Request for Internal Advice; Focused Assessment Pre-Assessment Survey Report # 211-06-FA1-P1-19818; Nissho; patent costs; assist; buying commission

HQ H086776 October 25, 2011 CLA-2 OT:RR:CTF:VS H086776 KSG CATEGORY: Classification Office of Regulatory Audit U.S. Customs & Border Protection One Penn Plaza, 11th Floor New York, New York 10119 RE: Request for Internal Advice; Focused Assessment Pre-Assessment Survey Report # 211-06-FA1-P1-19818; Nissho; patent costs; assist; buying commission Dear Field Director: This is in reply to your correspondence dated March 18, 2008, addressed to Phillips-Van Heusen Corporation (“PVH”), which our office received on December 7, 2009, asking for our review of audit findings in a Pre-Assessment Survey (“PAS”) report related to the proper appraisement of certain merchandise imported by PVH under transaction value. Counsel for PVH requested in a letter dated January 15, 2008, that the field seek the advice of Headquarters if it disagreed with PVH’s position. Counsel also submitted a letter dated August 4, 2010, which included documentation for two entries reviewed regarding the first sale issue, and a letter dated November 20, 2010, which included further information. At the request of counsel, a meeting was held on this matter at Headquarters. FACTS: The PAS report indicates that CBP reviewed apparel entries imported during the fiscal year ending January 31, 2006. The Report indicates that two entries were reviewed. The preliminary assessment of risk by CBP in the PAS report made four separate findings, concluding that the importer did not have adequate control for transaction value for the following reasons: 1) the importer incorrectly used first sale pricing; 2) patent costs were dutiable and not included in transaction value; 3) design costs were a dutiable assist and were not included in transaction value; and 4) commission expenses paid to an agent for procuring piece goods should have been included in transaction value. First Sale Issue Your office concluded in the PAS report that a bona fide sale did not take place between the factory and the middleman because the apparel manufacturer was an assembler of components that were provided to the manufacturer as an assist. The PAS report states that a percentage of the production processes were performed by other vendors and the manufacturer did not have title or assume the risk of loss for the imported merchandise. The report reviewed two entries that it states are illustrative of other entries at issue. The PAS report states that PVH filed 13,131 entries for the fiscal year ending January 31, 2006. The PAS does not indicate how many of the entries filed in 2006 utilized the first sale as a basis of appraisement. Entry One The first entry, xxxx702, involved PVH as the importer of record, Tritex Global Exp. LMT of Hong Kong (Tritex) as the middleman, and Celebrity Fashion Industrial Inc. of the Philippines (Celebrity) as the foreign manufacturer. The PAS Report states that PVH appraised the merchandise at [xxx] consisting of the costs of assembly (Cut, Make, Trim (CMT)) by Celebrity [xxx], the value of a fabric assist sent from Tritex to Celebrity [xxx], the fabric freight cost and a PVH assist of [xxx]. Tritex was paid [xxx] by PVH. Counsel for PVH provided the following documents for entry xxxx702: A purchase order from PVH to Tritex, dated June 14, 2005, for 5,190 men’s polo shirts (style 4597299) in four colors at a cost of [xxx)] indicating shipment directly to the importer in the U.S. A purchase order from Tritex to Celebrity, dated June 21, 2005, for 18,000 men’s polo shirts (style 4597299) in four colors at a cost of $[xxx], indicating shipment directly to the U.S.. An invoice (#4903) from Mindanao Textile Corporation of the Philippines, a company that PVH states is related to Celebrity Fashions, (there was no supporting documentation to substantiate or describe the relationship) dated June 28, 2005, describing a sale to Tritex of 5,190 pieces of men’s cotton knitted shirts at a cost of [xxx] to be shipped to New York. A proof of payment from Tritex to Mindanao through a Hong Kong bank dated August 3, 2005, for a series of invoices, including the invoice (#4903) for [xxx]. An invoice dated June 31, 2005, from Tritex to PVC for 5,190 shirts and the style number at a cost of [xxx]. A proof of payment dated June 31, 2005, from Izod, a PVH division, to Tritex in the amount of [xxx] for 5,190 pieces. An air waybill dated July 1, 2005, showing that Mindanao shipped 5,190 men’s cotton knit shirts of the same style number from the Philippines to New York JFK. A value calculation on Tritex letterhead dated July 6, 2005, showing [xxx], fabric cost [xxx], assist [xxx], and fabric freight cost [xxx] for a total of [xxx] for a dutiable value of [xxx]. The entry, filed on July 18, 2005, stated that the value of the imported shirts was [xxx]. Entry 2 The second entry, xxxx512, dated January 23, 2006, listed PVH as the importer of record for men’s cotton knit shirts. The entered value for the shirts on the CF 7501 is [xxx] The middleman was Binger Mktg Work Co. LTD of Hong Kong (Binger) and the foreign manufacturer was Eastboard Industries Co. of Thailand (Eastboard). The PAS Report states that Binger was paid [xxx] by PVH. The declared entered value, using the first sale, is [xxx]. The [xxx] consists of the assembly cost of [xxx] plus a fabric assist of [xxx] and a PVH assist of [xxx]. Counsel for PVH provided the following documents for entry xxx512: The purchase order, dated August 24, 2005, (stamped received September 19, 2005) from PVH to Binger, identifying Eastboard as the manufacturer for 22,650 striped shirts in six colors at [xxx] a unit for a total cost of [xxx]. A purchase order from Binger to Eastboard dated October 29, 2006, for 22,650 men’s cotton knitted polo shirts at a cost of [xxx]. Invoice # EB05-3183 dated December 12, 2005, from Eastboard to Binger for 22,617 units in the amount of [xxx]. Proof of payment from Binger to Eastboard dated January 19, 2006, which references invoice #EB05-3183 along with other invoice numbers, in the total amount of [xxx]. Proof of payment in the amount of [xxx] from PVH to Binger . A cargo receipt for Maersk shows that Eastboard shipped 22,617 men’s knitted shirts from Thailand to Newark on December 18, 2005 (the invoice number is referenced). A value calculation prepared by Binger, dated December 19, 2005, showing the assembly cost (CMT cost) of [xxx], and the fabric cost of [xxx], for a total of [xxx] a piece, totaling [xxx] for 22,617 pieces. CF-7501 showing an entered value of [xxx]. Counsel stated that the value statements prepared by the middleman shows the value of any assists provided by the middleman to the manufacturer. Counsel contends that the minor differences between the value statement and the entered value, [xxxx]unit represents packaging assists provided by PVH for hangtags and carton labels. Patent Issue CBP reviewed a non-exclusive license agreement between TAL Apparel Unlimited and PVH for pucker free seam technology, dated December 22, 1997. The agreement is a license to manufacture, have manufactured, import, distribute, use, and sell garments incorporating the Pucker Free Seam technology. In consideration, PVH paid [xxx] as a license fee payment. PVH agreed to pay [xxx] per calendar year beginning January 1,1998, for the right to sell 500,000 licensed products during each calendar year. After the initial 500,000 products, a royalty of [xxx] for each additional product is due. PVH states that it made royalty payments to avoid lawsuits, to prevent any production and sales problems and considered the payments as selling expenses. PVH later suspended payments based on a court case that determined that the patents were invalid. The PAS does not indicate which entries of imported goods or what line of garments were imported in 2006 to which this technology applies. Counsel states that the agreement relates to a method of preparing seams on dress shirts that eliminates puckering. Counsel also contends that PVH developed its own method of preparing seams that eliminates puckering for which it was granted a patent. PVH states that it paid the money to TAL while its own patent application was pending to avoid protracted litigation. Payments to TAL were suspended in early 2008 because TAL’s patent was held to be invalid in part or unenforceable. PVH contends that it used its own technology and not that of TAL and submitted an affidavit of Ellen Constatinides in which she states that PVH had no information about and did not use the TAL technology. PVH also submitted a letter dated August 17, 1994, from PVH to patent counsel describing the manufacturing details related to its pucker-free seam process, which PVH uses to produce mens’ shirts. Assist Issue The PAS report concludes that a London UK designer was paid for design work and this payment is a dutiable assist which was not included in the “price paid or payable.” The PAS report does not indicate what imported goods were tied to the design cost. The basis of this claim is an invoice on the letterhead of Palm Design Limited, located in London, England for [xxx]. The invoice lists six different codes followed by fabric descriptions such as “green/orange check” and tartan plaid.” There is no information in the PAS report which ties design work and/or the swatches to particular goods that were later produced and imported into the U.S. Counsel states that the payment was for the London, England company to provide fabric swatches and drawings used as inspiration by company designers in the U.S. to create new fabric patterns. PVH states that the swatches appearing on the invoice were not provided to makers of fabric or garments. It is not known if shirts were produced using the swatches on the invoice. No further information was provided regarding this issue. We asked your office if there was any further information in your files regarding this issue. The auditor indicated that there was no further information regarding this issue in your files. Buying Commission Issue The PAS states that “PVH entered into agreements with various suppliers to reimburse them for expenses and services in connection with piece goods that they purchase for PVH’s production. Since these charges are not related to specific purchase orders, they are not included in the FOB price of the product….The commissions paid by an importer to an agent for procuring piece goods that are incorporated into the imported merchandise, i.e. assists, were part of the cost of acquiring the assist and are dutiable….” The PAS Report did not tie the agreement to any specific entries of imported goods. No further information and no documentation were provided in the PAS Report concerning this issue. Counsel for PVH submitted copies of agreements between it and Gold Mine Garment Co. Ltd. (“Gold Mine”) dated May 5, 2004, TAP International Ltd. dated December 6, 1995, and Beijing Garments Int. & Exp. Corp. Inc. dated February 5, 2002, and an invoice issued by Gold Mine Garment Co., Ltd, for the period June 2010 as a representative sample invoice. We have examined the the agreement with Gold Mine. In the agreement between PVH and Gold Mine, Gold Mine agreed to assemble garments from fabric sourced from suppliers. The terms were negotiated between the suppliers and PVH and PVH agreed to reimburse Gold Mine for the purchase price of fabric. Gold Mine contacts suppliers designated by PVH to ensure timely delivery, schedules production, and makes inspections to assure that the fabric meets PVH’s quality standards and specifications. In exchange, PVH agrees to pay Gold Mine a 7% commission of the CIF purchase price of the fabric. Invoices would be submitted quarterly to PVH for fabric delivered in the prior 120 days. The representative invoice submitted by counsel is an invoice from Gold Mine to PVH and shows a 7% charge for production month June 2010, and lists 4 columns of information: invoice numbers, PO numbers, lot numbers and a USD amount. All the agreements provide that the assembler will be paid a percent commission based on the cost of the fabric to purchase the fabric on behalf of PVH on a quarterly billing basis. ISSUES: Whether the imported merchandise may be appraised based on the first sale between the foreign manufacturer and the foreign middleman. Whether payments pursuant to the 1997 agreement described above are a dutiable patent payment. Whether payment to a UK company is a dutiable assist. Whether payment for piece goods is considered a buying commission and therefore, not part of the price actually paid or payable. LAW AND ANALYSIS: The preferred method of appraising merchandise imported into the United States is the transaction value method as set forth in section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (“TAA”), codified at 19 U.S.C. 1401a. Transaction value of imported merchandise is the “price actually paid or payable for the merchandise when sold for exportation to the United States” plus amounts for five enumerated statutory additions. 19 U.S.C. 1401a(b). In order for imported merchandise to be appraised under the transaction value method, it must be the subject of a bona fide sale between a buyer and seller, and it must be a sale for exportation to the United States. We will assume for the purposes of this ruling that transaction value is the appropriate basis of appraisement. First Sale Issue In Nissho Iwai American Corp. v. United States, 982 F.2d 505 (Fed. Cir. 1992), the U.S. Court of Appeals for the Federal Circuit reviewed the standard for transaction value when there is more than one sale which may be considered as being a sale for exportation to the United States. The court ruled that for merchandise imported pursuant to a three-tiered transaction to be appraised on the basis of the manufacturer-middleman sale, the transaction must be conducted at arm’s length and the merchandise must be clearly destined for export to the United States at the time of the sale. The court reaffirmed the principle established in E.C. McAfee Co. v. United States, 842 F.2d 314 (Fed. Cir. 1988), that the manufacturer’s price, rather than the middleman’s price, is valid so long as the transaction between the manufacturer and the middleman falls within the statutory provision for valuation. In upholding the McAfee standard the court stated that in a three-tiered distribution system, “the manufacturer’s price constitutes a viable transaction value when the goods are clearly destined for export to the United States and when the manufacturer and the middleman deal with each other at arm’s length, in the absence of any non-market influences that affect the legitimacy of the sales price.” As a general rule, CBP presumes that the price paid by the importer is the appropriate basis for determining transaction value, and the burden is on the importer to rebut this presumption. See Treasury Decision (“T.D.”) 96-87, 30 Cust. Bull. 52/1 (January 2, 1997). To rebut this presumption, the importer must, in accordance with the court’s standard in Nissho Iwai, provide evidence that at the time the middleman purchased, or contracted to purchase, the imported merchandise, the goods were clearly destined for exportation to the United States and that the manufacturer and middleman dealt with each other at arm’s length. This documentary evidence must satisfy the requirements set forth in Nissho Iwai. CBP also advised in this T.D. that the importer must provide a description of the roles of the parties 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 establishes 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.” In addition, to establish whether the transaction is “at arm’s length,” the ruling request must state the relationship, if any, of the parties. The regulation set forth at 19 CFR 152.103(a)(3) states that “the price actually paid or payable may represent an amount for the assembly of imported merchandise in which the seller has no interest other than as the assembler. The price actually paid or payable in that case will be calculated by the addition of the value of the components and required adjustments to form the basis for the transaction value.” Example 1 states that if the components supplied by the importer are valued at $1.00 per unit and importer pays the assembler 50 cents per unit, the transaction value for the assembled unit is $1.50. The PAS Report contends that there is no sale between PVH and the foreign manufacturer because PVH provided a fabric assist and the manufacturer merely assembled the clothing. As stated in 19 CFR 152.103(a)(3), it was envisioned that goods assembled by a foreign manufacturer with materials provided as an assist could be valued based on transaction value. The use of transaction value requires a finding of a bona fide sale for exportation to the U.S. A transaction involving an unrelated manufacturer that assembled fabric provided by PVH and the middleman could be considered a valid first sale if all the Nissho requirements are satisfied. Neither the PAS Report nor the documentation submitted indicate that the middleman does not acquire title and risk of loss in the two entries examined. However, we have examined the documents submitted by the importer for the two entries referenced in the PAS report and have determined that the paper trail submitted is incomplete for entry #702. In entry #702, the middleman has a purchase order with Celebrity but Mindanao is the manufacturer. Although counsel states that Celebrity and Mindanao are related entities, no documentation was submitted to show the relationship or transaction between them. Further, the quantity amounts for the Celebrity purchase order and Mindanao’s invoice do not match up and are significantly different (18,000 pieces vs. 5,190 pieces). With regard to the second entry, entry #512, there is a minor difference in the quantity on the purchase order (22,650) and the quantity entered (22,617), which PVH states was due to some goods not meeting quality standards. There is also a minor discrepancy between the value statement prepared by Binger and the entered value. Counsel states that this is explained by a [xxx]/unit packaging assist provided by PVH for hangtags and carton labels. We find that the slight discrepancy in quantity due to quality issues does not disqualify this entry from appraisement under first sale. Further, counsel’s explanation that it added a packaging assist, which accounts for the slightly higher value, is reasonable. PVH has supplied a complete paper trail for this transaction and we find that PVH may use the first sale as a basis of appraisement for this entry. Based on our review of the paper trail described above, we find that the importer has not shown that there was a complete paper trail for entry xxxx702. II. Patent Issue The second issue raised was whether the payment by PVH to TAL of [xxx] in accordance with the 1997 Supply Agreement is a dutiable patent cost. The agreement is described above and states that it sets forth payment for the right to use the Pucker Free seam and Pucker Fee Seam technology. The additions to the price actually paid or payable include “any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of sale of the imported merchandise for exportation to the U.S. 19 U.S.C. 1401a(b)(1