Acceptability of Related Party Price; Transaction Value; Transfer Pricing Study; Post-Importation Adjustments

HQ H024857 January 7, 2014 OT:RR:CTF:VS H024857 YAG CATEGORY: Valuation Mr. Damon V. Pike The Pike Law Firm, P.C. 246 Sycamore Street, Suite 215 Decatur, Georgia 30030-3434 RE: Acceptability of Related Party Price; Transaction Value; Transfer Pricing Study; Post-Importation Adjustments Dear Mr. Pike: This is in response to your letter, dated March 13, 2008, in which you requested a ruling on behalf of your client, [***] (the “Importer”), regarding the acceptability of transaction value for certain products imported by your client and valued pursuant to the transfer pricing study and the Importer’s Marketing Contract. Additionally, you submitted to our office four (4) letters, dated June 12, 2008, January 6, 2009, January 30, 2013, and August 26, 2013 in response to our requests for additional information. Furthermore, we held a conference on June 18, 2008 and a telephone conference on April 30, 2013, wherein we discussed the relevant issues pertaining to your client’s request for a ruling. We apologize for the delay in responding to your ruling request. You have asked that certain information submitted in connection with your ruling request be treated as confidential. Inasmuch as your request conforms to the requirements of 19 CFR §177.2(b)(7), your request for confidentiality is approved. The information contained within brackets in this ruling as well as all attachments to your letter, requesting a ruling, and subsequent submissions will not be released to the public and will be withheld from published versions of this ruling. FACTS: [***], the Importer, is a U.S. corporation and a wholly owned subsidiary of [***], which is owned by [***] (“Manufacturer/Seller”). [***], Manufacturer/Seller is a global manufacturer of food processing equipment such as slicer, derinder/skinner, and ice machines. [***] manufactures the equipment in Germany and sells the merchandise to both related and unrelated distributors. The Importer markets and sells Manufacturer/Seller’s product lines (except for ice machines, which it does not import to the United States) throughout North America, which includes the United States, Canada, and Mexico. The Importer does not perform any manufacturing activities and purchases all the products it distributes from its related Manufacturer/Seller and its affiliates. [***] imports merchandise through various U.S. ports of entry, but primarily through Baltimore and Chicago. You state that in establishing the prices for its products, Manufacturer/Seller creates a global suggested retail price list on an annual basis and sells the finished goods both to related and unrelated distributors under the same conditions. You submitted a copy of the global retail price list as well as a list of all related and unrelated distributors to our office for consideration. Pursuant to your submission, all but three of the Manufacturer/Seller’s worldwide distributors are unrelated parties. Under the global price list, Manufacturer/Seller charges all of its unrelated distributors and the related Importer the same price: the global list price minus [***]% for slicers, [***]% for de-rinders, and [***]% for parts. The manufacturer establishes the global retail price list based on historical data from (1) its competitors, i.e. historical pricing data of what similar machines sell for in the marketplace, and (2) all of its global distributors, who engage in arms’ length negotiations with their customers over the final price. You also provided us with sample invoices in support of your statement that Manufacturer/Seller charges the same prices to its unrelated parties as it does to the Importer. Additionally, you provided marketing contracts between the Manufacturer/Seller and two of its unrelated distributors to show that the prices to the unrelated distributors were consistently set with the prices to the related distributors. With respect to the prices, identified on the sample invoices and the global retail price list, you stated that the Importer’s invoice amounts are converted to dollars by the foreign Manufacturer/Seller at an exchange rate determined as part of the annual transfer pricing formula calculation, so that the U.S. dollar amount is shown on the face of the Importer’s invoices. Thus, the unrelated distributors remit payment in Euros, while the Importer remits its payment in U.S. dollars. The risk of currency fluctuation is borne by the Manufacturer/Seller for sales to the Importer. However, such risk is borne by unrelated distributors when they purchase the merchandise from the foreign Manufacturer/Seller denominated in Euros. All products are normally invoiced with an “FOB Germany” Incoterm, although sometimes Ex-Works is also used. All distributors (related and unrelated, including the Importer) are free to sell the products to their customers at retail for whatever the market will bear. Furthermore, in this case, the profit the Importer earns on its sales must comply with the income tax transfer pricing rules in Germany and in the United States. Thus, you submitted to this office a properly executed transfer pricing study, completed by Deloitte Touche Company, on September 12, 2005 to document the Importer’s compliance with the IRS’ and German tax authority’s transfer pricing rules. The parties do not have an Advance Pricing Agreement (“APA”). Section 482 of the Internal Revenue Code (26 U.S.C. §482) requires that the arm’s length result of a controlled transaction be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length test. The transfer pricing study selected the Importer as the tested party because the Importer had the least complex functions and risk exposure than its parent company in Germany, and a “modified” Resale Price Method (“RPM”) was selected as the best method. The Importer used the operating margin as its Profit Level Indicator (“PLI”); hence, the use of the “modified” RPM. The term of the transfer pricing study submitted by the Importer is for one year, ending December 31, 2004, through December 31, 2005. According to the transfer pricing study, the final transfer price between the Importer and the Manufacturer/Seller is set so that the gross margin is sufficient to cover operating expenses of the Importer and to derive a reasonable operating profit which is within the lower and upper quartile of the inter-quartile range. Furthermore, pursuant to the transfer pricing study, comparable companies were chosen based on similarities of risks and functions between such companies and the Importer. The companies selected using the Standard Industrial Codes are part of the industry producing electrical machinery and parts. Additionally, after the completion of the study in September of 2005, both parties executed a Marketing Contract in the last quarter of 2005 to implement this transfer pricing formula into their contract obligations with each other. You submitted a copy of this Marketing Contract, together with your ruling request, for our consideration. Pursuant to the Marketing Contract, the parties determine whether the actual gross margin is outside the range of reasonable gross margins. Appendix 3 of the Marketing Agreement sets forth the full contract formula between the parties and specifies a range of reasonable operating margins from [***]% to [***]%. The parties determined that if the actual gross margin of the Importer falls below the lower gross margin of [***]%, the parties would mutually agree on a balancing payment to the Importer, which shall not be less than the difference between the actual gross margin and the lower gross margin of the Importer. Likewise, if the actual gross margin of the Importer is above the upper of gross margin, the parties would mutually agree on a balancing payment to the Manufacturer/Seller, which shall not be less than the difference between the actual gross margin and upper gross margin of the Importer. Finally, in 2007, the Importer built a new show room, which significantly increased the capital intensity of the Importer. Therefore, both parties agreed to amend the Marketing Contract as well as the transfer pricing study to reflect this change (both amendments were provided to our office for consideration and review). Therefore, the amendment to the transfer pricing study stated that the final transfer price between the Importer and its related Manufacturer/Seller should be set so that the gross margin will be sufficient to cover the Importer’s operating expenses and to derive a reasonable profit which would be within the lower and upper quartile of [***]% and [***]%. The Marketing Contract was amended as well, and based on a study that analyzed the operating margins of independent companies with functions and risks comparable to the Importer, the parties concluded that a range of reasonable operating margins is [***]% to [***]%. ISSUES: Do transactions between the Importer and the related Manufacturer/Seller constitute bona fide sales? Is it acceptable to take post-importation price adjustments (upward and downward) into account in determining transaction value? Do the circumstances of the sale establish that the price actually paid or payable by the Importer to the related Manufacturer/Seller is not influenced by the relationship of the parties and is acceptable for purposes of 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). 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 order to use transaction value, there must be a bona fide sale for exportation to the United States. Several factors are relied on to determine whether a bona fide sale exists. See Headquarters Ruling Letter (“HRL”) 546067, dated Oct. 31, 1996. Do transactions between the Importer and the related Manufacturer/Seller constitute bona fide sales? Several factors are relied on to determine whether a bona fide sale exists. See HRL 546067, dated October 31, 1996. In VWP of America, Inc. v. United States, 175 F.3d 1327 (Fed.Cir. 1999), the Court of Appeals for the Federal Circuit found that the term “sold” for purposes of 19 U.S.C. §1401a(b)(1) means a transfer of title from one party to another for consideration (citing J.L. Wood vs. United States, 62 CCPA, 25, 33, C.A.D. 1139, 505 F.2d 1400, 1406 (1974)). No single factor is decisive in determining whether a bona fide sale has occurred. See HRL 548239, dated June 5, 2003. CBP will consider such factors as whether the purported buyer assumed the risk of loss for, and acquired title to, the imported merchandise. Evidence to establish that consideration has passed includes payment by check, bank transfer, or payment by any other commercially acceptable means. Payment must be made for the imported merchandise at issue; a general transfer of money from one corporate entity to another, which cannot be linked to a specific import transaction, does not demonstrate passage of consideration. See HRL 545705, dated January 27, 1995. In addition, CBP may examine whether the purported buyer paid for the goods, and whether, in general, the roles of the parties and the circumstances of the transaction indicate that the parties are functioning as buyer and seller. See HRL H005222, dated June 13, 2007. Finally, pursuant to CBP’s Informed Compliance Publication, entitled “Bona Fide Sales and Sales for Exportation,” CBP will consider whether the buyer provided or could provide instructions to the seller, was free to sell the transferred item at any price he or she desired, selected or could select its own downstream customers without consulting with the seller, and could order the imported merchandise and have it delivered for its own inventory. To substantiate its claim that there was a bona fide sale between the Manufacturer/Seller and the Importer in this case, the Importer provided sample transaction documents, which included the following: written purchase order from the customer to the Importer, purchase order from the Importer to the parent company/Manufacturer in the foreign country, invoice from the Manufacturer/Seller to the Importer, a sample entry summary, accounts payable reconciliation of the Importer, showing a payment to the Manufacturer/Seller for the particular invoice issued by the Manufacturer/Seller, and the wire transfer from the Importer to the Manufacturer/Seller within 10 months of the importation, transmitting money pursuant to the received invoice. The Importer issues a purchase order to Manufacturer/Seller for machines and spare parts based on purchase orders from its customers in the United States. The Importer is a U.S. distributor of the merchandise and its purchase orders come directly from its customers in the United States, thus merchandise is clearly destined to the United States. Additionally, according to your submission, when the orders are filled in Germany, Manufacturer/Seller issues an invoice to the Importer using either the Ex-Works or FOB Germany Incoterms. The products are either shipped or delivered to the Importer’s distribution facility or are drop-shipped to the end customer. The invoice price reflects the formula specified in the Marketing Contract. The Importer is free to mark up the product upon re-sale to any of its customers, but has to achieve the profit margin formula set forth in its Marketing Contract based on the transfer pricing formula, specified in the transfer pricing study, prepared by Deloitte & Touche. The Importer is free to select any customers it wants without consulting the Manufacturer/Seller. Once the merchandise is delivered to the ultimate U.S. customer, the Importer remits the payment to the Manufacturer via wire transfer, at which time title formally transfers. Upon examination of the documents submitted by your client for our review, we determine that this payment indeed matches the invoice amount (and the invoice number), which ties back to the purchase order amount, thus linking it to the specific importation. However, under Section 6.1 of the Marketing Contract, title does not transfer from the Manufacturer to the Importer, until the Importer pays the Manufacturer for the merchandise after the date of importation. We accept your argument that passing of title after the date of importation, where all of the factors lead to the conclusion that a sale for export takes place, does not disqualify a sale from being a bona fide sale. See HRL H012659, dated November 17, 2007. Additionally, HRL 545504, dated May 5, 2005, states that for purposes of the transaction value provision, a bona fide sale may be found to exist even though actual payment has not been made for the goods. In this instance and upon examining the documents you provided, we find that the Importer can provide instructions to the seller, since it submits purchase orders based on certain specifications set forth by its customers; the Importer is free to sell merchandise at any price, as long as this price complies with the Marketing Contract transfer pricing rules; the Importer clearly can select its own customers without interference from the manufacturers, and the Importer can order the imported merchandise and have it delivered for its own inventory. Thus, we find that the Importer will be able to sufficiently prove the existence of a bona fide sale between the Importer/Buyer and the Manufacturer/Seller. 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 concerning the treatment of post-import adjustments made pursuant to a formal transfer pricing policy. See Customs Bulletin, Vol. 46, No. 23, dated May 30, 2012. Prior to the Customs Bulletin notice, effective date of July 30, 2012, CBP allowed adjustments, but not under the transaction value basis of appraisement.  CBP consistently held that transaction value in the transfer pricing context did not apply because the price was not fixed or determinable pursuant to an objective formula prior to importation. See HRL 547654, dated November 8, 2001 (revoked by HRL W548314, dated May 16, 2012). Nevertheless, sometimes these adjustments were allowed under the “fallback” method of appraisement. In other instances, CBP disallowed the adjustments completely because they were considered to be a post-importation rebate or decrease under 19 U.S.C. §1401a(b)(4)(B). In HRL W548314, CBP reviewed this matter and 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. HRL W548314 specifically referred to the adjustments made pursuant to a company’s formal transfer pricing policy or APA. In order to claim the post-importation adjustments (upward and downward), all of the following factors must be met: A written transfer pricing policy is 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 Importer meets the above referenced factors, CBP will accept the adjusted values, provided these adjusted values meet the circumstances of the sale (or test values) test, because the prices would be established pursuant to a “formula,” even though the prices were not fixed at the time of the importation. In this case, we find that when a related party price is determined in accordance with a formal transfer pricing policy that is in place prior to importation, the transfer price will be considered “fixed” for purposes of applying transaction value even though the policy provides for post-importation adjustments to be made to the transfer price. Hence, transaction value is not precluded when a formal transfer pricing policy allows for post-importation adjustments, such as compensating adjustments required by the transfer pricing study and the Marketing Contract. It is our position that in this case where the Importer provided us with its formal transfer pricing study, there is a valid transfer pricing formula, which establishes the price in effect prior to the importation. The Importer’s transfer pricing study was prepared in accordance with the IRS Code Section 482 and the OECD Transfer Pricing Guidelines. Moreover, the Importer also provided us with its Marketing Contract, executed by the parties in 2005 (prior to the date of importation of merchandise subject to this ruling request) and an amendment in 2008 (updating the agreement in accordance with the update to the Importer’s transfer pricing study). These documents set forth the pricing formula for transactions between the Importer and the Manufacturer/Seller. Further, the Importer adheres to its transfer pricing policy as established by the Marketing Contract and the Importer’s transfer pricing study. The Importer reports any adjustments made pursuant to its transfer pricing policy to the IRS in accordance with Section 482 of the IRS Code. The Importer accomplishes this reporting by booking the adjustments to its Cost of Goods Sold (“COGS”) prior to closing its books for the corporate tax year. Because these adjustments are made prior to the closing of the Importer’s books, they are reported to the IRS when the Importer files its corporate tax return for the year. The written transfer pricing study and the Marketing Contract also set forth the formula required to determine the final product prices, and the method by which a compensating adjustment should be made at year-end should the actual gross margin of the Importer not meet the parameters of the formula. Transfer pricing adjustments are made pursuant to a formula, which was included in the Marketing Contract and its amendment that was in place prior to the date of importation of merchandise covered by the contract and amendments, thus, the pricing formulas contained in the contract and amendment applied to all imports after the date of their execution. Additionally, the transfer pricing policy and the Marketing Contract specifically cover all merchandise, the price of which is to be adjusted, as necessary. Both documents are signed by all parties and clearly specify how the transfer price is to be determined, what adjustments are to be made, and how these adjustments are to be determined. At the end of each year, the Importer uses the formula to determine the final price. The specific adjustments at issue are directly related to the value of merchandise and are made at the end of the each fiscal year. The post-importation adjustments are made because the gross margin amount called in the contract formula is not met, and the Importer is thus not in accordance with the inter-quartile range mandated in its transfer pricing study and Marketing Contract. Calculations of post-importations adjustments start with the aggregate of all invoice prices of the imported merchandise purchased by the Importer from the Manufacturer/Seller, and which are recorded in COGS in the Importer’s accounting books for the given period. Based on its COGS and other operating expenses, the Importer adds a target profit margin to determine the price to the end U.S. customer. At the end of the fiscal year, the Importer calculates its gross profit, and then compares it to the contract formula to ascertain if it falls within the required range of profits. If the profit levels are too high, then COGS must be adjusted upward to reduce the gross profit; if the profit levels are too low, then COGS must be adjusted downwards to increase the Importer’s gross profit for the period covered. Thus, the contract formula has a direct impact on the reported customs values given that the aggregate of all reported values for a given period equals the figure recorded in COGS for the same period. Also, pursuant to our review of the provided documentation, there are no other conditions that may affect the acceptance of the transfer price by CBP. In this case, as long as the Importer maintains and provides accounting details from its books and/or financial statements to support the post-importation adjustments upon making a claim with CBP and describes the method of allocation of such adjustments, the Importer may claim downward and upward post-importation adjustments. Finally, the Importer requested that we specify the appropriate mechanism for the Importer to report upward post-importation adjustments and to tender any duties owned. Since 2008, the Importer has been filing “administrative letters” with CBP, explaining reasons for the adjustments and providing payment. Since the Importer systematically claims either upward or downward adjustments, pursuant to our decision in W548314, we strongly encourage the Importer to use Reconciliation to report the changes made pursuant to its transfer pricing policy and to adjust the transaction value to take into account these changes in the transfer price. In our view, Reconciliation is an ideal vehicle to declare all upward or downward post-importation adjustments that may occur in the future within the timeframe allowed by the transfer pricing study that directly relate to the value of the merchandise. Do the circumstances of the sale establish that the price actually paid or payable by the Importer to the related Manufacturer/Seller is not influenced by the relationship of the parties and is acceptable for purposes of transaction value? In W548314, we determined that the Importer needed to show that the relationship of the parties did not influence the adjusted prices. Thus, having established that the Importer’s transfer pricing policy constitutes a formula and that there is a bona fide sale for exportation to the United States in this case, we must determine whether the imported merchandise may be appraised under transaction value. 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 CFR §152.103(l). In this case, the Importer provided information regarding the circumstances of the sale. The Customs Regulations specified in 19 CFR 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, Customs 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 CFR §152.103(l)(1)(i)-(ii). In addition, Customs 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 CFR §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 CFR §152.103(I); see also HRL H037375, dated December 11, 2009; HRL H029658, dated December 8, 2009; and, HRL H032883, dated March 31, 2010. In this case, the Importer states that the Manufacturer/Seller also sells the imported merchandise to unrelated parties outside of the United States. In fact, all but three of the Manufacturer/Seller’s distributors are unrelated parties. Although CBP generally requires that the comparison sales to unrelated buyers be sales to buyers in the United States, CBP will consider evidence regarding sales to unrelated buyers in other countries, provided the Importer presents an adequate explanation as to why it is relevant to the transaction at issue. See HRL W548314, dated May 16, 2012. Considering the information and documentation provided by the Importer in this case, we are of the opinion that provided prospective transaction follow the approach analyzed here, the circumstance of the sale test will be met. The foreign Manufacturer/Seller grants the same discounts based on the global price list and the criteria established in the transfer pricing study to both related and unrelated buyers. As evidence of this practice, the Importer presented the global price list and invoices from its related Manufacturer/Seller to unrelated foreign buyers showing the base price for the merchandise and the discounts granted. See HRL 546953, dated May 5, 1999 and HRL 547019, dated March 31, 2000. The Importer also provided us with the Marketing Contracts between the Manufacturer/Seller and two of its unrelated distributors. These Marketing Contracts further show that the Manufacturer/Seller settles its prices to the Importer in a manner consistent with those to unrelated distributors - both use pricing formulas that seek to return a profit to the Manufacturer/Seller based on the global price list price minus the discount. These documents indicate that the Manufacturer/Seller charges all of its unrelated distributors and the related Importer the same price, with the only difference being that the provisional price to the related distributors is settled after the importation due to the post-importation adjustments made in accordance with the income-tax mandated requirements. Therefore, the foreign Manufacturer/Seller deals with unrelated buyers in the same way that it deals with related buyers. Since we find that the related party prices are settled in a manner consistent with the way the seller settles prices in sales to unrelated buyers, it is not necessary for us to examine in detail whether the transfer pricing study shows that the prices are also settled in a manner consistent with the normal pricing practices in the industry or that the all costs plus a profit test is satisfied in this instance. HOLDING: Based on the information presented, transactions between the Importer and its related Manufacturer/Seller constitute bona fide sales. We also determine that transaction value is the appropriate method of appraisement in this case. Finally, we find that the Importer may take into account downward and upward post-importation adjustments, to the extent necessary, to the provisional values of the imported merchandise declared to CBP, provided that the Importer maintains and provides upon request accounting details from its books and/or financial statements to support the claimed adjustments. Please note that 19 CFR §177.9(b)(1) provides that “[e]ach ruling letter is issued on the assumption that all of the information furnished in connection with the ruling request and incorporated in the ruling letter, either directly, by reference, or by implication, is accurate and complete in every material respect. The application of a ruling letter by a Customs Service field office to the transaction to which it is purported to relate is subject to the verification of the facts incorporated in the ruling letter, a comparison of the transaction described therein to the actual transaction, and the satisfaction of any conditions on which the ruling was based.”    Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns. Sincerely, Monika R. Brenner, Chief Valuation and Special Programs Branch