Customs Ruling HQ H314296 - Internal Advice; Related Parties; Unrelated final customer; Transaction Value

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HQ H314296
Aug 12, 2021

Type : Valuation • HTSUS :
Related: 546998; 548095; 548482; H138203; H260036; H032883; H065015; H088815; H292850; H037375; H246651; W547982

OT:RR:CTF:VS H314296 AP

Amy Guerriero, Field Director
U.S. Customs and Border Protection
Regulatory Audit and Agency Advisory Services
Office of Trade
10 Causeway Street, Room 895
Boston, MA 02222-1059

RE: Internal Advice; Related Parties; Unrelated final customer; Transaction Value

Dear Ms. Guerriero:

This is in response to your internal advice request dated October 7, 2020, initiated by counsel for [X] (the “importer” or [X]), concerning the applicability of transaction value as a method of appraisement of laser cutting machines imported into the United States via a multi-tiered transaction with related parties and the dutiability of royalty payments paid by the importer for the use of its parent company’s trademark. These questions arose as a result of a Focused Assessment Audit conducted by U.S. Customs and Border Protection’s (“CBP”) Regulatory Audit and Agency Advisory Services (“RAAAS”). Virtual meetings with the importer’s counsel and controller were held on April 30 and May 20, 2021.

The importer has asked that certain information submitted in connection with this internal advice request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 C.F.R. § 177.2(b)(7), the importer’s request for confidentiality is approved. The information contained within brackets as well as all attachments to your request for internal advice forwarded to our office and the documentation submitted by the importer’s counsel will not be released to the public and will be withheld from the published version of this decision.

FACTS:

The importer is headquartered in the United States [X]. It designs, produces, and distributes punching machinery, laser machinery, gas and solid-state laser resonators, and laser diodes. The importer primarily operates in the Machine Tools/Power Tools and Laser Technology/Electronics business divisions of the [X] Group. The importer is a wholly-owned North American subsidiary of [X] ([X] or “parent company”) located in Germany. The parent company owns a 100 percent direct interest quota in [X] in Germany ([X] or the “middleman”), and a 100 percent indirect interest quota in [X] in Switzerland ([X] or the “manufacturer”) and in the importer. The parent company coordinates payments from all its subsidiaries and acts as a central, clearing “bank.” [X] ([X] or “Company R”) in Alabama is the unrelated final customer in the U.S.

On June 6, 2017, the importer filed a claimed prior disclosure with respect to royalty payments it paid to its parent company. In its submission, the importer stated, it “believes” that the royalties “paid on imported merchandise sold in the U.S. may be dutiable.” On July 20, 2018, the importer filed another submission to perfect its claimed prior disclosure stating the subject royalties would not be dutiable as royalty payments or proceeds.

On July 17, 2020, RAAAS, Boston Field Office completed a focused assessment pre-assessment survey of the importer’s processes. The scope of the RAAAS audit included imports from July 1, 2015 through June 30, 2016. RAAAS selected and reviewed entries where [X] served as the U.S. importer of record to determine whether transaction value was properly declared to CBP. Your office determined that transaction value was not an acceptable basis of appraisement between the importer [X] and its related parties. The importer did not agree with RAAAS’ determinations and initiated this internal advice request.

The representative transaction that you used as an example and referred to us in your RAAAS internal advice request is entry number [X].

Transaction between the Manufacturer and the Middleman

The manufacturing agreement between the related manufacturer and middleman states that the products should be made by the manufacturer to the middleman’s order and according to the middleman’s specifications. The middleman oversees the ordering and distribution process. “Unless otherwise agreed, risk and title should pass to the principal [the middleman] ex works manufacturer’s factory.” (Emphasis added). The agreement “shall be subject to the laws of the Federal Republic of Germany, excluding the law of conflicts and the UN Convention on Contracts for the International Sale of Goods (CISG).”

Purchase Order (“PO”) Number (“No.”) [X] dated July 22, 2015, identifies the manufacturer as the foreign seller of laser machine [X] priced at [X] Euros (“EUR”) and delivered to the middleman on September 4, 2015.

Invoice No. [X] from the manufacturer to the middleman, dated September 4, 2015, lists the middleman as the buyer in Germany and indicates delivery is to Company R in Alabama. The terms of delivery are “FCA [X],” Switzerland. The payment terms are 30 days from the time of delivery. The original merchandise price is [X] EUR. The invoice states that the “delivery is subject to retention of title at our conditions.” The revised invoice no. [X] from the manufacturer to the middleman, dated December 11, 2015, corrects the sale price of the machine by adding [X] EUR to the original price of [X] EUR, for a total cost of [X] EUR. The invoice states that the “delivery is subject to retention of title at our conditions.”

Delivery Note No. [X], dated September 4, 2015, lists the middleman as the buyer, the terms of delivery of the transaction between the manufacturer and the middleman as “FCA (Free Carrier at) [X],” Switzerland and notes that the “shipping terms correspond to INCOTERMS 2010.” It shows that the manufacturer delivered the laser machinery to Company R in [X], AL.

The inventory records show that on September 4, 2015, the merchandise was in the middleman’s inventory. The middleman assumed the delivery costs and risk of loss when the merchandise was loaded on the truck at the manufacturer’s premises in [X], Switzerland. The middleman paid [X], the trucking/transport company that transported the laser machinery from Switzerland to the shipping port in Germany (Invoice No. [X] dated September 9, 2015, related to bill of lading no. [X]), to deliver the machine from the manufacturer in Switzerland to [X], the container company in Hamburg, Germany that loaded the machine onto containers and onto the vessel for ocean shipment.

Payment from the Middleman to the Manufacturer

The [X] Group uses a multilateral netting process to make payment arrangements for intercompany transactions to eliminate the need for multiple invoicing and payments among its affiliates. The parent company serves as the netting center that offsets accounts payables and accounts receivables to determine the net receivables and net payables between its subsidiaries. All subsidiaries send a single payment to the parent company, which in turn sends payments to the subsidiaries that are due payment. The parent company paid the manufacturer a total of [X] EUR ([X] EUR + [X] EUR) for the laser machine on October 23, 2015 ([X] EUR) and on February 19, 2016 ([X] EUR). The manufacturer received the payments via bank transfers on the same days.

Transaction between the Middleman and the U.S. Importer

The distribution agreement between the middleman and the importer states that as a distributor, the importer can determine selling prices in North America, and can buy in its own name and for its own account. The middleman owns the licenses of all product trademarks and grants the importer the non-exclusive and non-transferable right to use its product trademarks in advertising and promotional materials for the contractual products in the contractual territory only. Under the delivery terms, “Unless otherwise agreed, delivery of contractual products shall be ex warehouse of principal [the middleman] or its contract manufacturers. The risk of transport shall be borne by the distributor [the importer].” The products delivered to the importer “remain in the legal ownership of principal [the middleman] until distributor [the importer] has fully paid all outstanding invoices of principal [the middleman] that are due for payment. As long as principal [the middleman] remains the owner of contractual products shipped to the distributor [the importer], principal [the middleman] retains the right to separate these contractual products still owned and to take them back into its own premises.” (Emphasis added). The agreement is “subject to the laws of the Federal Republic of Germany, excluding the law of conflicts and the UN Convention on Contracts for the International Sale of Goods (CISG).”

The [X] U.S. Transfer Pricing Analysis Report for fiscal year ended June 30, 2016 (“FY 2016”) prepared by Deloitte Tax LLP (“Transfer Pricing Report” or “report”) states, “The title for products sold by the [X] Affiliates passes on to [the importer] as soon as they are shipped to the U.S. Similarly, the title of the products distributed by [the importer] passes on to the third parties as soon as the products leave [the importer’s] factories or warehouse.” The importer makes use of its third-party logistics and transportation network to ship and deliver products to its end customers in the U.S.

Purchase Order No. [X] dated July 22, 2015, from the importer to the middleman identifies the terms of payment as 90 days month end and the terms of delivery as “EXW Ex Works.” This PO was revised twice on July 22, 2015, to change the pricing and discount of [X] percent. It replaced PO No. [X]. The country of delivery is the U.S. The gross amount of the laser machine on the purchase order is [X] EUR less a [X] percent discount of [X] EUR for a total net price of [X] EUR. The “deliver to” address is Company R, [X] AL [X].

Invoice No. [X] from the middleman to the importer dated September 7, 2015, lists the shipment location as Company R in [X], AL and states that “[t]itle will not pass until payment is received in full.” The date of delivery is “09/2015.” The terms of payment are “Up to 12/30/2015 without deduction.” The terms of delivery are “FOB German Seaport.” The total net amount of the [X] machinery is [X] EUR, which includes a [X] percent customer discount. The importer [X] paid the invoice on December 18, 2015.

Sea Waybill Number [X] dated September 16, 2015, identifies the middleman as the shipper; the importer as the consignee; Hamburg, Germany, as the place of receipt and port of loading; and New York, NY, as the port of discharge and place of delivery. It lists container numbers [X]. The freight was shipped on September 16, 2015. The “Shipper’s Load & Count” identifies [X], Machine [X], and PO No. [X], and the stuffing location of the container company [X] located in Hamburg, Germany. The Packing List identifies the middleman’s head office in Germany, the delivery address of Company R in [X], AL, and Machine [X], [X], country of origin Switzerland.

Invoice No. [X] dated September 22, 2015 (total value of $[X]) from [X], the international freight forwarder that handled the ocean freight, to the importer indicates that the merchandise shipped via vessel, [X], from the Port of Hamburg, Germany, to the Port of New York. The importer paid the international freight forwarder via wire transfer on September 29, 2015, through [X] Bank. The importer assumed the risk of loss once the merchandise was on board the ship under the terms FOB German Seaport listed on the invoice. The delivery order from the importer to the transportation company [X] in Connecticut dated September 21, 2015, reveals that the merchandise was forwarded to the transportation company on September 26, 2015. The invoice from the trucking company, [X], to the importer dated October 2, 2015, shows that the merchandise was delivered from Global Terminal in Jersey City, NJ to the transportation company [X] in Connecticut. The bill of lading dated October 13, 2015, lists the importer, c/o [X] in Newark, NJ, as the shipper and Company R in [X], AL as the consignee. The freight was prepaid.

The importer’s broker issued three Delivery Orders for container numbers [X] with an arrival date of September 26, 2015. The containers were picked up at the Global Terminal Service in Jersey City, NJ, and delivered to the transportation company [X], CT on September 26, 2015. Container [X] was picked up by the trucking company [X] and delivered to the transportation company in [X], CT. Containers [X] were picked up by the transportation company [X] and delivered in [X] CT. A bill of lading from [X], located in Newark, NJ, shows that the merchandise was delivered to Company R in [X], AL on October 15, 2015 (prior to the importer’s payment to the middleman and the middleman’s payment to the manufacturer). The importer [X] provided Invoice No. [X] dated October 2, 2015, in the amount of $[X] from the trucking company [X] for the delivery of container [X] from the Global Terminal in Jersey City, NJ, to the warehousing company [X] in [X], CT. The trucking company [X] sent an itemized statement for all outstanding invoices, including Invoice No. [X], for $[X]. The importer paid [X] $[X] via wire transfer on October 14, 2015, through [X] Bank.

The entry/immediate delivery (CBP Form 3461) filed on September 23, 2015 and the entry summary filed on September 26, 2015, indicate that [X] was the importer of record and the total value listed for the [X] was $[X].

Payment from the U.S. Importer to the Middleman

The middleman’s [X] bank statement of December 18, 2015, shows that the middleman received the payment due for the merchandise from the importer on December 18, 2015.

Transaction between the U.S. Importer and the Final U.S. Customer Company R

Under the U.S. importer’s [X] Terms and Conditions of Services, “All [domestic] orders are FOB [Free on Board] Seller’s plant in [X], Connecticut (or FOB such warehousing facilities as Seller may establish).” The payment terms are “10% deposit with purchase order, 90% Net 30 Days from Shipment … The risk of loss passes to Buyer upon delivery of the goods to the carrier … The validity, interpretation and performance of this contract for sale shall be governed by the laws of the State of Connecticut.” The importer [X] “reserves a security interest in the goods (and the proceeds thereof) as security for the payment of the unpaid balance of the purchase price and Buyer’s performance of its other obligations hereunder. Buyer will execute and deliver to Seller such Uniform Commercial Code financing statements as Seller shall request in order to perfect such security interest … If Buyer shall not pay the full purchase price within 30 days from the date of shipment of the goods; Buyer will pay Seller thereafter an additional one and one-half percent (1-1/2%) per month on the unpaid balance of the purchase price until paid in full. Such charge shall be added to and become an additional part of the purchase price for the goods. Buyer also will pay all costs of collection incurred by Seller in collecting the purchase price for the goods and enforcing its security interest in the goods, including, without limitation, reasonable attorneys’ fees and expenses incurred by Seller.”

The June 26, 2015 purchase order from Company R to the U.S. importer [X] states that the delivery date is October 1, 2015, and the shipping method is “truck.” The unit cost of the laser machine [X] is $[X]. Company R receives a special discount of $[X]. The terms of the sale are “FOB [X], CT.” The payment terms are “10% Payment with Order. Balance Net 30 Days after Delivery.”

The October 13, 2015 invoice from the U.S. importer [X] to Company R states that the laser machines ships from “[X], CT, USA” to Company R’s location in “[X], AL” via [X]. The terms of delivery are “FOB [X], CT.” The payment terms are “10% Deposit, Balance Due Net 30 Days.” The invoice refers to the Terms and Conditions of Services.

In the Security Agreement dated July 8, 2015, Company R grants a security interest to the U.S. importer [X] under the Uniform Commercial Code (“UCC”) in the laser machine [X]. The security interest granted to the importer [X] is collateral security for the payment of the unpaid portion of the purchase price of the equipment. Upon payment in full of the equipment, [X] the importer will consider the security interest in the machine satisfied under the UCC.

Payment from the Final U.S. Customer Company R to the U.S. Importer

Company R paid 10 percent of the purchase price on August 17, 2015 and the remaining 90 percent of the purchase price on October 14, 2015.

Transfer Pricing Report

The Transfer Pricing Report for FY 2016 analyzed the purchase of machines and parts from [X] company affiliates in Germany and Switzerland by the importer for distribution in North America. The report was based on an analysis of the facts presented and an interpretation of the regulations under title 26, Internal Revenue Code, Sections 482 and 6662(e) and (h). The report determined the best method for evaluating the instant transaction for tax purposes was the Resale Price Method (“RPM”).

The report compared the importer’s gross margin (“GM”) achieved on the sale of machines and parts in North America from purchases of such tangible goods from [X] affiliates in FY 2016, to an arm’s-length interquartile range of results achieved by comparable uncontrolled North American distributors that performed similar functions, deployed similar assets, and bore similar risks to the importer. The report determined that an arm’s-length interquartile range of weighted average accounting adjusted GMs of certain claimed comparable North American distributors for the three-year period beginning the fiscal year ended June 30, 2014 (“FY 2014”) through FY 2016 to be [X] percent to [X] percent, with a median of [X] percent. For the same three-year period, the importer earned a weighted average GM on the North American sale of purchased machines and parts from [X] affiliates in Germany, Switzerland, and Austria of [X] percent, which according to the report fell within the interquartile range of accounting adjusted GMs of comparable North American distributors.

The report also analyzed the importer’s aggregate operating margin (“OM”) resulting from distribution of machine and parts purchased from the relevant [X] affiliates as well as purchases of tangible goods from uncontrolled third parties. The report compared the importer’s aggregate OM from all distribution sales for FY 2014 through FY 2016, to the accounting adjusted OMs achieved from certain claimed comparable uncontrolled North American distributors for the same three-year period that perform similar functions and deploy similar assets and bear similar risks to it. The report determined an arm’s-length interquartile range of accounting adjusted OMs achieved by comparable uncontrolled North American distributors to be [X] percent to [X] percent, with a median of [X] percent for the period FY 2014 through FY 2016. For the same period, the importer earned an OM on all distribution sales of [X] percent.

The report identified “suitably comparable” North American uncontrolled distributor companies that purportedly distributed comparable machine parts and spare parts to those purchased and resold by the importer from the relevant [X] affiliates. The report searched for active companies whose primary business activities were classified under SIC Code 50 – Wholesale Trade – Durable Goods and identified the following comparable companies: [1) [X] (“Company A”); 2) [X] (“Company B”); 3) [X] (“Company C”); 4) [X] (“Company D”); 5) [X] (“Company E”); and 6) [X] (“Company F”) The report did not compare the OM of companies in the same industry or companies who sold goods of the same class or kind.

The report concluded that based on the application of the RPM as the best method selecting the GM as the relevant profit level indictor (“PLI”), and its corroborative analysis of the importer’s aggregate OM for the period FY 2014 through FY 2016, the price at which the importer purchased machines in FY 2016 from [X] affiliates was at arm’s-length.

The report stated that the [X] affiliates were not responsible for or bore any risks or costs associated with the transportation of finished goods to the importer and that the importer’s third-party customers were responsible for transportation of products from the importer’s distribution locations and bore all costs associated with transportation. The report also stated that the importer generally maintained a lean inventory of the products it purchased from its affiliates for distribution into North America as the purchases were made based on customer orders and that the title passed on to the importer as soon as goods were shipped to the U.S. The title of the products distributed by the importer passed on to the third parties when the products left the importer’s factories/warehouse. The importer determined the price to the end customers based on the local list prices, the global list price minus discount (transfer price), competition from third parties, and local distribution and service costs. The [X] affiliate that was the Product Center determined the global list prices for different product specifications for the end customers. Pricing from affiliates was determined by the global transfer pricing policy.

The Importer’s Dun & Bradstreet and LexisNexis Dossier Reports

According to the importer’s Dun & Bradstreet and LexisNexis Dossier Reports, the importer’s primary Standard Industrial Classification (“SIC”) code is 3542 (Machine Tools, Metal Forming Types), and secondary SIC codes are 3546 (Power Driven Hand Tools) and 3541 (Machinery Tools, Metal Cutting Types). The importer’s primary North American Industrial Classification System (“NAICS”) code is 333517 (Machine Tool Manufacturing) and the secondary NAICS codes are 333991 (Power-Driven Hand Tool Manufacturing) and 332216 (Saw Blade and Hand Tool Manufacturing).

Company A supplies communications and security products and electrical and electronic wire and cable and its primary SIC code is 5063 (Electrical Apparatus and Equipment Wiring Supplies, and Construction Materials) and NAICS code is 423610 (Electrical Apparatus and Equipment, Wiring Supplies, and Related Equipment Merchant Wholesalers).

Company B is a distributor of electronic components and its primary SIC code is 5065 (Electronic Parts and Equipment, Not Elsewhere Classified) and primary NAICS code is 423690 (Other Electronic Parts and Equipment Merchant Wholesalers).

Company C distributes maintenance, repair, and operating products, pump equipment (such as centrifugal/metering/specialty pumps), and services to industrial customers in the U.S. It operates through three segments: Service Centers, Supply Chain Services, and Innovative Pumping Solutions. Its primary SIC code is 7389 (Business Services, Not Elsewhere Classified) and its primary NAICS code is 561990 (All Other Support Services).

Company D distributes automotive replacement parts, industrial replacement parts, office products, and electrical/electronic materials and its primary SIC code is 5531 (Auto and Home Supply Services) and its primary NAICS code is 423830 (Industrial Machinery and Equipment Merchant Wholesalers).

Company E, through its subsidiaries, sells wire and cable, hardware, and related services in the U.S., and its primary SIC code is 5063 (Electrical Apparatus and Equipment Wiring Supplies, and Construction materials, and its primary NAICS code is 423610 (Electrical Apparatus and Equipment, Wiring Supplies, and Related Equipment Merchant Wholesalers).

Company F, through its subsidiaries, is engaged in the sale, rental, and after-sale parts and service support of mobile equipment, power systems, and industrial components. The company operates through three businesses: Equipment, Industrial Components, and Power Systems. Its primary SIC codes are 50 (Wholesale Trade – Durable Goods) and 504 (Professional and Commercial Equipment Supplies), and its primary NAICS codes are 42 (Wholesale Trade) and 42344 (Other Commercial Equipment Merchant Wholesalers).

Dun & Bradstreet’s Hoovers OneStop Report, dated September 21, 2020, for the importer identified several companies ([X]) as competitors but none of them are used in the calculation of the RPM in the report. The closest industry peers ([X]) and the closest companies ([X]) were also not used in the RPM calculation.

Cost and Profit

The cost and profit documentation (invoices, payments, bill of materials, sales information, chart, and narrative) submitted by the importer reveals that: (1) the middleman sold the merchandise to the related U.S. importer [X] at cost and earned zero profit; (2) the manufacturer earned a gross profit margin of [X] percent on the imported laser machine; and the parent company [X] Group sold a total of 55 [X] laser machines and earned an overall gross profit margin of [X] percent.

Royalty Payments from the Importer to the Parent Company

The importer pays trademark royalty fees to its parent company for use of the [X] trademark. Under the intercompany licensing arrangement, the importer pays a royalty fee of [X] percent on the final sale price “net proceeds” on all domestic or imported merchandise bearing the trademark sold in the licensed territory, North America (U.S., Canada, and Mexico) after importation. The importer owes the royalty to the parent only when a [X] product, whether manufactured in the U.S. or overseas, is sold to unaffiliated companies.

The transfer pricing report looked at the royalty payment by the importer to the parent for the use of the [X] trademark and determined that the best method was the Comparable Uncontrolled Transaction (“CUT”) method. The report developed a set of comparable uncontrolled trademark licensing agreements whose terms were used to establish a range of royalty rates. The report selected five uncontrolled trademark licensing comparables that purportedly represented comparable terms and conditions to those of the trademark licensing agreement between the importer and the parent. The report found that an arm’s-length range of comparable uncontrolled trademark royalty rates to be [X] percent and [X] percent, with a median of [X] percent. The report concluded that as the importer paid a royalty of [X] percent on all third-party sales in FY 2016 for the use of the trademark to the parent, the importer did not pay more than an arm’s-length royalty rate. Per the report, during FY 2016, the importer paid $[X] as trademark license fees to the parent. According to the parent’s transfer pricing guidelines, “The trademark license is invoiced by the controlling department on a quarterly basis for the past quarter. Invoicing is effected in the local currency of each company.”

The importer asserts that the value of the imported merchandise should be based on the “first sale” price between the related foreign manufacturer in Switzerland and the related middleman in Germany, or the “second sale” price between the middleman and the related U.S. importer [X]. The importer also asserts that its royalty payments are not dutiable as a royalty or a subsequent proceed.

ISSUES:

Whether transaction value is appropriate to appraise the merchandise and which transaction may be used to appraise the imported merchandise.

Whether the royalty payments made by the U.S. importer to its parent company should be part of the price paid or payable for the imported merchandise or an addition to the price actually paid or payable for the imported merchandise.

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised 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 preferred 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 certain statutory additions. 19 U.S.C. § 1401a(b)(1). When transaction value cannot be applied, then the appraised value is determined based on the other valuation methods in the order specified in 19 U.S.C. § 1401a(a).

In Nissho Iwai Am. Corp. v. United States, 16 CIT 86, 786 F. Supp. 1002 (1992), rev’d in part, 982 F.2d 505 (Fed. Cir. 1992), the courts addressed the methodology for determining the transaction value of merchandise imported pursuant to a three-tiered transaction. In each case, the courts held that the price paid by the middleman could serve as the basis for transaction value for the shipments if the sale was negotiated at arm’s length, free from non-market influences, and involved goods clearly destined for the United States.

In accordance with the Nissho Iwai decision and our own precedent, we presume that transaction value is based on the price paid by the importer. An importer may request appraisement based on the price paid by the middleman to the foreign manufacturer in situations where the middleman is not the importer. It is the importer’s responsibility to show that the “first sale” price is acceptable under the standard set forth in Nissho Iwai. That is, the importer must present sufficient evidence that the alleged sale was a bona fide “arm’s length sale,” and that it was “a sale for export to the United States” within the meaning of 19 U.S.C. § 1401a. In the present case, the middleman and the importer must present sufficient evidence that the sale between the related party manufacturer and middleman is a bona fide arm’s length sale of “goods clearly destined for export to the United States.”

In Treasury Decision (“T.D.”) 96-87, dated Jan. 2, 1997, the Customs Service (the predecessor to CBP) advised that the importer must provide a description of the roles of the parties involved and must supply relevant documentation addressing each transaction that was involved in the exportation of the merchandise to the United States. The documents may include, but are not limited to purchase orders, invoices, proof of payment, contracts, and any additional documents (e.g., correspondence) that establish how the parties deal with one another. The objective is to provide CBP with “a complete paper trail of the imported merchandise showing the structure of the entire transaction.” T.D. 96-87 also provides that the importer must inform CBP of any statutory additions and their amounts. If unable to do so, the sale between the middleman and the manufacturer cannot form the basis of transaction value.

“Sale” means a transfer of ownership from one to another for consideration. VWP of Am., Inc. v. United States, 175 F.3d 1327 (Fed. Cir. 1999), citing J.L. Wood v. United States, 62 C.C.P.A. 25, 33, 505 F.2d 1400, 1406 (1974). Several factors may indicate whether a bona fide sale exists between a potential buyer and seller. In determining whether property or ownership has been transferred, we consider the terms of the sale and whether the occurring payments are linked to specific importations of merchandise and whether the roles of the parties indicate that they are functioning as buyer and seller. See Headquarters Ruling Letter (“HQ”) 545705, dated Jan. 27, 1995.

In order to benefit from a “first sale” value at importation, an importer must be able to establish all the elements of transaction value set forth in 19 U.S.C. § 1401a(b). From the shipping documents, it is not disputed that the goods at issue were clearly destined for the United States. However, we must determine if a bona fide sale occurred between the related parties.

In Hong Kong & Shanghai Banking Corp., Ltd. v HFH USA Corp., 805 F. Supp. 133, 140 (W.D.N.Y. 1992), the court determined that if a German choice-of-law clause were given effect, the title retention clause in the agreement would be operative and the supplier would have title to the goods. In the instant matter, the related manufacturer and middleman chose German law to apply to the sales contract between them. Pursuant to the manufacturing agreement between the related manufacturer and middleman, “Unless otherwise agreed, risk and title should pass to the principal [the middleman] ex works manufacturer’s factory” and the governing law is German law. The invoices from the manufacturer to the middleman indicate that the terms of delivery are “FCA [X],” meaning the manufacturer was responsible for getting the goods to the agreed upon location in [X], Switzerland and the risk of loss from that point transferred to the middleman. The invoices include a title retention agreement between the parties by noting that the payment terms are 30 days from the time of delivery and “delivery is subject to retention of title at [the manufacturer’s] conditions.”

Black’s Law dictionary defines a “commercial invoice” as “A document needed for a customs agent to show the value of goods, duties, and taxes. It shows the buyer, seller, date, sale terms, amount, packaging, description, value, and insurance fees.” (Emphasis added). In Italverde Trading, Inc. v. Four Bills of Lading, 485 F. Supp. 2d 187, 199 (E.D.N.Y. 2007), the court noted “[t]here is no question” that invoices constituted “actual or potential contracts” between an invoicing company and its customers. In Orbisphere Corp. v. United States, 13 CIT 866, 884-85, 726 F. Supp. 1344, 1357 (1989), the court held that the company was legally bound by the terms and conditions in the invoices relevant during the time of the commercial transaction. In Nakornthai Strip Mill Pub. Co. v. United States, 33 CIT 326, 328 n.6, 614 F. Supp. 2d 1323, 1327 n.6 (2009), the court agreed with Department of Commerce that “in many industries, even though a buyer and seller may initially agree on terms of sale, those terms remain negotiable and are not finally established until the sale is invoiced.” Thus, the invoices reflect the agreement reached by the Swiss manufacturer and the German middleman in the instant matter that title to the goods passed upon full payment and the German middleman received no title to the goods until it paid for the merchandise on October 23, 2015, and on February 19, 2016.

According to the distribution agreement between the middleman and the related U.S. importer, the products delivered to the importer “remain in the legal ownership of principal [the middleman] until distributor [the importer] has fully paid all outstanding invoices of principal [the middleman] that are due for payment ….” The parties chose German law to apply to the sales contract between the German middleman and the related U.S. importer [X]. This means that the middleman retained title to the goods until the U.S. importer fully paid. The terms of the sale between the middleman and the U.S. importer as reflected on the invoices were FOB German Port meaning that the risk of loss transferred from the middleman to the importer when the goods passed the ship’s rail in Hamburg, Germany. The payment terms in the transaction between the manufacturer and the middleman were 30 days from time of delivery. Both per the invoices and the distribution agreement, delivery to the middleman was subject to retention of title by the manufacturer. The U.S. importer [X] paid the middleman for the goods on December 18, 2015. The U.S. importer [X] had no title to the goods when the U.S. entry/immediate delivery was filed on September 23, 2015, and when the goods were delivered to Company R on October 15, 2015.

Under the U.S. importer [X]’s Terms and Conditions of Services, the payment terms are “10% deposit with purchase order, 90% Net 30 Days from Shipment.” If the final U.S. customer Company R does not pay on time, the importer [X] “reserves a security interest in the goods (and the proceeds thereof) as security for the payment of the unpaid balance of the purchase ….” The contract is governed by the laws of the State of Connecticut. We first address whether Connecticut common law or Article 2 of the UCC codified at Connecticut General Statute, Title 42A, Section 2-401 would apply. Since the contract is primarily for goods, the UCC applies. See CVD Equip. Corp. v. Taiwan Glass Indus. Corp., 2014 U.S. Dist. LEXIS 159745 at *12 (S.D.N.Y. 2014) (concluding that “as a matter of law … the Agreement is a contract primarily for goods, and is accordingly governed by the UCC.”).

According to the October 13, 2015 invoice from the U.S. importer [X] to Company R, the laser machine ships from “[X], CT, USA” to Company R’s location in “[X], AL,” the terms of delivery are “FOB [X], CT,” and the payment terms are “10% Deposit, Balance Due Net 30 Days.” The invoice is consistent with the Terms and Conditions of Services. The Security Agreement dated July 8, 2015, grants a security interest to the U.S. importer [X] under the UCC in the laser machine if Company R does not pay in full. Connecticut General Statute, Title 42A, Section 2-401 states, in relevant part, that “Unless otherwise explicitly agreed title passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods, despite any reservation of a security interest and even though a document of title is to be delivered at a different time or place; and in particular and despite any reservation of a security interest by the bill of lading ….” See also Italverde Trading, 485 F. Supp. 2d at 199 (noting that “title retention contracts are construed as creating only security interests under the U.C.C.” and that “title to goods passes when the seller fulfills his obligation to deliver the goods to the place identified in the contract.”). In the instant matter, title passed directly from the Swiss manufacturer to Company R when the U.S. importer [X] delivered the goods to Company R on October 15, 2015. After the transfer of title, the importer [X] retained no security interest in the goods under the UCC because Company R paid in full for the merchandise on October 14, 2015.

The roles of the parties and the circumstances of the transactions between the related manufacturer, middleman and U.S. importer indicate that the parties are not functioning as a buyer and seller. A sale involves a transfer of title from one party to another for consideration. See VWP of Am., supra. No sales occurred between the manufacturer and the middleman and between the middleman and the importer because the middleman had no title to the merchandise when it was shipped to the importer and delivered to Company R. The title transferred directly from the Swiss manufacturer to Company R in Alabama. In addition, the relationship between the related parties affected the price. Although the Swiss manufacturer received a late payment from the middleman, it still provided a sales discount for the merchandise, which would unlikely occur if the parties were unrelated. As a result, the transactions between the related parties (the manufacturer, middleman and U.S. importer) do not constitute bona fide sales.

Even if there were bona fide sales between the related parties, the “first sale” and “second sale” transaction values proposed by the parties still would not be acceptable. 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).

Under the circumstances of the sale approach, the transaction value between related parties (the Swiss manufacturer, the German middleman, and the U.S. importer [X]) will be considered acceptable if the parties buy and sell from one another as if they were unrelated, meaning their relationship did not influence the price actually paid or payable. The CBP Regulations in 19 C.F.R. Part 152 set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, CBP will examine the manner, in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 C.F.R. § 152.103(l)(1)(i)-(ii). In addition, CBP will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. See 19 C.F.R. § 152.103(l)(1)(iii).

Providing CBP with a transfer pricing study is not sufficient by itself to establish that a related party transaction value is acceptable. Additionally, CBP has held that the mere fact the importer/buyer allegedly earned an operating profit comparable to other functionally equivalent companies is not sufficient to establish compliance with the normal pricing practices of the industry, or that the related party price was settled in a manner consistent with the normal pricing practices of the industry in question. See HQ H138203, dated Oct. 11, 2011; HQ H260036, dated Feb. 24, 2015. 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. See HQ 546998, dated Jan. 19, 2000; HQ 548095, dated Sept. 19, 2002.

For the circumstances of sale test, the importer was unable to demonstrate that the price was settled in a manner consistent with the normal pricing practices of the industry in question. The companies in the transfer pricing report were not comparable to the importer as they did not operate in the same industry and did not sell merchandise of the same class or kind. 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. That the importer allegedly earned an operating profit comparable to other functionally equivalent companies is not sufficient to establish either the normal pricing practice in the industry in question or that the related party price was settled in a manner consistent with the normal pricing practices of the industry in question. See HQ 548482, July 23, 2004; HQ 548095, supra. The transfer pricing study did not include companies that were direct competitors, did not cover the relevant time period, and was not reviewed by the Internal Revenue Service (“IRS”). As a result, the importer did not satisfy the normal pricing practices of the industry test.

We note that the second circumstances of sale test is not applicable, as the [X] Group does not sell any merchandise directly to unrelated parties.

Regarding the third circumstances of sale test, known as the “all costs plus a profit” method, we need to determine 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 merchandise of the same class or kind.” 19 C.F.R. § 152.103(l)(iii). The importer asserts that an aggregate comparison of the profits achieved on sales from the manufacturer to the middleman against the manufacturer’s overall sales of the same class or kind of goods is appropriate, and cites to HQ H032883, dated Mar. 31, 2010; HQ H065015, dated Apr. 14, 2011; and HQ H088815, dated Sept. 28, 2011.

The “all costs plus a profit” methodology examines whether a related party price compensates the seller for all its costs plus a specified amount of profit. If the seller of the imported merchandise is a subsidiary of the parent company, the price must be adequate to ensure recovery of all the seller’s costs plus a profit that is equivalent to the parent company’s overall profit. See HQ 546998, supra. CBP has interpreted the term “equivalent” to mean equal or greater to the overall firm’s profit and typically considers the “firm” to be the parent. See HQ H292850, dated Dec. 13, 2018. CBP regulations do not define whether gross profit or operating profit should be considered. CBP is of the view that the operating profit margin is a more accurate measure of a company’s real profitability because it reveals what the company actually earns on its sales once all associated expenses have been paid. In certain circumstances, gross profit can be considered. See HQ H037375, dated Dec. 11, 2009. Pursuant to 19 C.F.R. § 152.102(h), “merchandise of the same class or kind” means “merchandise (including, but not limited to, identical merchandise and similar merchandise) within a group or range of merchandise produced by a particular industry or industry sector.”

The cited rulings are distinguishable. Unlike in the instant matter where the middleman in Germany is the buyer and the related Swiss manufacturer is the seller, in HQ H032883, the parent company served as the buyer and purchased paper fabric from its subsidiary in Canada, which served as the seller and sold the merchandise for resale to unrelated customers in the United States. The seller’s transfer pricing study in HQ H032883 included eight comparable companies manufacturing and selling products of the same class or kind as the imported merchandise, two of which were direct competitors of the Canadian subsidiary, which led to a conclusion that the seller’s price for the products was enough to ensure recovery of all costs plus a profit equal to the parent’s overall profits realized over a representative time period in the sales of merchandise of the same class or kind.

In HQ H065015, the company acted as the U.S. distributor of the instruments manufactured by its affiliate in Singapore and the reagents and chemicals manufactured by its affiliate in the United Kingdom. The company purchased the merchandise only from related manufacturers and did not sell to unrelated distributors in the United States. The ruling stated that, “In this case, both sellers are subsidiaries of the parent company; however, the Company uses the manufacturers/sellers’ profit, not the parent company’s profit, to satisfy the circumstances of the sale test. While we acknowledge that in certain circumstances it is possible to compare transactional profit to the seller’s overall aggregated result based on certain economic considerations … , it is not the case here.” HQ H065015 concluded that comparing the manufacturers’ profitability on the product-line level to the manufacturer’s total profit in the sale of the merchandise of the same class or kind into the United States did not reveal whether the sale was at arm’s length and was not appropriate. Finally, HQ H088815 involved “a related importer, middleman, manufacturer, and parent corporation.” Some of the suppliers of the raw materials were also related parties. CBP determined that it would not be appropriate to compare the profit of the manufacturer to the profit of the middleman because the middleman did not own or control the manufacturer, had different functions and activities, and operated in a different manner.

Here, the importer has not demonstrated that the price charged by the manufacturer in Switzerland was sufficient to recover all costs associated with production of the laser machine plus a profit equivalent to the parent’s overall profit over the representative period of time. For the transaction between the U.S. importer [X] and the middleman, the submitted invoices and payments demonstrate that the middleman sold the merchandise to the related U.S. importer at cost and earned zero profit. For the transaction between the middleman and the related Swiss manufacturer, the submitted bill of materials and sales information show that the manufacturer earned a gross profit margin of [X] percent on the imported laser machine [X]. The parent company [X] Group sold a total of 55 [X] laser machines and earned an overall gross profit margin of [X] percent. The manufacturer’s gross profit margin of [X] percent was 26.5 percent less than the parent’s overall gross profit margin of [X] percent. Accordingly, the circumstances of the sale test is not satisfied because the price between the Swiss manufacturer and the German middleman was not adequate to recover all costs plus a profit which is equivalent to the parent’s overall profit realized over a representative period of time, in sales of merchandise of the same class or kind.

Next, we will review test values. Test values refer to values previously determined pursuant to actual appraisements of imported merchandise. See HQ H246651, dated Feb. 5, 2014. The test values method is “an acceptable basis of appraisement only if the test value of the merchandise closely approximates previously accepted values of either sales of identical or similar merchandise to unrelated buyers or the deductive or computed value for identical or similar merchandise.” HQ W547982, dated May 20, 2002. Here, the importer has provided three liquidated entries around the same date as the imported merchandise. However, the importer does not have any sales of identical or similar merchandise to unrelated buyers in the U.S. and CBP does not have any test values for the subject merchandise. Therefore, in the absence of previously accepted test values, we have insufficient information to determine whether the related party prices closely approximate the price of merchandise of the same class or kind in sales to unrelated parties.

Accordingly, we determine that the transactions between the related parties (the Swiss manufacturer, the German middleman and the U.S. importer) are influenced by their relationship and the “first sale” and “second sale” transaction values are not an acceptable appraisement method. Since the merchandise may not be appraised based on the price paid or payable by the U.S. importer, the issue of the dutiability of the trademark royalty fees paid by the importer to the parent company for use of the [X] trademark is moot.

We conclude that the imported merchandise may be appraised using transaction value based on the price paid or payable by the final U.S. customer Company R to the U.S. importer. Company R is unrelated to the Swiss manufacturer and the U.S. importer. The manufacturer is functioning as a bona fide seller and Company R is functioning as a bona fide buyer. The submitted documentation as described above reveals that title to the goods transferred directly from the manufacturer to Company R who paid consideration for the merchandise. The middleman and the U.S. importer did not have title to the goods during the transactions. Company R held title to the goods when they were delivered to it in Alabama. As Company R is unrelated to the [X] Group, the sale to Company R is presumed to be at “arm’s length.” The laser machine is “clearly destined” for the U.S. when sold to Company R because it was made per order and the only possible destination for the imported merchandise was the U.S. HOLDING:

The merchandise may be appraised using transaction value based on the price paid or payable by the final U.S. customer Company R to the U.S. importer, and as a result, the royalty issue is moot.

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. Sixty days from the date of this letter, Regulations and Rulings, Office of Trade will take steps to make this decision available to CBP personnel and to the public on the CBP Home Page at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.

Sincerely,

Monika R. Brenner, Chief
Valuation & Special Programs Branch