OT:RR:CTF:VS H289520 JMV
Port Director
U.S. Customs and Border Protection
Port of Providence Rhode Island
300 Jefferson Boulevard, Suite 106
Warwick, RI 02886
Re: Internal Advice on the Acceptability of Transaction Value as a Method of Appraisement in Related-Party Transactions between [XXXXXXXXXXXXX] and [XXXXXXXXXXXX]
Dear Port Director:
This is in response to your August 17, 2017 request for internal advice on the proper basis of appraisement for goods imported and purchased by [XXXXXXXXXXXXXXX] (“Importer”) from its parent company, [XXXXXXXXXXXXXXX] (“Parent Company”). Importer contends that transaction value is the correct method of appraisement under 19 U.S.C. § 1401a(b). You asked whether Importer has supplied sufficient evidence to use transaction value in the context of these related-party transactions.
Importer requested confidential treatment for certain information contained in its submission and in the file. Pursuant to 19 C.F.R. § 177.2(b)(7), the identified information has been bracketed and will be redacted in the public version of this ruling.
FACTS:
Importer is a distributor of consumer goods business (“CGB”) products (e.g. finished crystal jewelry figurines and gift items to independent retailers or [XXXXXX] retail stores) and crystal components business (“CCB”) products (e.g. crystal elements and semi-finished products to original equipment manufacturers and other wholesale commercial customers for jewelry, textile and crystal architecture applications) through U.S. warehouse distribution channels. Importer imports all goods from Parent Company, which does not sell to any other company in the United States. Parent Company is an entrepreneurial principal/full-fledged manufacturer that coordinates the manufacture of CCB and CGB products for sale to Importer.
On May 24, 2014, the Office of Regulatory Audit (“RA”) completed a Focused Assessment Pre-Assessment Survey (“FAPAS”) on Importer for goods imported in 2011 and was unable to determine if the transaction value was the proper basis of appraisal. Therefore, RA is seeking this Internal Advice. During the FAPAS, RA reviewed various documents provided by Importer including the following:
The Purchase and Supply Agreement between Importer and Parent Company dated 2009;
[XXXXXXX] U.S. Holding Ltd. (“Holding Company”) Transfer Pricing Analysis Report (“TPAR”) prepared by PricewaterhouseCoopers (“PwC”) issued on September 10, 2012;
Importer U.S. Customs and Border Protection Related Party Pricing Analysis (“RPPA”) dated July 28, 2014;
The Transfer Pricing Policy for CGB and CCB Goods;
A written explanation from Importer on the setting of transfer prices;
2011 Price Lists for CGB and CCB goods;
Parent Company’s 2011 Income Statement;
2011 Financial Overview of Parent Company;
A Deductive Value Analysis Test for walkthrough of test entries;
Transfer Price Adjustments records from 2007-2011 and 2013; and,
Importer’s Profit and Loss Statement.
The Importer also provided our office with a financial analysis and banking records for the 2011 price adjustments, and Holding Company’s 2011 tax return documents.
The [XXXXXXXXXXX (“XXXXXX”)] sets the internal transfer prices for all group entities and for all group products, services, and intangibles, with the stated objective of ensuring that all distribution entities earn an arm’s length return in line with the functions they perform, the risks they assume, and the assets they employ. The Transfer Pricing Policy for CGB and CCB Goods claims to set forth the “principles and methods for determining transfer prices” for sales between Parent Company and Importer. According to the Transfer Pricing Policy and Importer’s explanation, the transfer pricing method was created to comply with U.S. Internal Revenue Code (“IRC”) § 482 and the associated Treasury Regulations, OECD Guidelines for arm’s length transactions, and international tax and customs regulations.
Importer claims that the transfer prices between Importer and Parent Company are determined based upon annual figures in which a specific operating margin is targeted. Transfer prices are set prospectively for the following calendar year after the recommended retail price for CGB products and wholesale customer price list for CCB products are established. The prices for CCB and CGB products to be sold in the United States are established after considering various factors such as prevailing market conditions, long term business strategy, quantum of inventory, demand in the U.S. market, sales goals, purchasing power of ultimate buyer, and sustainable growth for Parent Company and Importer. Once pricing is settled, Importer’s target operating margin is deducted to arrive at the transfer price between Parent Company and Importer. The target operating margin is determined based on the operating margins of unrelated functionally comparable U.S. companies and falls within the arm’s length benchmark range determined by the TPAR. Lastly, actual margins earned by Importer may differ from the target margin due to several economic and market conditions. In such instances, there would be a transfer pricing adjustment to bring Importer’s operating margin within an arm’s length range for income tax purposes.
Holding Company commissioned PwC to test Holding Company’s profitability on its distribution activities for FY2011, which is detailed in the TPAR. Holding Company is the U.S. holding company for [XXXXXX]’s U.S. operating companies, including Importer. This is reflected in the consolidated federal tax filings included in Importer’s submission to this office. Importer states that, while there are other companies under Holding Company, Importer was the primary importing entity for the [XXXXXX] group during the period under review. Holding Company was selected as the appropriate tested party for the annual transfer pricing studies in order to capture all U.S. distribution activities for both the wholesale and retail businesses.
Due to the cyclical nature of the retail and wholesale businesses, Holding Company was tested on both a one-year and four-year basis. Holding Company’s wholesale and retail activities were tested as one because both are closely integrated and have operational similarity. Additionally, the CGB business engages in both wholesale and retail activities and the operations and sales of these businesses are closely integrated. The Comparable Profits Method (“CPM”) was chosen as the best method to evaluate the intercompany results of Holding Company’s retail and wholesale distribution activities, and Return on Sales (“ROS”) as the most reliable Profit Level Indicator (“PLI”). PwC performed a search to identify a set of independent North American functionally equivalent companies engaged in retail and wholesale distribution of durable goods. The search yielded 32 comparable companies as the Comparable Industry Set (“CIS”), which yielded a FY2011 interquartile ROS range of [XX]% to [XX]% with a [XX]% median. During 2011, Holding Company earned a ROS of [XX]% for its distribution activities, which falls within the interquartile range. Furthermore, this set of 32 companies yielded a four-year (2008-2011) interquartile ROS range of [XX]% to [XX]%, with a [XX]% median. During the same four-year period, Holding Company earned a four-year weighted average ROS of [XX]% for its distribution activities, which again fell within the interquartile range. Based on this analysis, PwC determined that Holding Company’s results for its distribution activities on a one-year and four-year basis are consistent with the arm’s length standard. However, Importer does not have an Advance Pricing Agreement (“APA”) with the Internal Revenue Service (“IRS”).
Further, since the TPAR analyzed the transfer price under the IRS’ arm’s length standard, Importer also commissioned PwC to conduct a second pricing study to be completed for Customs purposes, which is outlined in the RPPA. PwC again determined that the CPM was the best available method since data for the Comparable Uncontrolled Price (“CUP”) method was unavailable. PwC also determined that the Net Cost Plus (“NCP”) is the most appropriate PLI. The NCP, also referred to as markup on total costs, is calculated by dividing operating income/profit by total costs (cost of goods sold plus operating expenses) and is used to evaluate service providers and manufacturers
The RPPA focuses its analysis on the seller, Parent Company. The RPPA analyzes Parent Company’s profits in comparison to its competitors in the European market along with one U.S. company, [XXXXXXX], as it is one of [XXXXXX]’s largest competitors. PwC identified an appropriate CIS of uncontrolled companies engaged in the same industry as Parent Company in the European market. Specifically, the search was tailored to include only companies whose main activities were the full-fledged manufacture of goods of the “same class or kind” as the imported merchandise, e.g. similar luxury gift items such as crystal or glass items, or jewelry, and which bore risks associated with such activities similar to those borne by Parent Company. PwC found a NCP interquartile range of [XX]% to [XX]%, with a median of [XX]% for 2011 for the CIS. Parent Company’s NCP of [XX]% is above the interquartile range, which Importer asserts is an indication that Importer’s pricing is consistent with the identified “industry” against which it is measured.
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 for transactions between unrelated parties is the 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 statutorily enumerated additions. 19 U.S.C. § 1401a(b)(1). However, the port director shall not disregard a transaction value solely because the buyer and seller are related. 19 C.F.R. 152.103(l)(1).
When the buyer and seller are related parties as defined in 19 U.S.C. § 1401a(g), transaction value 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, Importer does not dispute that Importer and Parent Company are “related persons” as defined by 19 C.F.R. § 152.102(g). However, Importer argues that transaction value may be applied despite its relationship with Parent Company. Importer bases its argument on the “circumstances of the sale” test, as test values are not available here.
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 in which the price was determined. The regulations, as set out in 19 C.F.R. § 152.103(l), provide three illustrative 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.
While these are examples to illustrate situations where the relationship has not influenced the price, other factors may also be considered. See 19 C.F.R. § 152.103(I); see also Headquarters’ Ruling Letter (“HQ”) H037375, dated December 11, 2009; HQ H029658, dated December 8, 2009; HQ H032883, dated March 31, 2010; and HQ H219515, dated October 11, 2012. For example, in HQ H219515, CBP found that even though none of the information provided strictly fell under the three illustrative examples, the sales price was not considered to be influenced by the relationship of the parties under the circumstances of the sale test, “based on the totality of the information considered and our review and examination of all relevant aspects of the transaction, including the way in which the Importer and the related manufacturers organize their commercial relations and the way in which the price in question was arrived at.”
Here, Importer argues that the transfer prices at issue meet the normal pricing practices of the industry criteria of the first illustrative example. Importer further argues that even if CBP finds that the evidence provided does not meet the criteria of the normal pricing practices analysis, all the documents provided, when considered in totality, are sufficient for a finding that the sale was not affected by the relationship of the parties under the circumstances of the sale test. Particularly, Importer argues that the transfer pricing studies and the manner in which sales are organized between the parties sufficiently demonstrate that the transfer price is not affected by the relationship of the parties.
Information provided to CBP in a transfer pricing study may be relevant in examining the circumstances of the sale, but the weight given to this information will vary depending on the details set forth in the study. See HQ H037375; and HQ 548482, dated July 23, 2004. A significant factor, by way of example, is whether the transfer pricing study has been reviewed and approved by the IRS. See HQ H037375; and HQ 546979, dated August 30, 2000. Whether products covered by the study are comparable to the imported products at issue is another important consideration. See HQ H037375; and HQ 547672, dated May 21, 2002. The pricing practices must relate to the industry in question, which generally includes the industry that produces goods of the same class or kind as the imported merchandise. HQ 546998, dated January 19, 2000; and HQ 548095, dated September 19, 2002. 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. See HQ 548482. The methodology selected for use in a transfer pricing study is also relevant. Id.
The TPAR was completed according to IRC § 482, which includes a different standard than customs law for demonstrating a transaction was conducted at arm’s length. The TPAR does not compare Importer’s profitability with that of comparable companies within the same industry. Instead, the TPAR compares Holding Company’s profitability to that of functionally equivalent companies that do not produce goods of the same class or kind. Further, the methodology used in the TPAR is the CPM, which is the least relevant method for customs purposes. HQ H219515. Finally, the TPAR has not been reviewed by the IRS leaving CBP unaware as to whether the assumptions on which the study is based and the conclusions derived would be acceptable to the IRS. Therefore, the TPAR by itself provides relatively little support to the assertion that the transaction value is acceptable under the circumstances of the sale test.
However, Importer also provided CBP with the RPPA, which looks to the customs law standard of an arm’s length transaction. While the RPPA also relied on the CPM, the RPPA examines companies within the same industry. The companies studied in the RPPA include independent companies whose entrepreneurial activities focused on the manufacturing of jewelry or glass and crystal products. The RPPA is therefore more relevant to CBP’s analysis than the TPAR as it focuses on companies within the same industry as [XXXXX].
Pricing practices of the industry
Through the RPPA, Importer sought to demonstrate that Parent Company and Importer’s transfer pricing practices were settled in a manner consistent with the industry in question. The Port’s position is that the RPPA, which focuses its analysis on the seller in the European market, should have used the importer in the U.S. market as the tested party. However, that is not necessarily the case in all circumstances. As a general rule, the tested party will be the party to the transaction with the least complex functional profile and for which the most reliable information is available. Moreover, under the circumstances of the sale test, when looking at the totality of the circumstances outside of the three illustrative criteria listed in §152.103(l)(1), there is no set evidentiary standard. Therefore, the fact that the RPPA focuses on the seller in the European market is appropriate.
Further, we reviewed the information contained in the RPPA and conclude that the products sold by the comparable companies are of the same class or kind. The RPPA concluded that the transactions are settled in a manner consistent with the normal pricing practices of the crystal, crystal components, jewelry, and glass industry and are therefore at arm’s length under U.S. Customs Law. The RPPA bases this conclusion on the finding that Parent Company’s profit for the period under review, fell above the interquartile range for the CIS, which Importer argues supports a conclusion that the transfer price is consistent with the pricing practices of the industry.
CBP has noted that an importer must have objective evidence of how prices are set in the relevant industry in order to establish the “normal pricing practices of the industry” in question. See HQ 542261, dated March 11, 1981 (CBP determined that the transfer price was defined with reference to prices published in a trade journal (the posted price) and other buyers and sellers commonly used the posted price as the basis of contract prices). CBP has never considered a transfer pricing study alone to be objective evidence of an industry pricing practice. See HQ H547672, May 21, 2002 (finding that a transfer pricing study does not ordinarily establish the normal pricing practices of the industry for the purposes of determining whether the price was settled in a manner consistent with the normal pricing practices of the industry).
Here, objective evidence is lacking regarding whether the transfer prices at issue are set in a manner consistent with the normal pricing practice of the industry in question. The information in the transfer pricing study merely provides a range regarding the chosen PLI. While a PLI that fell within this range may suggest that the transfer prices are similar to prices within the industry, it does not provide any objective criteria regarding how the industry sets its prices. Further, the fact that the PLI in the case at hand fell above the arm’s length range indicates that prices are not consistent with how the industry sets its prices.
An examination of whether other factors indicate that the relationship between the buyer and seller did not influence the price.
Importer argues that even if CBP finds that the evidence provided does not squarely fit into the normal pricing practices analysis (or any of the other illustrative examples), all evidence, when considered in conjunction, should lead CBP to determine that the sales were at arm’s length.
Importer cites HQ H219515 as support for their assertion that the transaction value should be accepted and claims that the facts there are very similar to the facts in the case at hand. In HQ H219515, the importer supplied CBP with a transfer pricing study prepared for IRS purposes and a detailed description of how the company set its transfer prices. Transfer prices were based on U.S. list prices, which were changed infrequently and typically only adjusted based on market conditions. A standard percentage discount to the U.S. list price for sales of all products within each product center is selected with the objective of allowing the importer to recover its costs for sales and distribution of the imported product, and to make a reasonable return. The importer submitted a report on the pricing practices in the relevant industry, information on the company’s profitability versus its competitors, and a transfer pricing matrix, which showed that the price fell within the arm’s length range. CBP stated that even though the information submitted by the importer to substantiate the circumstances of the sale analysis did not strictly fall under the three illustrative examples, referenced in 19 C.F.R. §152.103(l)((1)(i)-(iii), the price was not influenced by the relationship of the parties based on totality of facts, including the industry analysis and how the price was determined.
In the present case, as in HQ H219515, the Importer explains in detail how the related parties set their prices. Transfer prices are set prospectively for the following calendar year after the recommended retail price for CGB products and wholesale customer price list for CCB products are established. The prices for CCB and CGB products to be sold in the United States are established after considering various factors such as prevailing market conditions, long term business strategy, quantum of inventory, demand in the U.S. market, sales goals, purchasing power of ultimate buyer, and sustainable growth for Parent Company and Importer. Once pricing is settled, Importer’s target operating margin is deducted to arrive at the transfer price between Parent Company and Importer. This approach is consistent for all distributors.
In support of its pricing structure, the Importer provided a transfer pricing study prepared for IRS purposes, the TPAR, and an additional transfer pricing study prepared for customs purposes, the RRPA. CBP has found that, in related party transactions, a transfer pricing study, based on functionally comparable companies and prepared for tax purposes, provides some support for the assertion that a related party sale was conducted at arm’s length if the profit level indicator falls within the arm’s length range. HQ H176775, dated March 6, 2014; see also HQ H219515. The arm’s length principle requires that the conditions (prices, profit margins etc.) in transactions between related parties should be the same as those that would have prevailed between two independent parties in a similar transaction under similar conditions. Through an application of the most appropriate transfer pricing method, a transfer pricing study will give rise to a range of acceptable arm’s length results, known as the arm’s length range. Where the price or margin used in the controlled transaction falls within the arm’s length range, no transfer pricing adjustment will generally be required. However, where the price or margin falls outside of the arm’s length range, an appropriate point within the range will need to be selected.
We note that while the TPAR in this case concludes that the transfer prices comply with the arm’s length requirements of IRC § 482, the RPPA shows that Parent Company’s profit falls outside the arm’s length range established in the analysis for customs purposes. These findings suggest that the transfer price is not established as if the parties are unrelated for customs purposes. The aim of both customs valuation and transfer pricing methodologies is similar, with each ensuring that the price is set as if the parties were not related and had been negotiated under the normal business conditions. Therefore, the objective is to arrive at the price that would be acceptable for both, tax and customs administrations. Because the profit margin in the RPPA falls outside the arm’s length range, we find that the prices should be adjusted so that they fall into the arm’s length range established by both transfer pricing studies in order for the circumstances of the sale test to be met. Once the adjustments are made and the adjusted prices reflect the arm’s length transfer price acceptable for tax and customs purposes, the circumstances of the sale test is met and transaction value method of appraisement may be utilized by the Importer, subject to your office’s approval.
HOLDING:
Based on the information presented, we find that transaction value is the appropriate method of appraisement in this case.
You are to mail this decision to the internal advice requester no later than 60 days from the date of the decision. At that time, Regulations and Rulings of the Office of International Trade 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 Brenner, Chief
Valuation and Special Programs Branch