OT:RR:CTF:VS H292850 JMV
Port Director
U.S. Customs and Border Protection
Port of New York/Newark
1100 Raymond Boulevard
Newark, NJ 07730
Re: Internal Advice on the Acceptability of Transaction Value as a Method of Appraisement in Related-Party Transactions
Dear Port Director:
This is in response to your request for internal advice on the proper basis of appraisement for goods imported and purchased by [XXXXXXXXXXXXX] (“U.S. Company”) from its related company, [XXXXXXXXXXXXXXXXXXXXXXXX] (“Foreign Related Manufacturer”). U.S. Company contends that transaction value is the correct method of appraisement under 19 U.S.C. § 1401a. You asked whether U.S. Company has supplied sufficient evidence to use transaction value in the context of these related-party transactions.
The 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:
The [XXXXX] Group (“Group”) is a multinational group of companies supplying [XXX XXXXXXXXX], services, and solutions. All the affiliates within the Group share the same parent company, [XXXXXXXXXXXXXXXXXXXXXXXX], (“Parent Company”) headquartered in [XXXX]. Foreign Related Manufacturer has two functional roles within the Group: 1) conduct contract manufacturing for intercompany sales to U.S. Company, and 2) conduct entrepreneurial manufacturing for direct sales to unrelated parties in its local [XXXXX] market and related parties in other countries.
The Group operated as a division of [XXXXXXXXXXXXXXXXXX] until it was acquired by the [XXXXXXXX] in 2013. Following the acquisition, management began a complete operational review of all business practices and procedures. In 2014, the Group began the process of performing detailed reviews of all global intercompany transactions and a transfer pricing study was commissioned from PricewaterhouseCoopers (“PWC”). This transfer pricing study was provided to CBP for review. U.S. Company claims that the transfer pricing methods conform to the arm’s length standard as set forth in the relevant provisions of U.S. Internal Revenue Code (“IRC”) § 482, the U.S. Treasury Regulations, specifically the Transfer Pricing Regulations, and the Transfer Pricing guidelines for Multinational Enterprises and Tax Administrations issued by the Organization for Economic Cooperation and Development (or the “OECD Guidelines”). According to the transfer pricing policy, Foreign Related Manufacturer should be remunerated as a contract manufacturer on a cost plus basis. U.S. Company remunerates Foreign Related Manufacturer for manufacturing costs plus a markup of 8%. The transfer prices charged by Foreign Related Manufacturer to U.S. Company for the products are set once a year by the transfer pricing group and are set at the product group level.
The PWC transfer pricing study found that U.S. Company was the more complex entity and that Foreign Related Manufacturer was essentially operating as a contract manufacturer on behalf of U.S. Company. The method PWC used to test the intercompany transactions was the Comparable Profits Method (“CPM”) utilizing Foreign Related Manufacturer, the least complex entity, as the tested party and the Full Cost Mark-Up (“FCMU”) as the most appropriate Profit Level indicator (“PLI”).
The transfer pricing study compared Foreign Related Manufacturer to companies that are equivalent in terms of function and risks assumed. The study calculated a three year average of 6.6% and an interquartile range, or an arm’s length range, of 4.8 - 8.9%. The Group hired Deloitte to extrapolate information from the original PWC study to provide a further analysis that limited its scope to six comparable companies that were within the same industry. The three year average for companies in the same industry, [XXXXXXXXXXXXXXXXXXXXXXXX
XXXXXXX], was 7.7% with an arm’s length range of 4.5 - 9.23%. Foreign Related Manufacturer’s FCMU for 2014 on sales to U.S. Company was 7.4%, which is within the arm’s length range as determined by PWC for both sets of comparable companies. Further, Foreign Related Manufacturer’s FCMU for 2014 on all sales was 6.2% and the Parent Company achieved an operating profit for 2014 of 9.2%. However, U.S. Company notes that the Parent Company does not participate in any sales activity, and functions solely as a holdings company for the Group.
According to U.S. Company, the transfer prices between U.S. Company and Foreign Related Manufacturer are subject to retroactive transfer pricing adjustments. Retroactive price adjustments are generally made in Quarter 4 and, if needed, after the fiscal year end. U.S. Company claims that price adjustments are made on a trade weighted basis. U.S. Company is enrolled in the Reconciliation Program.
U.S. Company filed a prior disclosure with the Port of Philadelphia on August 28, 2014, which sought approval for post importation transfer price adjustments. The following documents were submitted for review:
two Memos from [XXXXX] taxation personal regarding intercompany transactions;
Global Core Transfer Pricing Documentation;
U.S. Transfer Pricing Documentation;
a spread sheet outlining operating margins and arm’s length ranges of companies in the [XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX] industry;
a chart outlining the goods imported and the duty associated with its Harmonized Tariff Schedule of the United States (“HTSUS”) subheading;
a spreadsheet which summarizes the additional duties and fees owed as a result of the retroactive transfer price adjustments; and
a list of entry lines and HTSUS subheadings affected by each set of adjustment.
CBP Regulatory Audit specifically expressed concern with reviewing the profit of Foreign Related Seller at an aggregate level instead of a transaction by transaction basis. CBP Regulatory Audit evaluated a specific product code and found that this one product was imported at a 75% profit margin. CBP Regulatory Audit believes this illustrates a potential for wide variances from one product to the next in order to meet the aggregate overall profit of 8% as outlined by the transfer pricing policy. The underlying concern here is that U.S. Company may be shifting profits to products that may have a lower tariff rate, thus lowering over all duties paid. U.S. Company states that the 75% margin was calculated before reconciliation and that it would be adjusted during reconciliation.
In response, U.S. Company forwarded this office a chart representing the imports from Foreign Related Manufacturer in 2014. U.S. Company noted that it also imported from its sister company in [XXXXX] but that those were duty free under the North American Free Trade Agreement. The imports from Foreign Related Manufacturer were 82% of U.S. Company’s imports in 2014. The chart indicates that over 50% of those imports were for [XXXXXX XXXXXX] with duty rates of 3.6% and 3.2%, only a 0.4% difference. The majority of those shipments were dutiable at the 3.6% rate. Additionally, over 70% of imports were dutiable in the range from 3.1% to 3.6%, with that lower rate applicable to [XXXXX]. U.S. Company argues that it had no financial incentive to shift costs to a lower duty rate because the 0.5% duty rate difference would not have been worth the effort, as it would have taken too much time and internal resources (including person-hours and costs). Additionally, U.S. Company points out that the majority of their entries and the highest value were at the 3.6% rate.
U.S. Company also provided this office with audited consolidated financial statements of Parent Company, and Parent Company’s Form 10-K, which is filed with the U.S. Securities and Exchange Commission (“S.E.C.”) as required, as the Parent Company is publically traded on the [XXXXXXXXXXXXX]. U.S. Company asserts that based on these documents, the operating profit is 3.3% for U.S. Company, 8.4% for Parent Company, and 11.6% for Foreign Related Manufacturer. The Markup on Total Costs is 3.4% for U.S. Company, 9.2% for Parent Company, and 13.1% for Foreign Related Manufacturer. When asked why these profit measures differed from those in the transfer pricing studies, U.S. Company states that the differences resulted from different measures of profit. U.S. Company states that the information in these documents is based on the standard accounting method, U.S. Generally Accepted Accounting Principles (“GAAP”), and shows how the profit rolls up into the company’s global results and is audited by external auditors. U.S. Company further states that it utilized U.S. GAAP since it is traded on a U.S. stock exchange governed by the S.E.C. and it needed to show global consolidated results. However, transfer pricing is based on the statutory accounting and tax rules of the foreign governments involved, to which the company must abide. Additionally, U.S. Company points out that countries around the world follow their own accounting and tax rules that force it to report profits in a different way.
ISSUES:
Whether transaction value is an acceptable means of appraisement.
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, 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, there must be a bona fide sale for exportation to the United States. Here, both the Port and the importer agree that a bona fide sale exists between the related parties.
However, 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 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. Headquarters’ Ruling Letter (“HQ”) 543568, dated May 30, 1986. The purpose of these rules is to ensure that the relationship between the parties does not affect the price. In this instance, all parties agree that the transaction involves related parties. However, no information is available concerning previously accepted test values. Consequently, the circumstances of the sale approach must be used to determine the acceptability of transaction value.
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 HQ H037375, dated December 11, 2009; HQ H029658, dated December 8, 2009; and, HQ H032883, dated March 31, 2010. In H219515, dated October 11, 2012, CBP found that even though none of the information 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.”
In this case, U.S. Company argues for a general approach that takes into account every aspect of the transactions at hand, while also looking to the illustrative examples as guidance, to determine whether transaction value is adequate. U.S. Company claims that its pricing practices are based on the pricing practices of the industry, and the “all costs plus” method.
Under the normal pricing practices of the industry method, CBP generally requires objective evidence of the normal pricing practices of the industry in question. For example, in HQ 542261, dated March 11, 1981, CBP determined that since the transfer price was defined with reference to prices published in a trade journal (the posted price), which other buyers and sellers commonly used as the basis of contract prices, the transaction value between related parties was acceptable.
Under the “all costs plus” method, CBP considers whether the price is adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time, in sales of goods of the same class or kind. 19 C.F.R. § 152.103(l)(iii). To substantiate an all costs plus profit claim, the importer should be prepared to provide records and documents of comprehensive product related costs and profit, such as financial statements, and accounting records including general ledger account activity, bills of materials, inventory records, labor and overhead records, relevant selling, general and administrative expense records, and other supporting business records. What Every Member of the Trade Community Should Know About: Determining the Acceptability of Transaction Value for Related Party Transactions, an Informed Compliance Publication of Customs and Border Protection, at 9 (available online at: www.cbp.gov).
Here, U.S. Company does not provide any of the information that has traditionally been used to sustain a claim under either the normal pricing practices of the industry method or the “all costs plus” method. Instead, U.S. Company bases its arguments on its transfer pricing study.
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 Internal Revenue Service (“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, dated July 23, 2004. The methodology selected for use in a transfer pricing study is also relevant. See HQ 548482, dated July 23, 2004. Thus, even though an importer’s transfer pricing study by itself is not sufficient to show that a related party transaction value is acceptable for Customs purposes, the underlying facts and the conclusions reached in a transfer pricing study may contain relevant information in examining the circumstances of the sale.
Pricing Practices of the Industry
U.S. Company argues that the transfer pricing study shows that Foreign Related Manufacturer’s sales to U.S. Company are at a price consistent with the prices of its competitors in the relevant market and industry segment. The transfer pricing study prepared for tax purposes compares U.S. Company to other comparable companies based on function and risk and the CPM, which is of little relevance for customs purposes. However, U.S. Company also provided an additional analysis that extrapolated six companies within the same industry, [XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX], from those functionally comparable companies. As mentioned above, an analysis of companies within the same industry provides more relevant evidence for customs purposes. This analysis of six comparable companies led to a calculated FCMU interquartile range of 4.5 to 9.23% with a median of 7.7%. Foreign Related Manufacturer’s operating margin fell within the interquartile range, or arm’s length range, at 7.4%. While this evidence is not entirely objective and cannot sustain a claim under a “pricing practices of the industry analysis,” it may be considered evidence under the totality of the circumstances.
All costs plus
U.S. Company also argues that the information in the transfer pricing study and other documents suggests that prices were set in a manner that allowed Foreign Related Manufacturer to recover all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time in sales of the same class or kind. Although equivalent is not defined in the regulations, CBP has interpreted this term to mean equal or greater to the overall firm’s profit. Generally, CBP considers the firm to be the parent company. However, CBP may consider the non-parent manufacturer/seller’s overall profit under certain economic conditions. See HQ H065015, dated April 14, 2011; and HQ H088815, dated September 28, 2011.
Here, U.S. Company argues that since the Parent Company is simply a holding company that does not engage in the sale of products, CBP should consider the overall profits of Foreign Related Manufacturer as the overall firm. U.S. Company bases its argument on HQ H032883, dated March 31, 2010. There, U.S. Company states, CBP compared the gross profits from sales to related buyers to the profits on overall sales of merchandise of the same class or kind. CBP found that the fact that the profits were similar suggested that the relationship did not affect the transfer price. However, CBP’s decision was not based merely on the application of the all costs plus a profit test. While CBP ultimately accepted the transfer price, it should be noted that in arriving to this conclusion, CBP examined all relevant aspects of the transaction, including multiple transfer pricing studies and updates, the Parent Company’s “Enterprise Pricing Model” (“EMP”) document, and a Verification Report by the Canada Border Service Agency. The percentage of profit for the subsidiary in sales of work in progress (WIP) goods to its related parent exceeded the median profit of companies examined in the subsidiary’s 2007 transfer pricing study, and the gross profit amount of the subsidiary in finished goods (FG) sales to its parent was higher than the gross profit amount in finished goods sales to unrelated parties. The net profit margins of sales of finished goods from the subsidiary to its related parent and to unrelated parties were found to be similar. CBP determined the related party prices were settled in a manner consistent with the way the seller settled prices in sales to unrelated buyers based on this information. With regard to the all costs plus a profit test, CBP did look at the information provided by the parties and determined that the subsidiary earned a healthy margin on the sale of goods to its related parent. What may not be clear from the decision is that the subsidiary’s gross profit margin for WIP goods was nearly the exact percentage called for in the EMP based on the transfer pricing studies. Further, the subsidiary’s gross profit margin on the sample FG transaction was greater than the subsidiary’s total gross profit in sales of FG goods which included sales to unrelated parties. Therefore, the quantity and depth of information considered in finding a healthy profit margin for the seller in HQ H032883, and ultimately finding that the prices between the related parties was not influenced by the relationship, was more than just a comparison of the profits from sales to related buyers to the profits on sales to unrelated buyers.
Similar to U.S. Company’s argument here, the company in HQ H065015, dated April 15, 2011, asserted that CBP should not look to the profit of the parent company, but rather the seller’s profitability on the product-line level should be compared to the manufacturer’s total profit in the sale of the merchandise of the same class or kind into the United States. CBP stated that this comparison “did not shed any light on whether the sale is at arm’s length.” In this instance, the comparison is even less convincing as U.S. Company is asking us to accept a comparison of aggregate profits on sales to the United States to overall aggregate profits.
U.S. Company has also asked us to consider the fact that, based on the SEC documents, the profit margin of Foreign Related Manufacturer is greater than that of the Parent Company, which U.S. Company states is the same as the profit margin of all subsidiaries. U.S. Company asserts that this also shows that the all costs plus a profit test is met. However, this also is not a comparison of profits in sales of goods of the same class or kind and does not meet the standard of the all costs plus a profit test.
While the comparisons that U.S. Company asks us to consider may suggest that prices are set in a manner that ensures the seller recovers all costs plus an adequate profit, this information is not enough for a positive finding under the all costs plus a profit method. However, this information may be considered evidence under the totality of the circumstances.
Other considerations
U.S. Company states that based the totality of the circumstance, specifically the fact that the profit level indicator falls within an arm’s length range and that there is a higher operating profit on sales to the U.S. as compared to other sales, we should find that the relationship of the parties did not affect the transaction value, citing HQ H219515, dated October 11, 2012 and HQ H029658, dated December 8, 2009.
CBP has considered transfer pricing policies that are designed “to provide entities with sufficient gross margin to allow recovery of all costs plus a reasonable margin” to be acceptable transaction values. In HQ H219515, the related parties utilized a standard price list and standard percentage discount for the importer’s products. CBP supported the pricing formula, which incorporated a range of gross margins tied to a period of time into which the importer’s gross margin could fit. CBP found that this pricing formula was evidence that the related party prices were acceptable under the circumstances of the sale test. While the pricing formula did not strictly fall within the examples under 19 C.F.R. 152.103(1)(1)(i)-(iii), CBP concluded that based on the totality of facts, including industry analysis and the way in which the prices were developed, the prices were not influenced by the relationship of the parties and thus transaction value was the acceptable basis of appraisal.
Similarly, in this instance we have a transfer pricing policy that aimed to enable Foreign Related Manufacturer to provide entities with a sufficient operating margin to allow recovery of all costs plus a reasonable margin. Foreign Related Manufacturer charges U.S. Company for all costs plus 8%. This pricing policy was implemented to ensure that the Foreign Related Manufacturer is achieving an appropriate profit margin that both complies with I.R.C. § 482 and brings Foreign Related Manufacturer’s profits in line with that of its competitors. However, in HQ H219515, the importer provided CBP with a price list for each product line and CBP noted that the gross profit for each product line was fairly consistent with the gross profits of its competitors.
Here, the CBP Regulatory Auditors expressed concern with analyzing the aggregate profit of the parties involved and believe that the testing of transaction value must result in proof that the methodology used is supported at the entry or transaction level. Auditor’s specifically point out that an evaluation of one product code from the walkthrough found a 75% profit margin for this one product. The Auditors state that this illustrates the potential for wide variances of profits from one product to the next in order to meet the aggregate overall 8% profit.
U.S. Company asserts that CBP has accepted aggregate profits in the past as evidence under the circumstances of the sale test. CBP has considered that when there is a transfer pricing policy implemented with the purpose of complying with IRC § 482, an analysis of aggregate profits may be sufficient. In HQ H029658, CBP found that an Advanced Pricing Agreement (“APA”) that based its conclusion on an aggregate operating margin that fell within the arm’s length range was an acceptable means of demonstrating that the transfer price was not affected by the relationship of the parties. However, the APA was reviewed and approved by both the IRS and a foreign tax authority. In making its decision, CBP also noted rigorous negotiations and a paper on the pricing practices of the industry. Additionally, when CBP has accepted a bilateral APA based on aggregate profits as evidence that the related party transactions were not affected by the relationship of the parties, CBP also stated that the importer must show that the profit earned by product line falls within the range established by the APA upon verification. See HQ 548233, dated November 7, 2003.
The evidence here is most similar to the evidence presented in HQ H289520, dated August 16, 2018. There CBP found that the circumstances of the sale showed that the relationship of the parties did not affect the transaction value. CBP based this decision on a review of financial records, two transfer pricing studies (one completed for customs purposes and the other for tax purposes), price lists, and the company’s transfer pricing policy. CBP stated that the prices should be adjusted so that they fall within the arm’s length range established by both transfer pricing studies in order for the circumstances of the sale test to be met.
Here, we only have one transfer pricing study conducted in accordance with I.R.C. § 482. However, from that study, the Group hired Deloitte to extrapolate information to provide further analysis that limited its scope to six comparable companies that were within the same industry as the seller, which is preferable under customs law. Additionally, U.S. Company provided us with the transfer pricing policy and a list of entry lines and HTSUS subheadings affected by each set of adjustment. U.S. Company states that the duty owed was calculated at the HTSUS subheading level, so in effect, at the product and entry level. If U.S. Company reconciles the prices of entered goods so that the price of each product reflects the cost plus an 8% mark-up, as outlined in the Group transfer pricing policy, then transaction value may be an acceptable basis of appraisal.
We note that an 8% profit would fall within the arm’s length range established in the analysis for both tax and customs purposes. These findings suggest that a transfer price that represents an 8% mark-up would be established as if the parties are unrelated for customs purposes. Once the adjustments are made and the adjusted prices reflect the arm’s length price on all product lines, the circumstances of the sale test is met and transaction value method of appraisement may be utilized by the U.S. Company, subject to your office’s approval.
HOLDING:
Based on the information presented, we determine that transaction value is the appropriate method of appraisement for sales between U.S. Company and the Foreign Related Manufacturer.
Sixty days from the date of this decision, the Office of Trade, Regulations and Rulings, will make this decision available for CBP personnel, and to the public on the CBP Home Page at http://www.cbp.gov by means of the Freedom of Information Act, and other methods of publication.
Sincerely,
Monika Brenner, Chief
Valuation and Special Programs Branch