HQ H029658
OT:RR:CTF:VS H029658 YAG
Port Director
U.S. Customs and Border Protection
Port of Seattle
1000 Second Ave., Suite 2200 Seattle, WA 98104
RE: Internal Advice Request; Acceptability of Transfer Price; Transaction Value; Related Party Transactions; Advance Pricing Agreement
Dear Port Director:
This is in response to the Importer’s request for internal advice, prepared by its outside counsel, Damon V. Pike, seeking approval of the proper basis of appraisement for motor vehicles and parts, imported from [***], filed on behalf of [***] (the “Importer”), on May 27, 2008. We regret the delay in responding.
The Importer has asked that certain information submitted in connection with this internal advice be treated as confidential. Inasmuch as the Importer’s request conforms to the requirements of 19 CFR §177.2(b)(7), the Importer’s request for confidentiality is approved. The information contained within brackets and all attachments to the internal advice request, forwarded to our office, will not be released to the public and will be withheld from published versions of this ruling.
FACTS:
The Importer/Buyer is a U.S. Corporation, which acts as an exclusive distributor of motor vehicles imported from the Seller/Manufacturer [***], the parent company, for re-sale in the U.S. market. The Importer also acts as the exclusive distributor for parts, accessories, and service tools imported from [***], the affiliate of the parent company. The Importer imports vehicles, parts, accessories, and service tools through numerous ports of entry. Furthermore, parts, accessories, and service tools are imported through these and other ports.
The Importer provided the following documents for our review: purchase orders, commercial invoices, packing lists, freight invoices, shipping advices, bank’s advices of acceptance and debit advices reflecting payment, broker invoice, CF3461, CF7501, etc. Additionally, the Importer provided a detailed description of its sales process. At the beginning of the process, the Importer prepares its pricing proposals for each upcoming series/model. This pricing proposal is used to support the Importer’s recommended FOB amount or the amount the Seller charges the Importer/Buyer, which is the value declared to CBP upon importation of the vehicles. Pursuant to the Importer’s submission, the pricing proposal is an analysis of the market segment for the model and includes an overview of sales plans, retail pricing comparisons with competitor vehicles within the same vehicle segment, suggested trim levels, and recommended Manufacturer’s Suggested Retail Price (“MSRP”) and dealer margins. At the same time the Importer prepares its pricing proposal, the Manufacturer/Seller is preparing a similar recommendation of FOB amount, dealer cost, and MSRP based on sales and profit goals. It is stated that the parties negotiate an acceptable price and the Manufacturer/Seller prepares final pricing studies and management reports for internal approval.
Once the Importer negotiates the price with its parent company, it issues purchase orders to the Seller on a periodic basis, which are accepted and filled by the Seller at its various manufacturing locations in [***]. Once the vehicles are ready to be shipped, the Seller issues an invoice to the Importer/Buyer, which transfers title and risk of loss at the port of embarkation. The Importer bears the cost of international freight and insurance, which is itemized separately on each invoice, and the payment terms are 90 days, which is made via regular wire transfer. The Importer selects all of its customers (the dealers). Additionally, it sets the dealer cost and MSRP at the beginning of the process based on the information available during the negotiations with the Seller/Manufacturer. It is stated that the Importer could order the imported merchandise and have it delivered for its own inventory.
It is claimed that the pricing in the automobile industry is essentially “market driven MSRP,” meaning that the end consumer determines the actual price they will pay for the vehicles they purchase. This end price takes into account the dealer’s return and the distributor’s return to cover its cost of distribution to the dealers. Any remaining profit or loss goes back to the parent company (manufacturer). As support, a paper, “Pricing Practices in the Automotive Industry” prepared by Ernst & Young, LLP, was submitted for our review.
In September of 2003, the Importer voluntarily applied for a bilateral Advance Pricing Agreement (“APA”) with the Internal Revenue Service (“IRS”) to cover all of its imported items (vehicles and parts) for the years of [***]. An APA constitutes a prospective agreement between a taxpayer and the IRS (and in the case of bilateral APAs, foreign tax authorities) regarding the correct transfer pricing methodologies under tax laws to be applied to transactions between related parties. The foreign Competent Authority in this instance is the [***].
After discussions, the IRS and the [***] reached mutual agreement regarding a bilateral APA governing the transfer price to be paid by the importer to the manufacturer relative to the importer’s distribution of the manufacturer’s products. The APA covers the sales of automobiles, light trucks, automotive parts, and accessories to the Importer. The tested party is the Importer. The term of the importer’s APA is for five tax years ending [***].
Section 482 of the Internal Revenue Code (26 U.S.C. §482) requires that the arm’s length result of a controlled transaction be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result. The application of the best method establishes an arm’s length range of prices or financial returns with which to test controlled transactions.
In its APA, the Importer identified the comparable profits method (“CPM”) as the best method for evaluating its related party or controlled transactions. The CPM examines whether the amount charged in a controlled transaction is an arm’s length price by comparing the profitability of the tested party to that of comparable companies. The Importer sets its prices according to the CPM. The profit level indicator selected was the operating margin. The importer’s operating margin is defined as follows: the sum of the Importer’s operating profit for the APA term divided by the sum of its net sales revenue for the APA term.
According to the APA, the arm’s length range is between [***]. This arm’s length range was established on the basis of an objective, third-pricing data for distributors (comparable companies), which perform similar functions and assume similar risks as the Importer. This range was proposed by the Importer to the taxing authorities of the United States and [***] in its Submission in Support of Request for Advance Pricing Agreement, which was included for our review, together with the internal advice request. In selecting comparables for its analysis, an independent accounting firm, KPMG, hired by the Importer, reviewed publicly-available databases and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 5000-5099 (Wholesale Trade – Durable Goods). After eliminating certain companies, KPMG used the Standard & Poor’s Compustat (“S&P Compustat”) database to obtain data for North American companies. This search generated a set of 125 unique companies out of which a final set of 21 comparable companies was selected, whose financial data was used to determine a target operating margin range for the Importer for the term of the proposed APA. It is important to note that although the accounting firm searched for companies that perform similar functions, incur similar risks, use similar intangible
assets as well as sell similar products, the final set of comparable companies represents a set of companies that sell a variety of products from air conditioners and heating equipment to tires to roofing materials. It is stated that the Importer was not able to identify any current information on comparable companies in the automotive industry.
Furthermore, the Importer states that it does not make compensating adjustments pursuant to its APA. The Importer states that it engages in rigorous negotiations with its parent company to set vehicle prices which allow the Importer to earn an operating profit that meets the target interquartile range of the APA. Accordingly, these negotiations have resulted in prices that have never needed an adjustment (except for the years 1999-2001 when a compensating adjustment in the amount of approximately [***] was booked). Thus, the Importer is not requesting a ruling with respect to any compensating adjustments. ISSUES:
Do transactions between the Seller and the Importer/Buyer constitute bona fide sales?
Do the circumstances of sale establish that the price actually paid or payable by the Importer/Buyer to the Seller was not influenced by the relationship of the parties and is acceptable for the purposes of transaction value?
LAW AND ANALYSIS:
Merchandise imported into the United States is appraised for customs purposes 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 primary method of appraisement is transaction value, which is defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. See 19 U.S.C. §1401a(b)(1). When transaction value cannot be applied, then the appraised value is determined based on the other valuation methods in the order specified in 19 U.S.C. §1401a(a).
In order to use transaction value, however, there must be a bona fide sale for exportation to the United States. Several factors are relied on to determine whether a bona fide sale exists. See Headquarters Ruling Letter (“HRL”) 546067, dated October 31, 1996.
Furthermore, there are special rules that apply when the buyer and seller are related parties, as defined in 19 U.S.C. §1401a(g). Specifically, transaction value between a related buyer and seller is acceptable only if the transaction satisfies one of two tests: (1) circumstances of sale or (2) test values. See 19 U.S.C. §1401a(b)(2)(B). “Test values” refer to values previously determined pursuant to actual appraisements of imported merchandise. Thus, for example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of merchandise under section 402(d) of the TAA. HRL 543568, dated May 30, 1986. In this instance, however, there are no previously accepted test values. You request that we examine the circumstances of the sale in order to determine the acceptability of transaction value. The purpose of these rules is to ensure that the relationship between the parties does not affect the price.
Do transactions between the Seller and the Importer/Buyer constitute bona fide sales?
In order for transaction value to be used as a method of appraisement, it is essential that a "sale" between the parties is available. In VWP of America, Inc. v. United States, 175 F.3d 1327 (Fed.Cir. 1999), the Court of Appeals for the Federal Circuit found that the term “sold” for purposes of 19 U.S.C. §1401a(b)(1) means a transfer of title from one party to another for consideration (citing J.L. Wood vs. United States, 62 CCPA, 25, 33, C.A.D. 1139, 505 F.2d 1400, 1406 (1974)).
No single factor is decisive in determining whether a bona fide sale has occurred. See HRL 548239, dated June 5, 2003. CBP will consider such factors as to whether the purported buyer assumed the risk of loss for, and acquired title to, the imported merchandise. Evidence to establish that consideration has passed includes payment by check, bank transfer, or payment by any other commercially acceptable means. Payment must be made for the imported merchandise at issue; a general transfer of money from one corporate entity to another, which cannot be linked to a specific import transaction, does not demonstrate passage of consideration. See HRL 545705, dated January 27, 1995.
In addition, CBP may examine whether the purported buyer paid for the goods, and whether, in general, the roles of the parties and the circumstances of the transaction indicate that the parties are functioning as buyer and seller. See HRL H005222, dated June 13, 2007.
Finally, pursuant to the CBP’s Informed Compliance Publication, entitled “Bona Fide Sales and Sales for Exportation,” CBP will consider whether the buyer provided or could provide instructions to the seller, was free to sell the transferred item at any price he or she desired, selected or could select its own downstream customers without consulting with the seller, and could order the imported merchandise and have it delivered for its own inventory.
As noted in the FACTS portion of this ruling, the Importer provided numerous documents to substantiate its claim that there was a bona fide sale between the Seller and the Importer/Buyer in this case. The Importer/Buyer prepares its pricing proposals, which are used to support the Importer’s recommended FOB amount. The parties negotiate an acceptable price, and based on the facts provided, the Importer clearly provides instructions to the seller. Further, the Importer issues purchase orders, and once the vehicles are ready to be shipped, the Seller issues an invoice to the Importer/Buyer, which transfers title and risk of loss at the port of embarkation. Moreover, the Importer sets the dealer cost and MSRP and can order the imported merchandise and have it delivered for it own inventory. Accordingly, based on the description of the importer’s sales process, substantiated by numerous documents submitted by the Importer, we find that the Importer sufficiently proved the existence of a bona fide sale between the Importer/Buyer and the Manufacturer/Seller.
Do the circumstances of sale establish that the price actually paid or payable by the Importer/Buyer to the Manufacturer/Seller was not influenced by the relationship of the parties and is acceptable for the purposes of transaction value?
Under this approach, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The Customs Regulations specified in 19 CFR Part 152 set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, Customs will examine the manner in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 CFR §152.103(l)(1)(i)-(ii). In addition, Customs will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. 19 CFR §152.103(l)(1)(iii). These are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well.
A. An examination of whether the related party prices are settled in a manner consistent with the way the seller settles prices for sales to unrelated buyers or with the normal pricing practices of the industry
The Manufacturer/Seller has some independent distributors of its vehicles, especially in South America. However, there are significant differences between the vehicles sold to the related Importer/Buyer in the United States and the vehicles sold to the unrelated distributors in South America. First, the Importer states that it is very difficult to quantify the differences in various governmental requirements and consumer preferences for each country. Second, the volume of vehicles sold in these foreign markets is substantially different from that of the United States and since the distributors in other countries are independent, the Importer has no access to their data, making it difficult to quantify the impact of volume differential on the transaction value. Therefore, it is impossible to ascertain whether the related party prices are settled in a manner consistent with the way the seller settles prices to unrelated buyers.
In support of its claim that the related party prices are settled in a manner consistent with the normal pricing practices of the industry, the Importer states that the automotive industry has a unique pricing approach that is consistent, with minor variations, across the industry. As indicated in the paper, “Pricing Practices in the Automotive Industry,” the Importer claims that the pricing in the automobile industry is essentially “market driven MSRP,” meaning that the end consumer determines the actual price they will pay for the vehicles they purchase. This end price takes into account the dealer’s return and the distributor’s return to cover its cost of distribution to the dealers. Any remaining profit or loss goes back to the parent company (manufacturer).
CBP has noted that the Importer must have objective evidence on how prices are set in the relevant industry in order to establish the “normal pricing practices of the industry” in question, and present evidence that the transfer price was settled in accordance with these industry pricing practices. See HRL 547672, dated May 21, 2002; HRL 548482, dated July 23, 2004; and, HRL 542261, dated March 11, 1981 (TAA. No. 19) (stating that where the transfer price was defined with reference to prices published in a trade journal (the posted price) and the posted price was commonly used by other buyers and sellers as the basis of contract prices, the transfer price was acceptable). The Importer has set forth certain statements describing the “market driven” pricing of how the automobile industry sets its prices. While the evidence provided by the Importer is not entirely objective, as determined by our previous rulings, we acknowledge that the vehicle pricing at all levels is based on the market driven MSRP. In other words, once a vehicle has been produced, pricing through the chain of manufacturing, assembly, marketing, and retail sale is based on actual retail prices paid by consumers, and not any hypothetical or expected prices or costs used in the development stage.
Furthermore, the Importer claims that the Seller’s prices to the Importer/Buyer are set in accordance with the normal pricing practices of the industry because the Importer/Buyer earns an operating margin comparable to that of 21 distribution companies, which formed the basis of the CPM analysis for tax purposes. We have reviewed the Importer’s Submission in Support of Request for Advance Pricing Agreement, dated September 2003 as well as the Importer’s Advance Pricing Agreement and the Importer’s valuation methodology. Upon our review, we find that the information contained in the documents is not sufficient to determine that, in this case, the related party prices are settled in a manner consistent with the normal pricing practices in the industry. In HRL 547672, dated May 21, 2002 and in HRL 548482, dated July 23, 2004, we stated that the transfer pricing study is not sufficient to establish that the transfer prices at issue are set in accordance with the normal pricing practices in the industry and that, once again, objective evidence is necessary. We also note that the pricing practices must relate to the industry in question, which generally includes the industry that produces the goods of the same class or kind as the imported merchandise. See HRL 546998, dated January 19, 2000; see also HRL 548095, dated September 19, 2002. In this case, a set of 21 functionally comparable companies was used to determine a target operating margin range for the Importer for the term of the proposed APA. This set of comparable companies was chosen from publicly available databases using the Wholesale Trade-Durable Goods SIC codes. Our review of these comparable companies indicates that these companies were chosen based on their functional comparability with the Importer. The comparable companies sell a variety of products from air conditioners and heating equipment to tires to roofing materials. The Importer, on the other hand, is an exclusive distributor of motor vehicles and parts and, therefore, a member of the automobile industry. CBP does not consider the industry in question to consist of other functionally equivalent companies if those companies do not sell goods of the same class or kind. CBP has ruled that the mere fact that the Importer allegedly earned an operating profit comparable to other functionally equivalent companies was not sufficient to establish either the normal pricing practice of the industry or that the related party price was settled in a manner consistent with the normal pricing practices of the industry in question. See HRL 548482, dated July 23, 2004 and HRL 548095, dated September 19, 2002. The Importer also claimed that the automotive industry, in general, used the same set of comparable companies in its transfer pricing arrangements. Since the Importer failed to substantiate this claim, we will not address this claim in this ruling. Thus, in this case, while this information does not definitely establish that the price was settled in a manner consistent with the normal pricing practices of the automotive industry, we find that the information presented gives insight on how the automobile industry determines the price, and, therefore, provides some evidence that the price was settled in a manner consistent with the normal pricing practices of the industry.
B. An examination of whether the price is adequate to ensure recovery of all costs plus profit
The Importer suggests that the APA and all supporting documentation submitted to CBP support its position that the transactions between the Buyer/Importer and the Seller are consistent with arm’s length transactions. The Importer claims that its APA establishes, in accordance with 19 CFR §152.102(i)(1)(iii), that the price is adequate to ensure recovery of all costs 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.
In this case, the Importer’s APA request analyzed in detail the various pricing methodologies under Section 482 of the Internal Revenue Code. Pursuant to the APA, the Importer’s profitability was compared to that of comparable companies, and the IRS approved the range of profitability after evaluating the information submitted by the Importer. We note that for purposes of the all costs plus profit test, the price must be adequate to ensure recovery of all costs plus a profit in sales of merchandise of the same class or kind. Pursuant to 19 CFR §152.102(h), the merchandise of the same class or kind means merchandise (including, but not limited to, identical merchandise and similar merchandise) within a group or range of merchandise produced by a particular industry or industry sector. As we mentioned before, none of the comparable companies chosen for the analysis sell goods of the same class or kind as the Importer, and only one company sells after market automotive parts. Whether the products, covered by the study (or an APA as in this case) are comparable to the imported products at issue, is an important consideration for CBP. HRL 547672, dated May 21, 2002. In other words, while CBP’s review of the companies deemed to be functionally comparable to the Importer may provide some evidence that the price is adequate to ensure recovery of all costs plus a profit, this information is less valuable since the companies are not engaged in the sale of the same class or kind of merchandise.
Another consideration in the all costs plus a profit example is the “firm’s” overall profit. The Importer argues that the buyer’s overall profit realized over a representative period of time should be considered as stated in HRL 563400, dated March 29, 2006. In HRL 563400, Rollo USA imported grinding machines and parts, which were used for producing cutting tools for various industrial and medical uses. In that case, CBP determined that the importer had not submitted sufficient information to establish that the circumstances of the sale were met. However, this ruling did not discuss the application of the all costs plus a profit method. We note that HRL 548233, dated November 7, 2003 looked at the buyer’s profit; however, normally CBP has examined the seller’s profit. See HRL 548482, dated July 23, 2004 and HRL H017761, dated September 27, 2007. Furthermore, while the buyer’s overall profit may be relevant, we note that in this case, the APA sets forth the range of profit levels based on comparable companies that do not necessarily sell goods of the same class or kind, which limits the comparability to satisfy the all costs plus a profit test. Nevertheless, the buyer’s overall profit is one of the factors that may be considered to indicate that the relationship between the buyer and seller did not influence the price.
C. An examination of whether other factors indicate that the relationship between the buyer and seller did not influence the price.
CBP has noted that whether the Importer’s transfer pricing methodology has been reviewed and approved by the IRS is a significant factor. HRL 546979, dated August 30, 2000. In this case, the Importer’s transfer pricing analysis has been reviewed and accepted by the IRS. In fact, the Importer entered into a bilateral APA with the IRS and the foreign tax authority. We find that the information submitted to the IRS and the fact that there is a bilateral APA constitute valuable information in evaluating the circumstances of the sale. See HRL 546979, dated August 30, 2000 and HRL 548233, dated November 7, 2003. We note that all of the Importer’s imported products are covered by the APA, reducing the possibility of profit manipulation. Thus, the Importer has chosen to have all of its related party transactions covered by the APA. Consequently, even though the CPM method reviews profitability on an aggregate basis and not a product-by-product basis, in the particular circumstances of this case we will not require the Importer to provide CBP with a further breakdown of product line profitability for comparability purposes. Further, although CBP did not participate in the APA pre-filing conference, the Importer provided CBP with a waiver that enabled access to the documents that were submitted to the IRS in the APA process that support the facts and statements made by the Importer in the course of this internal advice request. The fact that the foreign tax authorities have approved the APA mandated profit levels for the Importer and, as stated by the Importer’s counsel, presumably, have made the determination that the seller is earning an overall profit that will allow it to cover its costs, is another factor to show that the relationship between the parties did not affect the price. We also take note of the rigorous negotiations between the buyer and seller to determine an FOB price that permits the Importer’s operating profit to fall within the interquartile range established by a reference to unrelated comparable companies. Finally, the paper on the pricing practices of the automotive industry is another useful consideration.
Therefore, based on our review and examination of all 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, as specified in 19 CFR §152.103(l)(1)(i), 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 method of appraisement for this related party transaction.
HOLDING:
In conformity with the foregoing, transaction value is the appropriate method of appraisement in respect to sales between the Importer/Buyer and the Manufacturer/Seller.
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 and Rulings will make the decision available to CPB personnel, and to the public on the CPB Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns.
Sincerely,
Monika R. Brenner, Chief
Valuation & Special Programs Branch