RR:IT:VA 546979 VLB
RE: Acceptability of transfer prices for transaction value
Damon V. Pike
National Director
Customs Services
Deloitte & Touche LLP
191 Peachtree Street
Third Floor
Atlanta, Georgia 30303-1924
Dear Mr. Pike:
This is in response to your letters dated [ ], requesting a ruling on behalf of your client [ ] (“the Importer”). Specifically, you request a ruling on the acceptability of the transfer prices paid by the Importer for merchandise imported from related party suppliers. The transfer pricing methodology has been approved by the Internal Revenue Service (“IRS”) through the Advance Pricing Agreement (“APA”) program. You have also made a request for confidentiality which has been granted. The information contained within brackets will not be released to the public.
FACTS:
You state that the Importer is a U.S. corporation which acts as a wholesale distributor of [ ] and related products for household and commercial use in the U.S. market. The Importer has two suppliers, [ ] and [ ]. The Importer is related to both [ ] and [ ] as defined in 19 U.S.C. § 1401a(g).
On [ ], the Importer applied for an APA. You explain that an APA is a prospective agreement between a taxpayer and the IRS (and possibly other tax authorities) regarding the correct transfer pricing methodologies under tax law to be applied to transactions between related parties. In this case, the Importer also filed its APA request with the National Tax Administration (“NTA”) in Japan.
In addition, a member of my staff attended a conference between your client and the IRS, i.e. the APA prefiling conference. Your client also has provided a waiver to this office to enable access to the documents that were submitted to the IRS in the APA process.
In your letter dated [ ], you state that the APA, once approved, will set forth a range of profit levels that the Importer’s transactions must meet in order to meet the IRS arm’s length test under 26 U.S.C. 482 of the Internal Revenue Code (“section 482”). In the APA request, the Importer set forth an analysis of two different methodologies. The two methods were the Comparable Profits Method (“the CPM”) established under section 482 and the Japanese Profit Split method applied by Japan (see page 5 for further explanation). You further explain that in applying the Best Method Rule of section 482, the Importer’s analysis concluded that the CPM was the most reliable vehicle for evaluation the Importer’s related party transactions. The CPM examines whether the amount charged in the controlled transaction, i.e. the related party transaction, is at arm’s length by comparing the profitability of the “tested party”, in this case the Importer, the U.S. distributor/importer, with the profitability of comparable uncontrolled, i.e. unrelated, companies.
The Importer, by requesting Customs participation in the prefiling conference and by providing Customs access to information regarding the application of the CPM , enabled Customs to review the selection of the tested party, how the comparable companies were selected, the determination of financial results related to the controlled transactions, the selection of the years for comparison, what accounting adjustments were made to the financial statements of the comparable companies and of the Importer, the selection of the most reliable profit level indicator, the capital adjustments and the use of the interquartile range.
In March 2000, the Importer and the IRS signed the APA, in addition, the competent authorities of Japan and the United States executed a mutual agreement that is consistent with the APA. The APA covers all sales of products by [ ] and non-U.S. affiliates to the Importer during the APA term.
Appendix A of the APA contains the agreed upon transfer pricing methodology (“the TPM”). Pursuant to paragraph 2 of Appendix A the following methodology was agreed upon:
[ .]
Further, pursuant to paragraph 7 of the APA, if the Importer’s actual transactions are not in compliance with the TPM described above, the Importer’s taxable income must nevertheless be reported in an amount consistent with the TPM and the requirements of the APA. Thus, the Importer may make what are referred to in the IRS revenue procedures as “compensating adjustments.” Compensating adjustments are a means of allowing a taxpayer to retroactively account for any differences between actual transactional results and true arm’s length results, in this case arm’s length results that are defined in the APA.
ISSUE:
Whether transaction value is the proper method of appraisement for the transactions between the Importer and its related party suppliers.
LAW AND ANALYSIS:
Merchandise imported in the U.S. is appraised in accordance with section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a; TAA). The preferred method of appraisement is transaction value. Transaction value is defined as the “price actually paid or payable” for the merchandise when sold for exportation to the United States, plus certain enumerated additions. § 402(b)(4)(A) of the TAA.
Pursuant to § 402(b)(2)(A)(iv), the transaction value of imported merchandise shall be the appraised value only if the buyer and the seller are not related, or if the buyer and the seller are related, the transaction value is acceptable under § 402(b)(2)(B). § 402(b)(2)(B) provides that transaction value between a related buyer and seller is acceptable if the buyer demonstrates that the declared transaction value meets one of the following two tests: 1) Circumstances of the Sale, or 2) Test Values.
You cite the following section from the Statement of Administrative Action:
[t]he fact that the buyer and seller are related is not in itself grounds for regarding the transaction value as unacceptable and there will be related party transactions in which validation of the transaction value, using either of the two methods outlined above, will not be necessary. For instance, the Customs Service may. . .already have sufficient detailed information concerning the buyer and seller to be satisfied that the relationship did not influence the price actually paid or payable. In such case, where the Customs Service has no doubts about the acceptability of the price, the price will be accepted without requesting further information from the importers.
H.R. Doc. No. 96-153, 96th Cong., 1st Sess. 6A (1979), at 333, reprinted in 1979 U.S. Code Cong. & Ad. News 388.
You further point to the Customs regulations as follows:
Customs may already have . . . sufficient detailed information concerning the buyer and seller to be satisfied that the relationship did not influence the price actually paid or payable. In such case, if Customs has no doubts about the acceptability of the price, the price will be accepted without question further information from the importer.
19 C.F.R. § 152.103(l)(1)(I).
Based on these provisions, you argue that as long as detailed information is available to demonstrate that the relationship between the buyer and the seller did not influence the price actually paid or payable, no analysis under either of these two tests is required. Further, in this case, you suggest that the detailed and sufficient information mandated by the legislative history exists in the bilateral APA. You base this on the fact that the APA is a bilateral APA, and that the Importer had every incentive to provide the IRS and the Japanese taxing authority with absolutely accurate and complete information regarding its purchases from related suppliers when it filed its APA request.
While we agree that the Importer supplied a great deal of information to both taxing authorities, we do not agree that this should be sufficient for Customs to determine that the related party tests established in the TAA do not need to be applied. While the goal of both the TAA and section 482 of the Tax Code is to ensure that the transactions between related parties are at arm’s length, the method of making that determination is different under each law.
However, we do find that the information submitted to the IRS and the fact that there is a bilateral APA constitute valuable information in applying the circumstances of the sale test in 402(b)(2)(B)(1) of the TAA. You have argued that if Customs does determine that an examination of the circumstances of the sale test is required, then the information supplied meets Customs requirements for determining that the relationship did not influence the price.
The Statement of Administrative Action contains the following language describing the circumstances of the sale test:
[t]he Customs Service will examine relevant aspects of the transaction, including the way in which the buyer and seller organize their commercial relations and the way in which the price in question was arrived at, in order to determine whether the relationship influenced the price. If it is shown that the buyer and seller, although related, buy from and sell to each other as if they were not related, this will demonstrate that the price has not been influenced by the relationship and the transaction value will be accepted.
The Statement of Administrative Action also contains three examples of the circumstances of the sale test. First, if the price is determined in a manner that is consistent with normal industry pricing practice, then the price actually paid or payable will be deemed to not have been influenced by the relationship. Second, if the price is determined in the same way in which the seller deals with unrelated buyers, then the price actually paid or payable will be deemed to not have been influenced by the relationship. Third, if the price is adequate to ensure recovery of all cost plus a profit that is equivalent to the firm’s overall profit realized over a representative period of time in sales of merchandise of the same class or kind, this will demonstrate that the price had not been influenced by the relationship. 19 CFR §152.103(l).
You assert that the Importer meets the circumstances of the sale test and falls within the examples. You state that in analyzing whether the price is determined in a manner that is consistent with normal industry price practice, or the way in which the seller deals with unrelated buyers, the overriding question is whether the transactions at issue approximate an arm’s length price.
Further, you claim that the key determinant in arm’s length analysis is whether an adequate profit is realized on those transactions, and that the APA request analyzes this issue to determine the level of profit that should be earned by the buyer and the seller. You state that the Importer’s profitability was compared to that of ten comparable companies and that the IRS approved the range of profitability after evaluating the information submitted by the Importer. Thus, you conclude, the information demonstrates that the Importer earns a profit on sales of imported merchandise which is consistent with normal industry practices and thus satisfies the arm’s length test.
You also note that because Japan does not recognize the CPM, the Importer also computed the result under the Japanese Profit Split (“JPS”) method. You describe the JPS as follows:
The JPS examines whether an adequate profit is realized on sales of imported merchandise by computing a consolidated operating profit for the relevant transactions. The JPS essentially allocates the consolidated operating profits to the Importer and the related suppliers in proportion to each party’s contribution of labor and fixed assets.
Thus, you take the position that the APA seeks to determine whether each party, including the related sellers, recover its costs plus an adequate profit, and thus satisfy the arm’s length test when approved by the Japanese authorities.
As noted previously, Customs approach to related party transactions differs from the IRS approach. Specifically, the methods that you described review profitability on an aggregate basis, not a product by product basis. However, we note that in the Prefiling Submission to the IRS, the Importer stated that to establish a range at a less aggregate level, allocations of its profit and loss statement and balance sheet would have to be undertaken to analyze each product division individually and any such allocation would be potentially arbitrary and would reduce the reliability of the CPM approach. Further, the Importer noted that it would not be possible to find different sets of comparison companies for the Importer’s individual product divisions.
While Customs generally analyzes related party transactions at a more detailed product by product level, we note that all of the Importer’s imported products are covered by the APA. While this is not a requirement under the APA program, the Importer has chosen to have all of its related party transactions covered by the APA. Thus, we will not require the Importer to provide Customs will a further breakdown of product line profitability for comparability purposes. However, Customs expects that in any future verification, the Importer will be able to show Customs that the profit earned by product line falls within the agreed upon range specified in the APA.
Further, we conclude that more detailed information is not necessary because the transfer pricing agreement that the Importer must operate under is a bilateral agreement, in which both countries have reviewed the submission and negotiated a fair result for both taxing authorities. Our review of the information, including attending the APA prefiling conference and review of information submitted to the IRS pursuant to the waiver referenced previously, allows us to conclude that we have examined the relevant aspects of the transaction, including the way in which the Importer and its related suppliers organize their commercial relations, as well as the way in which the price in question was arrived at between the parties. Based on this review we hold that the Importer has demonstrated that the price has not been influenced by the relationship for purposes of the circumstances of the sale test. Thus, transaction value is the proper basis of appraisement for the related party transactions.
We note that if the Importer must make compensating adjustments to comply with paragraph 7 of the APA, the adjustments must be reported to Customs immediately and any additional duties resulting from the adjustments must be tendered to Customs.
HOLDING:
Transaction value is the proper method of appraisement for the transactions between the Importer and its related party suppliers.
Sincerely,
Thomas L. Lobred, Chief
Value Branch