HQ 546638 - Internal Advice Concerning Dutiability of Advance Payments Made Against Future Royalties for Contracted Plant Capacity; Price Actually Paid or Payable; Generra; Chrysler - United States International Trade Commision Rulings

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HQ 546638

October 4, 1999

VAL RR:IT:VA 546638 LPF

CATEGORY: VALUATION

Port Director
U.S. Customs Service
2701 Rockcreek Pkwy. - Suite 202
N. Kansas City, MO 64116

RE: Internal Advice Concerning Dutiability of Advance Payments Made Against Future Royalties for Contracted Plant Capacity; Price Actually Paid or Payable; Generra; Chrysler

Dear Port Director:

This decision concerns a request made by Barnes, Richardson & Colburn on behalf of their client, [*******************************************] (importer), concerning the dutiability of advance payments made by the importer to its foreign seller for contracted plant capacity. As set forth in counsel's January 4, 1995 initial internal advice request, we grant confidential treatment to the identity of the importer, the name and location of the foreign supplier and the name of the proprietary merchandise. Accordingly, we have excised, in the public version of this decision, the bracketed confidential information. We regret the delay in the issuance of our response.

FACTS:

On April 4, 1981, the importer entered into an agreement with [********************] (seller), an unrelated corporation, for the latter's development and testing of a sustained time release form of their previously developed drug. Development of the time release drug was to occur via three stages. In Stage I, the seller was to review technical data and conduct tests to determine whether the program should progress to Stage II. Stage II consisted of designing a finished dosage for production which included various types of testing and screening. In Stage III, the seller produced trial batches, tested them and conducted quality procedures. This agreement further provided that the importer was to be the exclusive licensee of the seller's technology and know-how, the latter agreeing to provide the importer with any technical data necessary for utilization of such know-how. Acquiring the exclusive license to utilize the U.S. process patent for production, the importer agreed to pay the seller $30,000 to be credited against future royalties. Additionally, the importer agreed to pay the seller a 2.5% royalty based on its net sales of the final product.

On September 27, 1985, the parties entered into an addendum to the agreement whereby the seller agreed to provide specified quantities of the time release drug to the importer. Additionally, the seller was to establish a production facility for such manufacture. As consideration, the importer paid the seller $1,200,000 in advance royalties. It was agreed that the importer would purchase the necessary drug to be shipped to the seller for use in the manufacture of the time release product.

The case record also contains an April 4, 1986 letter whereby the importer agreed to pay the seller $500,000 to complete product development (the payment being recoverable as a credit against royalties) and a September 29, 1986 letter where the importer agreed to pay the seller another $1,600,000, fully recoverable as credit against royalties, for the seller to fully capitalize expansion and accommodate production of the time release drug. The record reflects that counsel does not contest the dutiability of any of these amounts, which are conceded to pertain to production of the time release drug.

However, in an October 25, 1989 agreement, the parties contracted for the exclusive right concerning the method of preparing the dosage of the time release drug. The seller further agreed to manufacture and sell such a product to the importer. Counsel explains that although the importer had the right to manufacture the product in the U.S., attempts failed, so the importer purchased the majority of the product from the seller in bead form. With the exception of samples provided by the seller already in final capsule form, a subsidiary of the importer encapsulates the beads within the Customs territory of the U.S. Accordingly, the majority of the time release drug is imported in drums and subsequently blended and put in capsules based on the seller's technology. The seller assembles and blends different shellacked beads abroad and subsequently, within the Customs territory of the U.S., the importer performs a test to identify the components.

The agreement defines several relevant terms as follows. “Know-how” means the method of preparing shellac-coated beads of the drug capable of delaying the full release of the compound when administered to humans, developed by the seller and licensed to the importer. Section 1.01. “Product” means shellac coated beads produced using the know-how or capsules containing such beads in finished dosage form of sixty, ninety, one hundred twenty and one hundred eighty milligram capsules. Section 1.02. “Contracted plant capacity” means the physical capacity, in facility, plant and equipment terms, agreed to be committed to the manufacture of the product by the seller, and for which advance payments have been made by the importer. Section 1.05.

The payments currently at issue are those set forth in Section 2.07 of this agreement. Specifically, the agreement provides that the recovery of advance payments made by the importer in consideration for the seller's provision of contracted plant capacity shall be made against future royalties, using the specified recovery formula. However, in no instance shall recovery exceed one-third of royalty due in any one period. In the event of the seller's breach of the provision providing for the seller's manufacture and sale of the product (Section 2.01), the importer may recover the balance of all advance payments.

Counsel describes these payments as interest free loans made to finance the seller's fulfillment of the contract. Further, counsel provides that the seller's work was necessary for FDA approval of the New Drug Application (NDA). This occurred by the seller providing dosage information and information for the completion of the Chemical Manufacturing Control section of the NDA which was key to its approval. The seller also provided information to the importer which was used in the blending and encapsulating procedures relative to similar products the importer produces in the U.S.

Counsel asserts that the royalties are not part of the price actually paid or payable for the merchandise pursuant to section 402(b)(4)(A) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. §1401a, nor should be added to the price actually paid or payable to comprise part of the transaction value as royalties or proceeds pursuant to 19 U.S.C. §1401a(b)(1)(D) and (E), respectively.

ISSUE:

Whether the advance payments made by the importer against future royalties, in consideration for the seller's provision of contracted plant capacity, are included within the transaction value as part of the price actually paid or payable, or as royalties and/or proceeds.

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. §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 the enumerated statutory additions. These statutory additions include, among other things, royalties related to the imported merchandise and proceeds of any subsequent resale, disposal, or use of the imported merchandise. Sections 402(b)(1)(D) and (E).

The "price actually paid or payable" is defined in section 402(b)(4)(A) of the TAA as the "total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise...) made, or to be made, for the imported merchandise by the buyer to, or for the benefit of, the seller."

Numerous court cases have addressed the meaning of the term “price actually paid or payable.” In Generra Sportswear Co. v. United States, 8 CAFC 132, 905 F.2d 377 (1990), the court considered whether quota charges paid to the seller on behalf of the buyer were part of the price actually paid or payable for the imported goods. In reversing the decision of the lower court, the appellate court held that the term “total payment” is all-inclusive and that “as long as the quota payment was made to the seller in exchange for merchandise sold for export to the United States, the payment properly may be included in transaction value, even if the payment represents something other than the per se value of the goods.” The court also explained that it did not intend that Customs engage in extensive fact-finding to determine whether separate charges, all resulting in payments to the seller in connection with the purchase of imported merchandise, were for the merchandise or something else.

In Chrysler Corporation v. United States, 17 CIT 1049 (1993), the Court of International Trade applied the Generra standard and determined that although tooling expenses incurred for the production of the merchandise were part of the price actually paid or payable for the imported merchandise, certain shortfall and special application fees which the buyer paid to the seller were not a component of the price actually paid or payable. With regard to the latter fees, the court found that the evidence established that the fees were independent and unrelated costs assessed because the buyer failed to purchase other products from the seller and not a component of the price of the imported engines.

Accordingly, it has been Customs position that based on Generra, there is a presumption that all payments made by a buyer to a seller are part of the price actually paid or payable for the imported merchandise. However, this presumption may be rebutted by evidence which clearly establishes that the payments, like those in Chrysler, are completely unrelated to the imported merchandise.

In this case, we find that the payments made to the seller constitute part of the price actually paid or payable for the imported merchandise. As discussed below, counsel has not demonstrated that the subject payments are completely unrelated to the imported merchandise.

While counsel avers that the amounts in question are interest free loans, and carried on the importer's books accordingly, the submitted evidence does not demonstrate that this necessarily is the case. In prior decisions, such as Headquarters Ruling Letter (HRL) 545995, issued October 12, 1995, Customs has relied on the counsel of its Regulatory Audit Division (RAD) in carefully scrutinizing amounts claimed to constitute non-dutiable loan payments (i.e., as fully disclosed in the financial statements of both parties). For instance, in HRL 545995, RAD indicated that an intercompany loan should be listed in the individual accounts of each party. Company balance sheets would reflect such bona fide loans as an account in the Current Liability Section titled “Notes Payable - Short Term” and, conversely, in the Current Assets Section titled “Notes Receivable - Short Term.” In the current matter, Customs does not possess such evidence.

Additionally, the fact that counsel characterizes such amounts as “interest-free” loans raises some concern as to the precise nature of the payments, insofar as Customs generally would understand such loan amounts indeed to carry an interest rate in arm's length transactions. Furthermore, the plain language within the agreement makes reference to advance payments made in consideration for contracted plant capacity to be made against future royalties. Nowhere does the agreement itself describe such amounts as interest-free loans.

Finding that the evidence does not support counsel's characterization of the amounts as loans, Customs must consider if such amounts from the buyer to the seller could, however, be considered completely unrelated to the imported merchandise. Considering again the plain language of the relevant agreement, we note that contracted plant capacity means, “physical capacity, in facility, plant and equipment terms, agreed to be committed to the manufacture of the product....” This definition, insofar as it includes equipment utilized for the manufacture of the imported merchandise, indicates that such amounts, in fact, are related, if not inextricably connected, to the imported merchandise. Accordingly, Customs finds such amounts to be dutiable as part of the price actually paid or payable for the imported merchandise. This already being the case, Customs finds it unnecessary to analyze whether the amounts in question likewise could be considered part of the transaction value as dutiable royalties and/or proceeds.

HOLDING:

Based on the evidence and information provided, the advance payments made by the importer against future royalties, in consideration for the seller's provision of contracted plant capacity, are included within the transaction value as part of the price actually paid or payable.

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 and to the public on the Customs Home Page on the World Wide Web at www.customs.treas.gov, by means of the Freedom of Information Act, and other methods of public distribution.

Sincerely,

Thomas L. Lobred
Chief, Value Branch

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