Internal Advice Request; Related Party Transactions

HQ H233328 April 1, 2015 OT:RR:CTF:VS H233328 EE CATEGORY: Valuation Port Director U.S. Customs and Border Protection Miami International Airport 6601 NW 25th StreetAttn: Port Office Miami, FL 33122-3215 RE: Internal Advice Request; Related Party Transactions Dear Port Director: This is in response to your memorandum, dated September 11, 2012, forwarding a request for internal advice submitted by Page Fura, P.C., on behalf of the Importer [X], concerning the appropriate method of appraisement of certain fabrications and subassemblies of construction and earthmoving machines purchased by the Importer from its foreign related party, the Seller [X]. The request for internal advice arose in connection with a prior disclosure filed by the Importer’s attorney indicating that certain values related to either related or third-party supplied materials may have been miscalculated on reconciliation entry filings. The Importer has requested 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 ruling. FACTS: The Importer is a supplier of components and subassemblies which are used in the manufacture and assembly of various construction equipment machines produced primarily at the U.S. facilities of its parent company [X]. The U.S. parent company, the Seller, and the Importer entered into the Tripartite Supply and Purchase Agreement (“TSPA”) effective January 1, 2005. Under the TSPA, the Importer is given the non-exclusive right to purchase production material from the Seller. The Importer and the Seller negotiate the price for the production material which is subject to authorization by the U.S. parent company. The price for the merchandise is re-determined and adjusted on a quarterly basis to ensure that an adequate return is realized by the Seller. The Importer uses the reconciliation process to adjust declared values. The TSPA is supported by a Manufacturing Supply Agreement (“MSA”) between the U.S. parent company and the Seller, effective January 1, 2005, which establishes the compensation to be paid to the Seller with respect to its manufacture of production material in [X]. The Seller’s compensation is established pursuant to paragraph 5 of the MSA. Paragraph 5.1 of the MSA provides that the Seller is compensated for the production materials by recovering a target manufacturing supply return plus all of its costs of operations, subject to performance adjustments. The target manufacturing supply return is calculated by multiplying the capital base by the annual return percentage of [X]% appropriately adjusted for any fiscal period that is less than a fiscal year. The capital base includes fixed assets less depreciation, accounts receivable (excluding loans and interest receivable by the Seller) and inventory of the Seller related and/or allocated to the production of the production material as well as all finished products. The capital base is re-determined periodically. The cost of operations include all operating expenses which are related to and/or allocated to the production of the materials, including but not limited to the cost of raw materials inventory, depreciation, maintenance, repairs, utilities, labor, benefits, rents, supplies, insurance, disposal costs for indirect scrap material, and foreign currency gains and losses to the extent such relate to other operating expenses. Expenses incurred by the Seller, which are for the sole account of the Importer, are included in the costs of operations. To the extent the total amount of the Seller’s compensation is different than the Seller’s net sales, any excess in the Seller’s net sales are adjusted either through a reduction in the future selling price of the production material from the Seller to the Importer or paid by the Seller to the Importer, and any shortfall in the Seller’s net sales may be adjusted either through an increase in the future selling price of production material from the Seller to the Importer or is paid by the Importer to the Seller at the option of the parties. Any adjustment identified is captured as part of the Importer’s reconciliation filings to ensure adherence to the [X]% profit requirement. Furthermore, the Seller reports monthly to the Importer details of the cost of materials acquired for use in the manufacturing supply. Where costs of materials are greater than the planned costs, the Importer may make a payment to the Seller for the amount of the difference. Where the cost of materials is less than the planned costs, the Seller will issue a credit note to the Importer for the amount of the difference. Such amounts may be included in the actual performance results of the Seller for the purpose of the performance measures. Certain target performance measures are established to be used as a tool to evaluate the Seller’s performance in the area of cost control. At the end of each calendar quarter, if the Seller’s actual performance exceeds the performance measures, the Seller is entitled to a positive performance adjustment calculated pursuant to the performance measures. If the Seller’s actual performance adjustment fails to meet the performance measures, the Seller shall be charged a negative performance adjustment calculated pursuant to the performance measures. Performance adjustments can either be made through adjustments to the sales price of the production material from the Seller to the Importer or through payments between the two companies at the option of the parties. The Importer claims that the annual return percentage of [X]% is consistent with arm’s length pricing. In support of its position, the Importer submitted the following transfer pricing documents prepared for tax purposes: (1) The U.S. parent company’s global tax policy letter; (2) U.S. parent company’s Intercompany Pricing Practice Letter; (3) A transfer pricing study for the tax year ending December 31, 2007; (4) A transfer pricing study in [X] for the fiscal year ending December 31, 2009; (5) An excerpt from a U.S. importing tax study for fiscal year ending December 31, 2009. As previously noted, the Importer submitted a transfer pricing study for the tax year ending December 31, 2007, conducted by PricewaterhouseCoopers (“PwC”), which evaluates the arm’s length nature of the transactions between the U.S. parent company and its principal foreign affiliates, including the Seller. The transfer pricing study was conducted in compliance with Section 482 of the Internal Revenue Code (“IRC”). The Comparable Profits Method (“CPM”) was determined by PwC to be the best method to evaluate the intercompany tangible transactions between the Seller and the U.S. parent company. 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. The Seller was chosen as the tested party since it was determined that the Seller is a less complex entity than the U.S parent company. PwC compared the profit level indicators (“PLI”) of the Seller from 2005 to 2007 to the PLIs achieved by the selected independent companies during the same period. The PLI selected for the tax year ending December 31, 2007 was Return on Capital Employed (“ROCE”) and Return on Sales (“ROS”). PwC concluded that the Seller’s 2005 to 2007 average adjusted ROS was below the adjusted ROS interquartile range and was within the adjusted ROS full range established by the sample of independent U.S. manufacturers of production components. The Seller’s 2005 to 2007 average adjusted ROCE was below the adjusted ROCE interquartile range and was within the adjusted ROCE full range for the sample of independent U.S. manufacturers of production components. In selecting comparables for its analysis of the Seller’s manufacturing activities, PwC used Standard & Poor’s Global Vantage, Thomson Financial Compact D Worldscope (formerly known as Global Researcher), Standard & Poor’s Compustat, and Thomson Financial D SEC databases for independent U.S. companies classified under the following Standard Industrial Classification (“SIC”) codes: 331 (Steel Works, Blast Furnaces (Including Coke Ovens), and Rolling Mills); 345 (Screw Machine Products, And Bolts, Nuts, Screws, Rivets, and Washers); 346 (Metal Forgings and Stampings); 349 (Miscellaneous Fabricated Metal Products); 351 (Engines and Turbines); 352 (Farm and Garden Machinery and Equipment); 353 (Construction, Mining, and Materials Handling); 354 (Metalworking Machinery, and Equipment); 356 (General Industrial Machinery and Equipment); 359 (Miscellaneous Industrial and Commercial); 371 (Motor Vehicles and Motor Vehicle Equipment); 3315 (Steel Wiredrawing and Steel Nails and Spikes); 3316 (Cold-Rolled Steel Sheet, Strip and Bars); 3317 (Steel Pipe and Tubes); 3324 (Steel Investment Foundries); 3325 (Steel Foundries, Not Elsewhere Classified); 3621 (Motors and Generators); 3647 (Vehicular Lighting Equipment); 3694 (Electrical Equipment for Internal Combustion Engines); and, 5072 (Hardware). For the period 2005 through 2007, the search generated seven hundred and sixty six (766) potentially comparable companies. In order to limit the search, PwC excluded companies that: had less than two years of reported data during the 2005 to 2007 period; had Weighted Average Operating Losses greater than 100 percent of sales; had R&D/Sales ratio greater than 3.0 percent; and had controlled and duplicate companies. Additionally, PwC primarily focused on Tier I suppliers (e.g., companies that sell automotive and construction equipment components and parts to original equipment manufacturers) and eliminated companies that primarily manufacture products other than automotive or construction equipment components and parts, manufacture complex technology intensive components, do not use a significant amount of steel or other commodity material in their manufacturing operations, lack manufacturing functions, operate in a different industry markets, engage in unrelated activities, sell primarily to consumers or the government, filed or were under bankruptcy protection during the 2005 to 2007 period. This search and selection yielded twenty (20) comparable companies. The financial data for the comparable companies identified may have been adjusted for differences in levels of inventory, accounts receivable, and accounts payable between the tested party and each comparable company. We note that the comparable companies identified do not necessarily manufacture products of the same class or kind as the Seller, and there is no indication that these comparable companies are direct competitors of either the Importer or the Seller. Moreover, the excerpt from a U.S. importing tax study for fiscal year ending December 31, 2009 provides that PwC compared the profit level indicators (“PLI”) of the Seller from 2005 to 2009 to the PLIs achieved by the selected independent companies during the same period. PwC concluded that the Seller’s average 2005 to 2009 markup on total cost was below the adjusted markup on total cost interquartile range of results but was within the full range established by the sample of similar independent North American manufacturers of production components. The Seller’s average 2005 to 2009 adjusted ROCE was below the adjusted ROCE interquartile range of results and was within the full range of results established by the sample of similar independent North American manufacturers of production components. As previously noted, the complete tax study was not provided, and our office was not provided with a list of comparables used in this tax study. The Importer claims that the [X]% profit realized by the Seller, established through the MSA and adopted by the Importer through the TSPA among itself, the U.S. parent, and the Seller, falls within the interquartile range of comparable companies. Further, the Importer claims that the transfer pricing study in [X] for the fiscal year ending December 31, 2009 established in Section 5 that the initial financial reporting for the Seller during calendar year 2009 resulted in an operating profit of [X]% based on the Mark-up on Total Costs as applied under [X]’s Transaction Net Martin Method, which falls within the interquartile range of comparable North American manufacturers. Moreover, the Importer claims that since that profit was calculated against the Seller’s total cost of operations, the all costs plus a profit test is satisfied. Finally, counsel for the Importer submitted the following documents for a sample transaction to substantiate a bona fide sale between the Importer and the Seller: an entry summary, a commercial invoice issued by the Seller to the Importer and corresponding purchase order and packing list; payment record from the importer to the seller; a bill of lading; and the Master Title Transfer Agreement between the U.S. parent company and its affiliates. ISSUES: Do the transactions between the Importer and the Seller constitute bona fide sales? Do the circumstances of sale establish that the price actually paid or payable by the Importer to the 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 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). Do transactions between the Importer and the Seller constitute bona fide sales? In order for transaction value to be used as a method of appraisement, there must exist a bona fide sale between the buyer and the seller. 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 v. United States, 62 C.C.P.A. 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 HQ 548239, dated June 5, 2003. CBP will consider such factors as to 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 HQ 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 HQ 547197, dated August 22, 2000; and HQ 546602, dated January 29, 1997. Finally, pursuant to the 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. As noted in the FACTS section of this ruling, the Importer provided numerous sample documentation to substantiate its claim that there was a bona fide sale between the Importer and the Seller. The commercial invoice from the Seller to the Importer lists EXW term of sale. “Ex works” is a term of sale which means that the seller fulfills his obligation to deliver when he has made the goods available at his premises to the buyer. See Incoterms 2000, International Chamber of Commerce, 27 (1999). Consequently, the buyer assumes all risk of loss or damage involved in taking the goods from the seller’s premises. Id. The payment record indicates that a payment, which references the invoice number issued by the Seller to the Importer, was made from the Importer to the Seller. This payment corresponds to the amount on the invoice, issued by the Seller to the Importer. Further, Section 4.1 of the MSA states that title to the merchandise will pass EXW (Incoterms 2000) the Seller’s place of manufacture “in accordance with the terms of Section 2 of the Master Title Transfer Agreement, entered into by the parties, effective January 1, 2006, [X].” Accordingly, based on the documents submitted for our review, we find that there is a bona fide sale between the Seller and the Importer. Additionally, there is a sale for exportation to the U.S. since the bill of lading lists the origin as the Seller’s premises and the destination as the Importer’s premises. Do the circumstances of sale establish that the price actually paid or payable by the Importer to the Seller is not influenced by the relationship of the parties and is acceptable for purposes of 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 C.F.R. § 152.103(l). In this case, you provided information regarding the circumstances of the sale. The CBP 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, 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)