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 ac