VAL:RR:IT:VA 548482 jsj
Mr. Damon V. Pike
Deloitte & Touche
Customs and International Trade Services
191 Peachtree Street, NE
Atlanta, Georgia 30303-1924
Re: Transaction Value; Price Actually Paid or Payable; Related Party Transactions; Transfer Pricing Study.
Dear Mr. Pike:
The purpose of this correspondence is to respond to your request dated January 29, 2004. The correspondence in issue requested, on the behalf of xxxxxxxxxxxxxxxxxxxxxxxxxxxxxxx. (buyer/importer), a binding valuation ruling concerning transactions between the importer/buyer and xxxxxxxxxxxxxxxxxxxxxxxxxx (seller).
This ruling is being issued subsequent to the following: (1) A review of your submission dated January 29, 2004; (2) A review of the attachments to the submission; (3); A telephone conference conducted on May 27, 2004 between representatives of Deloitte & Touche, the buyer/importer and the Customs and Border Protection (CBP) Office of Regulations and Rulings; and (4) A review of your submission dated June 3, 2004, prepared in response to the telephone conference.
The attachments to the submission of January 29, 2004 included: (a) A U.S. Customs Service Compliance Assessment Report of the buyer/importer dated: November 25, 1996; (b) A list of xxxxxxxxxxxx imported by the buyer/importer and the merchandise’s corresponding ten-digit Harmonized Tariff Schedule of the United States subheadings; (c) A copy of a “Sales and Purchase Agreement” between the seller and the buyer/importer; (d) A commercial invoice from the seller to the buyer/importer; (e) A wire transfer request of the buyer/importer; (f) Records of wire transfers; (g) A transfer pricing study entitled: “Economic Analysis of the Pricing of Intercompany Transactions,” dated: September 2003, prepared for xxxxxxxxxxxxxxxxxxxxxxxxxxxx, the parent company of the buyer/importer; (h) Documents identified by the submitter as a Department of the Treasury, Internal Revenue Service “Revenue Agent Report” addressing the period 1997 – 2001; and (i) A Power of Attorney empowering Deloitte & Touche to act on the behalf of the buyer/importer in this ruling request.
The buyer/importer requested confidential treatment pursuant to 19 C.F. R. 177.2 (b)(7) for information identified in its ruling request and in correspondence dated August 6, 2004. Customs and Border Protection has concluded that the information for which confidential treatment has been sought was clearly identified and is commercial or financial information the disclosure of which would cause substantial harm to the competitive position of the ruling requester or another interested party. Confidential treatment will, therefore, be extended in accordance with the request of the buyer/importer. Confidential information will be underscored in this ruling letter and will be redacted in the public version. Attachments one through nine of the submission dated January 29, 2004 will also be treated as confidential.
The buyer/importer specifically requested that this ruling only address the acceptability of the transaction value method of appraising merchandise sold to the buyer/importer by the seller. No issues other than the relationship between the parties will, therefore, be addressed. No inferences regarding any other legal or factual issues should be made.
FACTS
The buyer/importer is an importer of xxxxx. The seller is a “sister” company of the buyer/importer and sells xxxxx to the buyer/importer. The buyer/importer purchases xxxxxxxxxx xxxxxxxxx of its xxxxxxxxx from the seller. The buyer/importer receives the remaining xxxxxx imports on consignment.
U.S. Customs Service auditors, subsequent to completing a Compliance Assessment Audit of the buyer/importer in November of 1996, concluded that the transactions between the buyer/importer and the seller were not arm’s length transactions pursuant to Customs regulations. The Audit Report, finding no previously accepted transactions of identical or similar imports, recommended the use of the deductive value method of appraising imported merchandise, subject to the importer requesting the use of computed value. The importer/buyer advises Customs and Border Protection, the successor of the Customs Service, that it currently uses the deductive method of appraising its imports.
The buyer/importer acquires xxxxx from the seller pursuant to a “Sales and Purchase Agreement” executed by the parties on July 1, 1993. The importer describes the agreement as an “open purchase order” agreement that is similar to a requirement contract. The prices paid by the buyer/importer to the seller are set in Schedule A of the agreement pursuant to Paragraph 3 and are adjusted in accordance with Paragraph 4. Paragraph 3 states:
Seller shall sell and Buyer shall purchase product, shipped on an FOB per-box basis at prices indicated in Schedule A (attached) subject to adjustments as provided in paragraph 4:
Schedule A identifies merchandise by size and quantity and sets a per-box price.
Paragraph 4 provides that the prices set pursuant to Paragraph 3 and Attachment A shall be adjusted in the following manner:
At the end of each quarter during the term of this contract, or upon termination hereof for any cause or reason, there shall be an accounting made between the parties, whereby an adjustment will be made to the product costs, so that the Buyer will realize a reasonable operating profit on products purchased from the Seller. This profit shall be based on a percentage of net sales made to third parties by the Buyer under the guidelines established by section 482 of the U.S. Internal Revenue Code. (Emphasis added).
The buyer/importer, in accordance with the Agreement is to:
maintain complete books and records of account and shall within ten (10) days following discharge of each shipment furnish Seller [The seller] with a complete account sales of each cargo, reflecting all costs, sales, prices, etc., which are appropriate in reflecting the outturn of each cargo.
The seller arranges for the international transportation of the merchandise, with the buyer/importer’s prior approval, and supplies the vessel to transport the merchandise. The merchandise is loaded on the vessel at the risk and expense of the seller. Title to the xxxxx and the risk of loss passes to the buyer/importer from the seller “immediately before and no later than when the cargo enters U.S. territorial waters for the last time prior to entering the port of unloading.”
The seller issues an invoice to the buyer/importer when the merchandise is ready for shipment. The buyer/importer accounts for the invoice as a payable on its general ledger. The terms of sale are “30 days net.” According the importer, “[o]nce a certain number of invoices have accumulated, xxxxxxxxxxxxxxxx [the importer/buyer] issues a ‘Wire Transfer Request’ to pay for the goods purchased” from the seller. Payment is made by way of wire transfer with a record of the transfer being maintained by the buyer/importer
The transfer pricing study included in the buyer/importer’s submission further describes the transactions between the buyer/importer and the seller. Section II, C. of the study, entitled: “Description of Intercompany Transactions,” sets forth the xxxxxxxxxxxxxxxxx, the study preparer’s, understanding of the intercompany transactions. The study states:
The scope of this analysis covers the intercompany transactions between xxxxxxxxxxx [the buyer/importer] and xxxxxxx [the seller].
xxxxxx [the seller] is responsible for coordinating xxxxxxxx production outside the United States, purchasing xxxxxxx from related and unrelated parties outside the United States, selling
xxxxxxxx to related and unrelated wholesalers, allocating the xxxxxxx supply among the worldwide markets, and loading the produce on ships. xxxxxx [the seller] is financially responsible for shipping the xxxxxxxx to related and unrelated wholesalers. The majority of the xxxxxxxx handled by xxxxxxxx [the seller] is xxxxxxxxxxxxxxxxx.
xxxxxxx [the buyer/importer] performs sales, marketing, and distribution functions associated with the sales of the xxxxxxxxxxxxx [group’s]xxxxxxxxxxxxx in North America. xxxxxxxxx [the buyer/importer] also operates distribution centers, warehousing, xxxxxxxxxxxxxxxxxx facilities in various locations across the United States. xxxxxxxxxxx [the buyer/importer] sources a majority of its xxxxxxxx from xxxxxxxxx [the seller] and a limited amount from other related and unrelated parties in the United States and xxxxxxxxx. For example, all xxxxxxxxxxxxxxxxxxxxxxxxxxxx are sourced from xxxxxxx [the seller]. xxxxxxxxxxxx, xxxxxxxxxxxxxxxxxxx are sourced from related, xxxxxxxxxxxxx and unrelated, xxxxxxxxxx sources.
In addition to its core xxxxxxxxxx distribution functions, there are two relatively small business units within xxxxxxxx [the buyer/importer] that perform certain value-added services. These units are referred to as xxxxxxxxxxxxxx. The xxxxxxxxxxxxxx, xxxxxxxxxxx, and packages certain types of xxxxxx and sells them to unrelated customers. xxxxxxxxx [the buyer/importer] entered the xxxxxxxxxx operations in 1999 through the acquisition of two xxxxxxxxx businesses. In FY02, xxxxxxxxx accounted for xxxxx xxxxxxxx percent of xxxxxxxxxxxx [the buyer/importer’s] total revenue.
xxxxxxxxxx sells a variety of xxxxxxxxxxxx to customers such as xxxxxxxxxxx and to retail customers through its web site. xxxxxxxxxx is an insignificant portion of xxxxxxxxxx [the buyer/importer’s] overall business.
xxxxxx [the seller] contracts with xxxxxxx [the buyer/importer] to be xxxxxxxx [the buyer/importer’s] main supplier of xxxxxxx for the North American market. As Chart 2 indicates (refer to page 8 of this report), approximately xxx percent of xxxxxxxxxx [the buyer/importer’s] cost of goods sold in FY02 were comprised of products purchased from xxxxxx [the seller]. xxxxxxxx [the buyer/importer] assumes no risk related to the xxxxxxxxxxxxxx xxxxxxxxxxxx purchased from xxxxxxxxxx [the seller]. xxxxxxxxx [the buyer/importer] pays xxxxxxx [the seller] a price for the xxxxxxxx calculated to permit xxxxxxx [the buyer/importer] to earn an arm’s-length distributor’s profit. In cases where xxxxxxxxx or
other supply issues leave xxxxxxxxx [the seller] unable to supply xxxxxxxxx [the buyer/importer] with xxxxxxxxx to fulfill its contracts with
customers, xxxxxxxxxxx [the buyer/importer] must purchase products from third-party xxxxxxxxx. In FY02, third-party purchases accounted for approximately xxxxx percent of xxxxx [the buyer/importer’s] cost of goods sold.
The study, prepared by the economic consulting group, but bearing the signature of no one, suggests that it compares the profitability of the buyer/importer to that of other functionally equivalent companies in an effort to establish that the transfer prices between the seller and the buyer/importer are consistent the with arm’s length standards of the Internal Revenue Code, section 482. The study has four primary sections. The first section provides a company and industry overview, as well as the consultant’s description of the intercompany transactions. The second section undertakes a “functional analysis” of the buyer/importer and the seller. The third aspect of the report describes the consultant’s understanding of the Internal Revenue Service law and regulations as they relate to the determination of taxable income of a controlled taxpayer to demonstrate that intercompany transactions are consistent with an arm’s length result. The fourth major aspect of the study provides the economic analysis of the intercompany sales between the buyer/importer and the seller.
The study chose the Comparable Profits Method (CPM) for analyzing the arm’s length nature of the intercompany transactions based on the IRS “best methods” rule. According to the xxxxxxxxxxxxx study prepared for the buyer/importer’s parent company, “[u]nder the CPM, the profitability achieved by a set of broadly comparable independent firms establishes the arm’s length range of profitability that is appropriate for the tested party.” Subsequent to selecting eleven companies deemed to be functionally equivalent, the study compared the average adjusted operating margin for the tax years 2000 to 2002 and arrived at an inter-quartile range of xxxxx percent to xx percent. The study concludes that the transactions between the buyer/importer and the seller are consistent with arm’s length transactions because the buyer/importer’s operating margin was xxxxxxxxx percent and, therefore, within the inter-quartile range of companies selected for comparison in the study.
ISSUE
May xxxxxxxxxxxxxxxxxxxxxxx, the importer-buyer, utilize the transaction value method of appraisement for importations of merchandise purchased from xxxxxxxxxxxxxxxxxxxxxxxxxx, the seller, a related company ?
LAW AND ANALYSIS
The federal agency responsible for interpreting and applying the United States Code and the regulations of U.S. Customs and Border Protection, as they relate to the final appraisement of merchandise, is Customs and Border Protection. Customs and Border Protection, in accordance with its legislative mandate, fixes the final appraisement of imported merchandise in accordance with Section 402 (b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979.
The preferred method of appraisement is transaction value. Transaction value is the “price actually paid or payable for merchandise when sold for exportation to the United States,” plus amounts equal to the five statutorily enumerated additions. 19 C.F.R. 152.103 (a) and (b).
Bona Fide Sale
The transaction between the buyer/importer and the seller must be a bona fide sale in order for the transaction to be accepted as the transaction value. The term “sale” is not defined, however, in either the value statute or CBP regulations. Customs and Border Protection must, therefore, look to jurisprudence for assistance in providing meaning to this term.
The Court of Appeals for the Federal Circuit in J.L. Wood v. United States, 505 F.2d 1400, 1406 (Fed. Cir. 1974) defined “sale” as the transfer of property from one party to another for consideration. No single factor is deemed to be conclusive in determining whether a sale exists. The relationship between the parties, as to whether they are functioning as buyer and seller, can only be ascertained by a review of the entire situation. One of the factors in determining whether a transfer of property or ownership has occurred is “whether the alleged buyer has assumed the risk of loss, and whether the buyer has acquired title to the imported merchandise.” Customs and Border Protection will also examine the “roles of the parties and the circumstances of the transaction” to determine if the parties are interacting as buyer and seller.
It is the conclusion of this office, based on the information provided by the ruling requester, that the transaction between the buyer/importer and the seller is a bona fide sale. Although the precise price or consideration is not readily determinable, there is sufficient information to conclude that consideration is exchanged for the merchandise being sold.
A review of the terms of sale and the evidence presented in the submission, namely the agreement, the commercial invoice, the wire transfer requests and the record of wire transfers support the importer’s position. The terms of sale indicate that title to the merchandise and the risk of loss shift from the seller to the buyer/importer “immediately before and no later than when the cargo enters U.S. territorial waters for the last time prior to entering the port of unloading.” The payment documents lead CBP to the conclusion that the parties are fulfilling their contractual obligations, exchanging goods for financial consideration and functioning as buyer and seller.
Acceptability of Related Party Price
Although the transaction between the buyer/importer and the seller constitutes a bona fide sale, the use of the transaction value method of appraisement is not necessarily possible. Recourse to transaction value is limited to, among other circumstances, those transactions in which “[t]he buyer and seller are not related, or the buyer and seller are related but the transaction value is acceptable.” 19 C.F.R. 152.103 (j)(1)(iv). Transactions between a related buyer and seller are acceptable “if an examination of the circumstances of sale indicates that their relationship did not influence the price actually paid or payable” or if the transaction value closely approximates certain test values. 19 C.F.R. 152.103 (j)(2).
The buyer/importer and the seller are “related persons” for the purposes of the Customs laws. Deloitte & Touche, on the behalf of the buyer/importer suggests that although the buyer and seller are related, the relationship does not influence the price actually paid or payable for the imported merchandise and the transaction value method of appraisement is acceptable pursuant to the circumstances of sale test.
Circumstances of Sale Test
Customs and Border Protection has not been provided with previously accepted values that could serve as “test values” pursuant to 19 C.F.R. 152.103 (j)(2)(i)(A) and (B) and, therefore, will only employ the “circumstances of sale” analysis. This office initially notes, in accordance with CBP regulations, that CBP “shall not disregard a transaction value solely because the buyer and seller are related.” 19 C.F.R. 152.103 (l)(1). The focus of CBP in examining the transfer pricing arrangement between the buyer/importer and the seller, in order to determine whether the relationship influenced the price, will be on “the way in which the buyer and seller organize their commercial relations and the way in which the price in question was arrived at.” Statement of Administration Action, H.R. Doc. No. 103-316, 103rd Cong., 2d Sess. (1994) reprinted in Customs Valuation Under the Trade Agreements Act of 1979, at 53-54; see also 19 C.F.R. 152.103 (l)(1)(i).
The appraisement of imported merchandise pursuant to the transaction value method will be acceptable, even for a transaction between related parties, if the price is settled “in a manner consistent with the normal pricing practices of the industry in question, or with the way the seller settles prices for sales to buyers who are not related to him.” Statement of Administration Action, Id.; see also 19 C.F.R. 152.103 (l)(1)(ii). The importer may further demonstrate that the relationship between the buyer and the seller did not influence the price by establishing 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….” Statement of Administration Action, Id.; see also 19 C.F.R. 152.103 (l)(1)(iii).
Normal Pricing Practices of the Industry
Deloitte & Touche, the buyer/importer’s representative, suggests to CBP that the pricing practices employed by the buyer/importer and the seller are “consistent with the normal pricing practices of the industry in question” and, therefore, acceptable for the purposes of transaction value. 19 C.F.R. 152.103 (l)(1)(ii). The importer states to CBP that the xxxxxxxx industry is a “backward integrated” industry and that the “ultimate selling price (and thus ultimate profit) determines the costs of the product throughout each step in the sale from the xxxxxxx to the final customer.” The importer’s submission advises CBP that the seller’s “pricing practices to xxxxxxxxxxxx [the buyer] and all other worldwide affiliates are the same: the local country affiliates all adhere to a global transfer pricing policy which (with local variations such as choice of methodology) requires the local affiliate to earn an adequate operating profit in their jurisdiction based on the local transfer pricing regulations.”
Although the buyer/importer suggests that the pricing practices between itself and the seller “comports with the normal pricing practices of the industry,” this office is unable to reach the same conclusion based on the information presented. The buyer/importer has made statements concerning the pricing practices of the xxxxxxxxx industry, but has not presented any information to support its statements.
Customs and Border Protection in this instance, similar to the circumstances in HQ 547672 (May 21, 2002) concludes 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. Customs noted that the study in HQ 547672 did not provide the requisite objective criteria regarding how the industry sets its prices. CBP reaches the same conclusion in this ruling letter.
Objective evidence addressing how prices are set in the relevant industry, in order to establish the “normal pricing practices of the industry” is essential. CBP, in HQ 542261 (Mar. 11, 1981) (TAA No. 19), determined 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. In such instances, the determination could be made that the transfer price was settled in a manner consistent with the normal pricing practice in the industry. Customs and Border Protection specifically notes that the Deloitte & Touche submission of January 29, 2004 did not direct CBP’s attention to any aspect of the transfer pricing study to support its assertion and CBP’s independent review of the forty-six page study did not reveal any discussion of the “normal pricing practices” of the xxxxxxxxxxx industry. The suggestion that the seller’s prices to the buyer/importer are set in accordance with the normal pricing practices of the xxxxxxxxxxx industry because the buyer/importer allegedly earns an operating profit comparable to other allegedly “functionally equivalent” companies is not sufficient.
Price Adequate to Ensure Recovery of All Costs Plus Profit
The buyer/importer suggests to CBP that the “Economic Analysis of the Pricing of Intercompany Transactions,” or the transfer pricing study, submitted with the ruling request supports its position that the transactions between the buyer/importer and the seller are consistent with arm’s length transactions. The importer suggests that its transfer pricing study establishes, in accordance with 19 C.F.R. 152.103. (l)(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.”
The importer asserts that its application of the Comparable Profits Method (CPM) of analyzing companies determined by xxxxxxxxxxxxxxxxxxxxxxxxxx, the parent company’s, consultant to be functionally comparable to the buyer/importer demonstrates that the buyer/importer’s profit falls within the transfer pricing study conclusions of the inter-quartile range. This conclusion, the importer asserts, establishes the arm’s length nature of the the buyer/importer and the seller’s intercompany transactions. Customs and Border Protection is not able to accept this line of reasoning.
“[W]hile the goal of both the TAA [Trade Agreements Act of 1979] and section 482 of the Tax Code,” as previously stated by CBP, “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.” HQ 546979. Headquarters Ruling 546979 observes that the Internal Revenue Service CPM method reviews profitability on an aggregate basis, not a product-by-product basis. CBP regulations, particularly, 19 C.F.R. 152.103. (l)(1)(iii), examine the recovery of profit on a product-by-product basis. The existence of a transfer pricing study does not, by itself, obviate the need for CBP to examine the circumstances of sale in order to determine whether a related party price is acceptable. See HQ 546979.
Information provided to CBP in a transfer pricing study may be relevant to the application of the circumstances of sale test, but the weight to be given that information will vary depending on the detail set forth in the study. A significant factor, by way of example, is whether the transfer pricing study has been reviewed and approved by the IRS. See HQ 546979. Whether the products covered by the study are comparable to the imported products at issue is another important consideration. See HQ 547672 (May 21, 2002). The methodology selected for use in a transfer pricing study is also relevant.
The transfer pricing study submitted to CBP by the buyer/importer has not been reviewed by the Internal Revenue Service leaving CBP unaware as to whether the assumptions on which the study is based and the conclusions derived would be acceptable to the IRS. Although Customs has, in the past, given some weight to an importer’s transfer pricing methodology when it has been based on the Comparable Profits Method, special circumstances were present. See HQ 546979. It is important to note the following special circumstances that were present in HQ 546979: 1) The transfer pricing methodology had been approved by the IRS through the Advance Pricing Agreement (APA) program; 2) Customs participated in the APA pre-filing conference between the importer and the IRS, and had access to the information provided to the IRS throughout the APA process; 3) The importer provided Customs with a waiver that enabled access to the documents that were submitted to the IRS in the APA process; 4) All of the importer's imported products were covered by the APA; and 5) The transfer pricing agreement was a bilateral agreement for which the transactions had been examined and accepted by the taxing authorities of both the United States and Japan. Customs determined, based on these unique circumstances, that the circumstances of sale test of CBP regulations had been met.
Customs and Border Protection notes that the “tested party” in the submitted transfer pricing study is the buyer/importer. The focus of interpretative note (iii) of section 152.103 (l)(1), is the seller’s costs and profit. CBP regulations, in order to determine whether the transaction in issue was conducted at “arm’s length,” examines whether the seller received a price that enabled the recovery of all costs, plus a reasonable profit as described in detail in interpretative note (iii). The transfer pricing study submitted by Deloitte & Touche, on the behalf of the buyer/importer, does not, therefore, provide CBP with the information necessary to conclude that the relationship between the buyer/importer and the seller did not influence the price.
The buyer/importer’s transfer pricing study, in Section V. “Economic Analysis,” C. “Search Strategy for Comparable Independent Distributors,” describes the approach taken by the consultant to select those companies deemed to be “broadly comparable” to the buyer/importer based on “functions performed, markets served, and risks borne.” CBP’s review of the companies deemed to be “functionally” comparable by the consultant does not lead this agency to the conclusion that they are engaged in the sale of the same class or kind of merchandise. CBP reiterates that its regulations focus on the particular merchandise being imported. The buyer/importer purchases a variety of xxxxxx, and relying on the submissions of Deloitte & Touche, purchases no other type of merchandise. A simple review of the companies deemed “functionally comparable” by the importer establishes that at least some of those businesses involve xxxxxxxxxxx items. It is also significant to note that the descriptions of the allegedly comparable companies are not based on independent examinations undertaken by the buyer/importer’s consultant, but rather are descriptions offered by the companies themselves. Customs is aware of no independent verification undertaken by the buyer/importer’s consultant to confirm the functional comparability.
It is the determination of Customs and Border Protection, that the information submitted is insufficient for CBP to conclude that the relationship between the buyer/importer and the seller did not affect the price paid or payable. The use of transaction value by the buyer/importer based on the facts presented would not be acceptable.
HOLDING
The transaction value method of appraisement, based on the information submitted, is not an acceptable method of appraising merchandise purchased by xxxxxxxxxxxxxxxxxxxxxxxxxx, the importer/buyer, a subsidiary of xxxxxxxxxxxxxxxxxxxxxxxxxxxx, the parent company, from xxxxxxxxxxxxxxxxxxxxxxxxxxxxx, the seller, another subsidiary of xxxxxxxxxxxxxxxxxxxxxx, the parent company.
Sincerely,
Virginia L. Brown, Chief
Value Branch