OT:RR:CTF:VS H258447 RMC
Assistant Field Director, Office of Regulatory Audit, Branch 441
Office of International Trade
U.S. Customs and Border Protection
Port of Charlotte
1901 Crossbeam Dr.
Charlotte, NC 28217
Re: Internal Advice on the Acceptability of Transaction Value as a Method of Appraisement in Related-Party Transactions between [Parent Company] and [Subsidiary Company]
Dear Assistant Field Director:
This is in response to your September 16, 2014 request for internal advice on the valuation method that [Subsidiary Company] uses when it imports parts from its parent company. [Subsidiary Company] contends that transaction value is the correct method of appraisement under 19 U.S.C. § 1401a. You asked whether [Subsidiary Company] has supplied sufficient evidence to use transaction value in the context of these related-party transactions.
FACTS:
[Subsidiary Company] is a manufacturing company with factories in [State X] and [State Y]. It is a subsidiary of [Parent Company], a [foreign] multinational manufacturing company headquartered in [Country Z]. As part of [Subsidiary Company’s] operations, it regularly imports parts from [Parent Company] including [ ].
The valuation of these related-party transactions has been at issue for more than ten years, including matters pertaining to additional payments for price changes, raw-material surcharges, and assists for tooling. In 2008, a CBP Regulatory Audit team determined that transaction value was not an acceptable method of appraisement for [Subsidiary Company’s] imports from [Parent Company] because of inadequate controls in making additional payments for raw materials and in declaring tooling assists. [Subsidiary Company] agreed to implement adequate controls and to use the Automated Commercial System (“ACS”) Reconciliation Prototype for post-entry adjustments for tooling and surcharges.
[Subsidiary Company] also agreed to update its manual to include the use of Automated Commercial System (“ACS”) Reconciliation Prototype for post-entry adjustments for tooling and surcharges. In verifying the post-entry adjustments, the Port of Miami also reviewed the transfer price between [Parent Company and Subsidiary Company]. The Port believes that the advance pricing agreement, which uses a comparable-profits method, does not identify appropriate comparison companies for purposes of determining the median percentage profitability for each industry and calculating the prices paid by [Subsidiary Company].
Your office is now conducting an audit to determine if transaction value is the correct basis of appraisement. [Subsidiary Company] has provided the following documents to support its position that transaction value is appropriate because the circumstances of the sale show that [Subsidiary Company] and [Parent Company’s] relationship did not influence the price actually paid or payable:
Entry summaries
Invoices of parts
Vendor payment details
Master Service Agreements between [Subsidiary Company] and [Parent Company] (2007-09 and 2010-11) that describe an “all costs plus profit” transfer-pricing methodology for tax purposes based on the comparable profits method (“CPM”)
According to [Subsidiary Company], the CPM “evaluates whether the amount charged in a controlled transaction is arm’s length based on objective measures of profitability (profit level indicators or ‘PLIs’) derived from uncontrolled taxpayers that engage in similar business activities under similar circumstances. The arm’s-length profit range for a particular contract function will be determined by applying a PLI range to the Service Provider’s costs incurred and/or resources employed to perform such function.”
With respect to its distribution activities, the Master Servicing agreement requires that the arm’s-length PLI range be determined on the basis of a United States or North American study of comparable uncontrolled companies that engage in similar business activities under similar circumstances. The PLI range is the interquartile range of the comparable study. Comparability adjustments are made as necessary to reflect the service provider’s limited risks borne and lack of intangible assets owned and other differences between the service provider and uncontrolled companies. The comparability study is updated periodically.
Advance Pricing Agreements Annual Reports (2009, 2010, and 2011)
Example of the price calculations for a transmission
Emails with further explanations of valuation methodology
ISSUE:
Whether transaction value is an acceptable means of appraisement under the circumstances of the sale test.
LAW AND ANALYSIS:
Merchandise imported into the United States is appraised for customs purposes in accordance with U.S. value law under section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (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. 19 U.S.C. § 1401a(b)(1).
Special rules 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 the two tests: (1) circumstances of the sale; or (2) test values. See 19 U.S.C. § 1401a(b)(2)(B); 19 C.F.R. § 152.103(l). Here, [Subsidiary Company] argues that transaction value may be applied despite its relationship with [Parent Company] because it meets the requirements of the “circumstances of the sale” test.
Under the “circumstances of the sale” test, CBP looks for evidence showing that the parties’ relationship did not affect the price paid or payable. All relevant aspects of the transaction are analyzed including the way the buyer and seller organize their commercial relations and the way that the price was determined. 19 C.F.R. § 152.103(l) provides three examples that demonstrate that a relationship did not influence the price: (i) the price was settled in a manner consistent with the normal pricing practices of the industry in question; (ii) the price was settled in a manner consistent with the way the seller settles prices for sales to buyers who are not related to it; or (iii) 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.
[Subsidiary Company] has stated that it “ensures that all costs plus a representative profit are realized on intercompany transactions” consistent with the requirements in the “all costs plus profits” method in 19 C.F.R. § 152.103(l)(1)(iii). [Subsidiary Company] presents three main pieces of evidence in support of this contention: (1) Product Cost Calculations that provide a detailed breakdown of the costs for all parts; (2) an Advance Pricing Agreement with the IRS; and (3) a Transfer Pricing Policy.
To establish costs, [Subsidiary Company] argues that its Product Cost Calculations accurately track all costs associated with the production of the [ ] parts and components it buys from its parent company. The “General Model for Product Cost Calculation” accounts for 23 different cost items including, among others, direct materials, scrapping and cancellation costs, vendor tool costs, conversion overhead costs, product improvement expenses, warranty expenses, and outgoing shipping and handling costs. The Product Cost Calculations then provide three ways to allocate various costs to specific items. First, resources directly consumed by the product, such as direct materials and direct labor, are directly traced to it. Second, resources consumed by a cost driver that can be related to the product, for example, purchasing costs linked to the number of parts used in the product, are attributed to it. Lastly, resources consumed in producing the product that cannot be directly traced or attributed to the product, such as production maintenance costs, are fairly allocated to it.
We agree that the [Parent Company] Product Cost Calculations adequately account for all the costs that [Parent Company] incurs in the production of the items it sells to [Subsidiary Company]. The 23 categories of costs that [Subsidiary Company] tracks appear to inventory all the direct and indirect costs that go into its products. Further, its methodology for tracing, attributing, and allocating these costs to specific products persuades us that its cost figures are accurate.
We do not agree, however, that the methodology allocates an acceptable profit as required in 19 C.F.R. § 152.103(l)(1)(iii). Under that provision, “the firm’s overall profit” is determined by the parent company’s profits over a representative period of time (e.g., annually) in sales of merchandise of the same class or kind. See, e.g., Headquarters Ruling (“HQ”) H206175, dated January 29, 2015 (stating that “pursuant to these rulings (HRL 542792, HRL 546998, and HRL H065015), the ‘firm’s overall profit’ means the profit of the parent company in the circumstance where the seller of the imported merchandise is a subsidiary of the parent company.”). Thus, the price here must reflect [Parent Company’s] costs plus a profit that is equivalent to [Parent Company’s] overall profit in sales of merchandise of the same class or kind. Although the regulations do not specify whether to consider gross profit or operating profit, CBP usually considers operating profit because it is a more accurate measure of what the company actually earns on sales once associated expenses have been paid. See HQ H037375, dated Dec. 11, 2009.
Three aspects of [Subsidiary Company’s] methodology for allocating profits to related-party transactions are problematic under 19 C.F.R. § 152.103(l)(1)(iii). First, it does not consider the parent company’s profits as required under 19 C.F.R. § 152.103(l)(1)(iii). Instead, [Subsidiary Company’s] methodology for allocating profits depends on its own profit levels. For example, its transfer pricing method addresses four discrete areas—manufacturing, distribution, research and development, and logistics—each of which aims to allocate a profit or markup consistent with [Subsidiary Company’s] own profits in that area. But only the profits of [Parent Company] are relevant under the “all costs plus profit” method. Second, the profit levels are not specific to “representative period of time in sales of merchandise of the same class or kind.” It is unclear what period of time the required profit levels correspond to, and they are not calculated based on sales of merchandise of the same class or kind, but instead refer to all manufacturing activities. Lastly, it is unclear whether [Subsidiary Company’s] profit markups refer to gross profits or operating profits, which CBP considers to be a more accurate measure of a company’s profitability. See, e.g., HQ H018314, dated March 13, 2013.
[Subsidiary Company] emphasizes that its methodology specifically addresses IRS Code Section 482 and has been accepted by the IRS. Although whether an importer’s transfer pricing methodology has been reviewed and approved by the IRS is a significant factor in CBP’s analysis, it is not conclusive. See HQ 546979, dated Aug, 30, 2000; and HQ H029658, dated Dec. 8, 2009. Because [Subsidiary Company] claims that its intercompany price meets the requirement of the “all costs plus profit” test, it still must satisfy CBP’s requirements in 19 C.F.R. § 152.103(l)(1)(iii) in order to use transaction value. As explained above, [Subsidiary Company] has not met those requirements in this case and thus may not appraise its imports from [Parent Company] on the basis of transaction value.
When imported merchandise cannot be appraised on the basis of transaction value, it is appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. § 1401a(a)(1). The alternative bases of appraisement, in order of precedence, are: the transaction value of identical or similar merchandise (19 U.S.C. § 1401a(c)); the deductive value (19 U.S.C. § 1401a(d)); the computed value (19 U.S.C. § 1401a(e)); and the “fallback” method (19 U.S.C. § 1401a(f)). Because no information was provided on sales of similar merchandise, sales of the merchandise in the United States, or costs to produce the merchandise, it is not possible to determine which method should be applied based on the information provided.
We suggest that you request information from [Subsidiary Company] to establish which valuation method in the 19 U.S.C. § 1401a hierarchy is appropriate in this case. Although it is likely that [Parent Company] sells the merchandise at issue only to [Subsidiary Company], information on sales of identical or similar merchandise at the same commercial level and in substantially the same quantity would be relevant to establishing whether the method in 19 U.S.C. § 1401a(c) is appropriate. Similarly, information on sales of the merchandise in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation would be relevant to establishing whether the method in 19 U.S.C. § 1401a(d) is appropriate. Finally, if those two methods are unavailable, computed value under 19 U.S.C. § 1401a(e) could be established based on [Parent Company’s] cost calculations and additions for profit, any assists, and packing costs.
HOLDING:
Transaction value is not an acceptable means of appraisement for the related-party sales between [Parent Company] and [Subsidiary Company] because [Subsidiary Company] did not sufficiently demonstrate that the intercompany price between [Parent Company] and [Subsidiary Company] was adequate to ensure [Parent Company’s] recovery of all costs plus a profit.
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 CBP personnel, and to the public on the CBP 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.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch