products for sale outside the U.S., including those using the XXX license. The purpose of this charge-back is to credit ABC Company for non-U.S. sales (since, as stated above, ABC Company paid the global fee). Agreement #YYY ABC Company entered into YYY Agreement with YYY Company, an unrelated company, that grants ABC Company a license to “make, have made, use, sell, offer to sell, and import” certain licensed products in the U.S., Japan, and Europe. YYY AGreement covers certain products whose manufacture or use in the absence of an agreement would infringe at least one claim of patent rights held by YYY Company. The merchandise is not manufactured or sold by YYY Company. The products are manufactured under license by ABC Europe and sold to the ABC Company. ABC Company is required by the YYY License to pay a running royalty on a quarterly basis based on a percentage of the net sales of licensed products. The definition of “net sales” includes any commercial disposition or use of license products to or by a third party less certain expenses. Certain adjustments were to be made to compensate each party for prior loans and advances under prior agreements. As in the XXX agreement, no royalty payments are due if the licensed product is used in research, clinical trials, promotional samples, or compassionate use. In addition to the running royalties, there is also a fee due upon execution and annually as license maintenance fees, whether or not any goods were manufactured or imported. The YYY License Agreement also covers jointly developed products and improved products and in some cases, royalties to ABC Company by the YYY Company. ABC Company pays royalties to YYY Company for its share (U.S. sales). ABC Europe pays through the ABC Company to YYY Company for its pro-rata share of the royalties due for sales outside the U.S. Agreement #ZZZ ABC Company entered into an agreement with ZZZ Company that grants ABC Company a non-exclusive worldwide irrevocable right and license, to make, have made, use, import, export, lease, sell and offer for sale certain products and utilize certain medical processes. The ZZZ license covers certain medical equipment and related devices that are manufactured in the EU by another ABC related party, ABC- EU, under license from ZZZ Company. In addition, the license covers certain “treatment cards” which contain a crystal and enable the apparatus to function. No royalties are paid directly by ABC-EU to ZZZ Company. The royalties are paid by ABC Company to ZZZ Company on a quarterly basis based on net sales, which does not include research, clinical trials, promotional samples or for compassionate use customary in the trade. Agreement #XYZ ABC Company entered into an agreement with XYZ Company that grants ABC Company the license to import, have made, or convey, directly or through a distributor, for use in the U.S. certain medical apparatus for performing medical procedures which may include inventions or improvement of such procedures. ABC Company and XYZ Company contemplates that they will use, offer to sell, sell, lease, exchange, otherwise dispose of or make available for use certain medical apparatus utilizing certain inventions or improvement covered by one or more of ABC patents or XYZ patents. This agreement is also a settlement of a lawsuit between ABC Company and XYZ Company. XYZ Company is a third-party holder of patent rights. The license agreement between ABC Company and XYZ Company requires that a royalty be paid for each medical procedure performed on a patient with the equipment, regardless of whether the equipment was manufactured in the U.S. or not. The use of the medical equipment is calculated by a auditable tamper-resistant counting mechanism satisfactory to XYZ Company as provided for in the agreement. ABC Company makes payments to XYZ Company for U.S. procedures performed using the medical equipment, paid on a monthly basis based on monthly reports. ISSUE: Whether the described royalty payments pursuant to the XXX, YYY, ZZZ, and XYZ agreements are an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D). LAW AND ANALYSIS: 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 basis of appraisement under 19 U.S.C. 1401a is transaction value defined as the “price actually paid or payable for the merchandise when sold for exportation to the United States,” plus Amounts for enumerated statutory additions to the extent not otherwise included in the price actually paid or payable. The additions include “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.” 19 U.S.C. 1401a(b)(1)(D). For purposes of this ruling, we assume that transaction value is the proper method of appraisement for the imported merchandise. As a general matter, we note that royalty payments may be included in transaction value as part of the price actually paid or payable or as an addition thereto. See, e.g., General Notice, “Dutiability of Royalty Payment,”Vol. 27, No. 6 Cust. B. & Dec. at 1 (February 10, 1993); H.R. Rep. No. 317, 96th Cong., 1st Sess., at 80 (1979) (“General Notice”). In the particular circumstances of this case, however, the royalty is not paid to the seller or a party related to the seller and no subsequent proceeds accrue directly or indirectly to the seller, our analysis is confined to whether the royalty payments are included in transaction value as an addition to the price actually paid or payable under 19 U.S.C. 1401a(b)(1)(D).  With respect to the dutiability of royalty payments and license fees, the Statement of Administrative Action (“SAA”), H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 48-49, which forms part of the legislative history of the TAA, provides, in pertinent part, that: Additions 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 a 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. For example, if the buyer pays a third party for the right to use, in the United States, a trademark or copyright relating to the imported merchandise, and such payment was not a condition of the sale of the merchandise for exportation to the United States, such payment will not be added to the price actually paid or payable. However, if such payment was made by the buyer as a condition of sale of the merchandise for exportation to the United States, an addition will be made. As a further example, 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. In the General Notice, Customs set forth a three-part analysis designed to assist in determining whether the royalty payments in question are related to the imported merchandise and are condition of sale such that they are included in transaction value as an addition to the price actually paid or payable. As set forth in the notice, the questions are: Was the imported merchandise manufactured under patent? Was the royalty involved in the production or sale of the imported merchandise? Could the importer buy the product without paying the fee? The general Notice indicates that affirmative answers to the first and second questions, and a negative answer to the third question point toward dutiability. Question three goes to the heart of whether the payment is considered to be a condition of sale. In analyzing these factors, CBP has taken into account certain considerations which flow for the language set forth in the SAA. These include, but are not limited to: (1) the type of intellectual property rights at issue (e.g., patents covering processes to manufacture the imported merchandise will generally be dutiable); (2) to whom the royalty was paid (e.g., payments to the seller or a party related to the seller are more likely to be dutiable than are payments to an unrelated party); (3) whether the purchase of the imported merchandise and the payment of the royalties are inextricably intertwined (e.g., provisions in the same agreement for the purchase of the imported merchandise and the payment of the royalties; license agreements which refer to or provide for the sale of the imported merchandise, or require 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 the failure to pay royalties); and (4) payment of the royalties on each and every importation. See Headquarters Ruling Letter (“HRL”) 546203, dated May 21, 1998. In this case, based on the information provided, the responses to each of the three above-listed questions are as follows: 1. Was the imported merchandise manufactured under patent? In this case, the royalty payments at issue under all four agreement (XXX, YYY, ZZZ, and XYZ) are for imported merchandise manufactured under patents covering processes used to manufacture the imported goods. 2. Was the royalty involved in the production or sale of the imported merchandise? Under all four agreements, royalty payments are not made to the seller of the imported merchandise or to a party related to the seller. ABC Company has the right “to make, have made, import, use, sell and offer to sell” the imported merchandise in agreements XXX, YYY, and ZZZ. However, pursuant to agreements XXX, YYY, and ZZZ, ABC Company cannot produce or sell the imported merchandise or offer to sell it if the royalty fee is not paid. Therefore, the royalty is involved in the production or sale of the imported merchandise and answer to question two is affirmative for agreements XXX, YYY and ZZZ. However, regarding Agreement XYZ, the royalty is more of a “use” royalty, based on medical procedures performed using the patented equipment. If the imported merchandise is not used, no royalties are due. Therefore, for the royalty paid pursuant to agreement XYZ, it is not involved in the production or sale of the imported merchandise, The answer to question two is negative for agreement XYZ. Could the importer buy the product without paying the fee? Under Agreements XXX, YYY, and ZZZ, the products cannot be purchased or imported without the payment of the royalty fee. The SAA provides that a royalty payment made by a buyer as a condition of the sale of the merchandise for exportation to the United States will be added to the price actually paid or payable. CBP has generally interpreted this to mean that royalties will be dutiable, even if paid to third parties, if they constitute a condition of the sale for exportation. See HQ HRL H004991, dated April 2, 2007. Counsel argues that since no payments are due for products used in research, clinical trials, promotional samples, or compassionate use or goods stored in warehouses, the royalty payment is not conditioned on the sale of the imported product. CBP ruled in HRL 545998, dated November 13, 1996, that where buyer’s royalty payment for a patent only accrued on the commercial sale of the finished good, the payment was still considered a condition of sale of the imported product. In that case, the royalty payment on the patent was not due if the good was not produced, if there was no sale, or if the imported pharmaceutical was used in research and development. Counsel noted in that case that the royalty on the imported pharmaceutical product was “not due on each and every ounce of imported merchandise sold to the importer/buyer.” for instance, no royalty was due on imported goods used in the importer/buyer’s research and development. Like HRL 545998, in this case, royalties will ultimately be due on all imported products which are sold in the United States with exclusions for certain products such as goods used in research. Therefore, we find that the answer to question 3 for the agreements XXX, YYY, and ZZZ is negative. Therefore, we find that the payment of “on-going royalties” based on the royalty agreement between ABC Company and XXX, YYY, and ZZZ are a condition of sale and included in transaction value as an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D). With regard to XYZ agreement, the imported equipment could be bought without paying the royalty fee if it is never used. The payment of the royalty fee is not tied to the sale; in fact, the royalty payment could potentially be made to XYZ for a number of years based on the usage. The payment of the royalty fee is not a condition of the sale for exportation of the imported equipment. Therefore, the answer is in the affirmative and the payment of the “per-use” royalty would not be included in the transaction value as an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D). HOLDING: The payment of royalties based on the agreements XXX, YYY, and ZZZ, as set forth above, between ABC Company and Companies XXX,YYY, and ZZZ are a condition of sale of the imported merchandise and included in transaction value as an addition to the price actually paid or payable for the imported merchandise under 19 U.S.C. 1401a(b)(1)(D). Based upon the information provided, we find that the payment of a royalty fee based on the royalty agreement between ABC Company and XYZ is not a condition of sale of the imported merchandise and not included in transaction value as an addition to the price actually paid or payable under 19 U.S.C. 1401a(b)(1)(D). This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations & Rulings will make the decision available to CBP personnel, and to the public on the CBP Home page on the internet at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution. Sincerely, Monika R. Brenner Valuation & Special Programs Branch