OT:RR:CTF:VS H340157 EE
Center Director
U.S. Customs and Border Protection
Machinery Center of Excellence and Expertise
1901 Crossbeam Drive
Charlotte, North Carolina 28217
RE: Internal Advice; Protest No. 1601-24-107165; Transaction Value; Related Party Transactions; Post-Importation Adjustments
Dear Center Director:
We are providing internal advice with regard to Protest No. 1601-24-107165 filed on May 22, 2024 by Damon V. Pike, customs advisor at BDO USA, PC on behalf of the importer, Schaeffler Group USA Inc. (hereinafter, the “protestant”), concerning the treatment of certain post-importation adjustments.
The protestant 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 request for confidentiality is approved. The information contained within brackets and all attachments to this internal advice request, forwarded to our office, will not be released to the public and will be withheld from published versions of this decision.
FACTS:
The Schaeffler Group is a global automotive and industrial supplier which manufactures high-precision components and systems for engine, transmission, and chassis applications. It also produces rolling and plain bearing solutions for a wide range of industrial applications, including automotive and commercial vehicle original equipment and replacement parts markets. The protestant serves as the regional headquarters for the Schaeffler Group in the Americas and is a subsidiary of Schaeffler Technologies AG & Co. KG (“Schaeffler AG”), the parent company based in Germany.
The protest at issue concerns refunds due to a decrease in the reported customs values resulting from the protestant’s year-end transfer pricing adjustments in fiscal year 2022. The protestant claims that the adjustments took place in accordance with the intercompany pricing formula set forth in the P 174756 Corporate Directive Transfer Pricing (“TP Directive”) document. The protestant states that the vast majority of the adjustments (covering Type -01 entries) were reported via the filing of reconciliation entries. However, because the customs broker erred in not flagging all eligible entries and because reconciliation does not cover all entry types, e.g., Type -03 entries, protests were filed for entries in 2022 that were not eligible to be flagged for reconciliation.
The protestant claims that based on the market environment and its corporate structure, the Schaeffler Group established an intercompany pricing formula that demonstrates prices are at arm’s length. This formula is based on a Process Contribution Analysis (“PCA”), which determines the allocation of functions and risks, including those of the protestant and its related sellers. In performing the PCA, the objective is to quantify the contribution made by defined functional units. Accordingly, function and risk profiles of the Schaeffler Group companies are determined and value-added contributions are assigned for each business division. Each division’s operating business processes are evaluated separately given the different value drivers, process weightings, and entity contributions to the Schaeffler Group as a whole. As a result of the PCA, the value-added contributions of the respective functional units or Group companies are converted into mark-ups on costs for unfinished goods and mark-downs on resale prices for finished goods. These mark-ups and mark-downs play a key role in the setting of transfer prices contained in the operational systems for goods and tangible assets. The mark-ups and mark-downs are calculated pursuant to the PCA formula under the Cost-Plus transfer pricing method (for sales of unfinished goods used as components in manufacturing further finished articles) or under the Re-Sale Minus transfer pricing method (used for re-sales of finished goods to unrelated customers in the United States). All mark-ups and mark-downs for both finished and unfinished goods resulting from the PCA formula and budget-setting process are compiled in an annual Appendix to the TP Directive for each Group company and apply to all imports beginning May 1st of each year. The protestant states that the PCA intercompany pricing formula is in place for all sales of merchandise (and subsequent imports) by related sellers to the protestant during the coming year. Once the transfer prices are set at the beginning of May, periodic reviews during the fiscal year take place to gauge whether the targeted profit margins are still within the percentages mandated by the TP Directive. This review covers budget values, target values for average resale prices, production costs, and currency conversions. At the end of the fiscal year, if the operating margin is outside of the range mandated by the formula, i.e., too little profit or too much profit, debit or credit notes to the cost of goods sold (“COGS”) account are issued to bring the margins back into the mandated range of operating margins that are acceptable to the Internal Revenue Service (“IRS”).
Finished Goods
The protestant states that the starting point of the market-driven intercompany pricing formula for imports of finished goods is retail prices to its unrelated end customers in the United States. This retail sales price then impacts the transfer price (intercompany price) because the protestant must earn a certain profit margin after application of the mark-down percentage under the Re-Sale Minus method. The protestant claims that the resulting price is arm’s length because it is negotiated between unrelated parties based on several factors. A typical commercial pricing negotiation involves the protestant quoting a unit price for a particular customer. That price is informed, in large part, by:
• historical purchases, e.g., how well the unit sold during the previous year and all prior years;
• whether a particular customer has ordered a large volume of parts and thus had received discounts in the past;
• how many years remain for the life of the unit (based on the original sales cycle plan of the application for the finished good, e.g., how many years remain in the life cycle of the motor vehicle in which the part will be used);
• how much the final sales prices were over or above the original quote;
• changes in manufacturing and distribution costs, e.g., utilities, cost of raw materials, labor costs, freight and transportation expenses; and
• market conditions such as shortages.
Unfinished Goods
The protestant states that similar to finished goods, market-driven pricing plays a key role in establishing the intercompany price for imports of components that will be used in further manufacturing. The budget planning process each year starts with an “assessment basis” on which the mark-up using the Cost-Plus method is applied. The assessment basis includes the cost of raw materials purchased from outside vendors, the utility costs in running the factory, labor costs, and various other direct production costs for each individual material in the company’s SAP ERP system. Most of these costs are driven by market conditions and outside pricing of raw materials, especially in the volatile market for steel and aluminum that make up a large percentage of raw material purchases. Other production-related costs and other operating expenses are also calculated during the budget-setting process, such as research and development, and SG&A (selling, general, and administrative) costs. The PCA formula applies the Cost-Plus method to the assessment basis to arrive at a net margin target for the business division at issue (the manufacturing plant producing the component). The PCA formula factors in advance intercompany purchases of materials needed to make the unfinished good to arrive at an aggregated total mark-up.
To further support its claim that the related party price is at arm’s length, the protestant provided the Local File Transfer Pricing Documentation for the fiscal year 2022 which evaluates the arm’s length nature of the transactions between the protestant and its related sellers. The transfer pricing documentation was prepared under Section 482 of the Internal Revenue Code (“IRC”). The Comparable Profits Method (“CPM”) was determined to be the best method to evaluate the protestant’s imports of unfinished goods from related sellers for further manufacturing in the United States into finished goods as well as imports of finished goods from related sellers for re-sale and distribution to unrelated customers in the United States. The CPM examines whether the amount charged in a controlled transaction is an arm’s length price for tax purposes by comparing the profitability of the tested party to that of comparable companies that engage in similar business activities under similar circumstances. The tested party under the CPM transfer pricing analysis is the entity that performs the least complex functions and faces the least amount of risk.
In order to obtain information on independent entities whose activities are comparable to the intercompany sale of unfinished goods performed by the protestant or its related entities, a comparable search analysis was performed using the TP catalyst (an online version of the Amadeus database) database provided by Bureau van Dijk. The search process involved the analysis of the entities in the database, the elimination of unsuitable entities, and the selection of comparable entities. The benchmark analysis aimed at identifying independent limited scope manufacturers of bearings and car parts in China. A separate benchmark analysis was performed aimed at identifying independent limited scope manufacturers of bearings and car parts in Western Europe. As a result of the search, a set of 15 comparable companies was identified in China and 11 comparable companies in Western Europe. The mark-up on total costs (the ratio of operating profits to total costs incurred to produce operating profits “MOTC”) was selected as the appropriate Profit Level Indicator (“PLI”). WTS GmbH (“WTS”), a German-based global tax and advisory firm, concluded that the MOTC earned by the protestant’s related entities in Europe, Schaeffler Technologies AG & Co. KG and Schaeffler Automotive Buehl Gmbh & Co. KG, when performing manufacturing activities in FY 2022 was [X]% and [X]% respectively, which was within the arm’s length range of weighted average MOTC between [X]% and [X]% for the three-year period FY 2019-2021 for Western European manufacturers. WTC concluded that similarly, the MOTC of [X]% achieved by Schaeffler (China) Co., Ltd. was within the arm’s length range of the weighted average MOTC between [X]% and [X]% for the three-year period FY 2019-2021 for Chinese manufacturers.
In order to obtain information on independent entities whose activities are comparable to the intercompany purchase of finished goods performed by the protestant or its related entities, a comparable search analysis was performed using the Capital IQ database provided by S&P Global Market Intelligence. The search process involved the analysis of the entities in the database, the elimination of unsuitable entities, and the selection of comparable entities. The benchmark analysis aimed at identifying independent distributors of bearings and car parts in the region Americas. As a result of the search, the comparable set of independent entities was identified. The operating margin (Earnings Before Interest and Tax / Sales) was selected as the appropriate PLI for this analysis. As a result of the comparable search analysis, a set of ten comparable distributors of bearings and car parts in the region Americas was identified. WTC concluded that the operating margin earned by the protestant [X]% in FY 2022 was within the arm’s length range of weighted average operating margins between [X]% and [X]% for the three-year period FY 2019-2021.
The protestant provided the following documents for our review: P 174756 Corporate Directive Transfer Pricing document; commercial documents from a sample entry; a walkthrough of the transfer pricing policy and formula applied to representative merchandise items covered by the protest at issue; the intercompany pricing formula procedures; the markups and markdowns for all merchandise imported by the protestant in 2022; debit and credit notes for the protestant’s transfer pricing adjustments for 2022; methodology and calculations used to arrive at the duty refund at issue resulting from the adjustments for fiscal year 2022; the protestant’s Local File Transfer Pricing Documentation for fiscal year 2022; Schaeffler Group Benchmarking Analysis for years 2019-2021 covering Manufacturing of Bearings and Car Parts -Western Europe - prepared by WTS; Schaeffler Group Benchmarking Analysis for years 2019-2021 covering Manufacturing of Bearings and Car Parts - China - prepared by WTS; Schaeffler Group Benchmarking Analysis for years 2019-2021 covering Distribution of Bearings and Car Parts – North America - prepared by WTS; and the affidavit of the protestant’s Tax Director stating that the financial results/profit margins at issue have been reviewed and accepted by the income tax authorities of Germany and the United States.
ISSUES:
Do the circumstances of the sale establish that the price actually paid or payable by the protestant to its related sellers is not influenced by the relationship of the parties and is acceptable for purposes of transaction value?
Is the related party price fixed or determinable pursuant to an objective formula at the time of importation for purposes of determining transaction value?
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). In order to use transaction value, there must be a bona fide sale for exportation to the United States. The bona fide sale for exportation is not at issue in this internal advice request; accordingly, we limit this decision to the examination of the related party price and the treatment of post-importation adjustments.
There are special rules that apply when the buyer and seller are related parties, as defined in 19 U.S.C. § 1401a(g). Specifically, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, an examination of the circumstances of the sale indicates that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain “test values.” 19 U.S.C. § 1401a(b)(2)(B); 19 C.F.R. § 152.103(l).
Do the circumstances of the sale establish that the price actually paid or payable by the protestant to the seller is not influenced by the relationship of the parties and is acceptable for purposes of transaction value?
Under this approach, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The Customs Regulations specified 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, U.S. Customs and Border Protection (“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. 19 C.F.R. § 152.103(l)(1)(iii). Nonetheless, these are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well. See 19 C.F.R. § 152.103(I); see also HQ H037375, dated December 11, 2009; HQ H029658, dated December 8, 2009; and HQ H032883, dated March 31, 2010.
In this case, the protestant argues for a general approach that takes into account various aspects of the transactions and claims that the protestant and its related sellers organize their commercial relations and use methodologies to derive an arm’s length price. Specifically, both the sellers and the protestant base their global income tax reporting obligations on market-driven pricing such that the relationship does not influence the price, i.e., the amount of tax paid in each jurisdiction depends on the profits earned by each party to the transaction. The profit margins are determined by application of the PCA intercompany pricing formula which is greatly impacted by market conditions. Further, the profit margins are regularly reviewed throughout the year via economic analyses and profit margin testing of manufacturers and distributors of merchandise of the same class or kind as that of the protestant (bearings and auto parts).
In HQ H301778, dated June 4, 2024, CBP held that the related-party price was acceptable as transaction value for the imported goods. In that case, the importer provided three main pieces of evidence to support the arm’s-length nature of the transactions. These consisted of a transfer pricing study, an industry benchmarking analysis, and profitability figures for the all costs plus profit test. CBP indicated that taken in isolation, each of the three main pieces of evidence was insufficient to establish that the relationship did not influence the price since the transfer pricing study applied the Comparable Profit Method, which generally has the least relevance for customs valuation purposes, and contained outdated profitability figures; the industry benchmarking analysis did not establish that the seller’s method of setting prices was a normal practice in the relevant industry; and the profitability figures provided for the importer and its parent company were not broken down into appropriate categories for purposes of the all costs plus profit test. Despite these shortcomings, CBP found that the transfer pricing study established that the seller maintained a consistent method of setting prices to its related affiliates for over 30 years; the industry study showed that the seller’s observed range of return on sales was within the range of results in each benchmarked set; and, the profitability figures for the importer and the seller generally showed that the seller earned very similar, and in many cases higher, gross margins in its sales to the importer than it did in its worldwide sales across five different categories of goods. Accordingly, CBP held that even though none of the information provided strictly fell under the three illustrative examples under 19 C.F.R. § 152.103(l)(1)(i)-(iii), based on the totality of the circumstances, the related party sales price was not influenced by the relationship. See also HQ H228298, dated June 3, 2014.
In the instant case, the protestant explained in detail how it organizes its commercial relations and sets its prices with the related sellers. As previously noted, for finished goods, the amount of profit that the protestant must earn is ultimately determined by the re-sale prices of the imported goods to unrelated buyers. For unfinished goods, used as components in further manufacturing, the cost basis is largely driven by external market conditions. Once the price is determined, the PCA formula calculates the appropriate mark-down percentage for finished goods and mark-up percentage for unfinished goods so that the profit amount needed to meet the budgeted prices for each finished or unfinished good is assigned. Throughout the fiscal year, the targeted profit margins are periodically tested via detailed economic analyses and profit margin testing of manufacturers and distributors of goods for the same industry (bearings and auto parts). A final check is performed at year-end through the preparation of a Local File (under U.S. transfer pricing rules) to confirm that those rules are completely adhered to and that the targeted interquartile operating profit margins are achieved after all year-end adjustments have been booked. Further, the set of comparable companies are all engaged in the manufacture or distribution of the same classes or kinds of merchandise as the protestant’s foreign vendors and the protestant: bearings and auto parts.
Even though the evidence presented does not fall strictly within a single illustrative example specified in 19 C.F.R. § 152.103(l)(1)(i)-(iii), we find that the price between the protestant and the related sellers is not considered influenced by the relationship for purposes of 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 protestant and the sellers organize their commercial relations and the way in which the price in question was arrived at. As a result, we find that transaction value is the proper method of appraisement for the related party transactions.
Is it acceptable to take post-importation price adjustments (upward and downward) into account in determining transaction value?
On May 30, 2012, CBP published a notice of HQ W548314 that revoked a prior valuation ruling concerning the treatment of post-import adjustments made pursuant to a methodology specified in the importer’s formal transfer pricing policies. This ruling became effective on July 30, 2012. See Customs Bulletin, Vol. 46, No. 23, dated May 30, 2012. In HQ W548314, CBP proposed a broader interpretation of what is permitted under transaction value to allow a transfer pricing policy/APA to be considered a “formula” in the transfer pricing context, provided certain criteria are met. HQ W548314 specifically referred to the adjustments made pursuant to a company’s formal transfer pricing policies or APAs. In order to claim the post-importation adjustments (upward and downward), all of the following factors must be met:
A written transfer pricing policies in place prior to importation and the policy is prepared taking IRS code section 482 into account;
The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return;
The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted;
The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and,
No other conditions exist that may affect the acceptance of the transfer price by CBP.
Therefore, if the protestant meets the above referenced factors, CBP will accept the adjusted values, because the prices would be established pursuant to a “formula” prior to importation, even though the prices were not fixed at the time of importation.
A written transfer pricing policy is in place prior to importation and the policy is prepared taking IRS code section 482 into account
In the instant case, the TP Directive, which sets forth the detailed market-driven intercompany pricing formula prepared under Section 482 of the Internal Revenue Code of the United States, was issued in November 2019 and July 2022 and governed all imports as of January 1, 2022 through the remainder of 2022. Therefore, the Protestant’s written transfer pricing policy existed and the pricing formula was agreed upon prior to the importation of goods in 2022.
The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return
In this case, the credit note adjustments from the related sellers were recorded in the protestant’s accounting books and the protestant’s income figures were based on the intercompany pricing formula as reflected in the accounting books. The income reported to the IRS for the protestant reflected the results of the application of the PCA intercompany pricing formula that was confirmed by preparation of the Local File (transfer pricing study prepared specifically for income tax purposes) and the adjusted cost of goods sold figure was used in preparing the 2022 tax return. Accordingly, the second factor is met.
The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted
In this case, the protestant’s Intercompany Pricing Formula Procedures sets forth how the TP Directive’s transfer pricing policy and formula are applied to calculate planned, budgeted prices for all finished and unfinished goods – and how the adjustments are determined and booked from an accounting standpoint at the end of the fiscal year. The mark-up and mark-down percentages for all covered merchandise (finished and unfinished goods) are set forth in this document. Accordingly, the third factor is met.
The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States
The protestant records the post-importation adjustments for purchases from related entities on its books, i.e., debit and credit notes, which were provided to our office. Accordingly, this factor is also met.
No other conditions exist that may affect the acceptance of the transfer price by CBP
Pursuant to our review of the documents submitted, there are no other conditions that may affect the acceptance of the transfer price by CBP. In this case, the protestant provided detailed information to satisfy the above-referenced criteria. Accordingly, post-importation adjustments may be taken into account in determining the transaction value under 19 U.S.C. §1401a(b).
HOLDING:
In conformity with the foregoing, transaction value is the appropriate method of appraisement in respect to sales between the protestant and the related sellers. The protestant may take into account post-importation adjustments to the values of the imported merchandise declared to CBP for the year at issue. Protest No. 1601-24-107165 is referred back to your CEE for appropriate action.
You are to mail this decision to the U.S. importer, through the importer’s customs consultant, no later than 60 days from the date of the decision. At that time, the Office of Trade, Regulations and Rulings, will make the decision available to CBP personnel and the public at www.cbp.gov, through the Freedom of Information Act and other methods of public distribution.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch