Acceptability of Related Party Price; Transaction Value; Advance Pricing Agreement; Post-Importation Adjustments

HQ H256363 January 29, 2015 OT:RR:CTF:VS H256363 EE 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; Advance Pricing Agreement; Post-Importation Adjustments Dear Mr. Pike: This is in response to your letter, dated March 11, 2013, in which you request a ruling on behalf of your client, [X] (the “Importer”), concerning the acceptability of transaction value for certain motor vehicles and parts purchased and imported by the Importer from its related parent company [X] (the “Seller”) in [X]. You have asked that certain information submitted in connection with this ruling 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 ruling 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, a U.S. corporation, is the exclusive distributor of motor vehicles, motorcycles, and parts imported from the Seller for re-sale in the U.S. market to unrelated dealers, which in turn sell the imported merchandise to end customers. Its vehicle brands include [X] and [X]. The Importer is owned by [X] (the “Holding Corporation”), which also owns two other U.S. entities: [X] and [X]. One consolidated federal income tax return is filed that includes these three entities. You state that the Importer is related to the Seller within the meaning of 19 U.S.C. § 1401a(g). You state that the Importer currently imports vehicles through U.S. Customs and Border Protection (“CBP”) Ports of Entry in Newark NJ, Baltimore MD, Charleston SC, Brunswick GA, and Oxnard CA. In the future, the Importer will import through Galveston TX. The pricing process for vehicles and motorcycles begins with the preparation of a “business case” for each new model to be sold to all of the Importer’s global related distributors and independent importers during the coming year. The Importer is the distributor for the U.S. In determining the price for each new model vehicle and motorcycle to be sold, both the Importer and the Seller contribute specific information as part of the pricing process. The Seller calculates the development, manufacturing, and distribution costs. Through its product and price planning departments, the Seller also reviews the options of the prior model and determines if certain options need to be replaced or if completely new options are warranted. The Seller then defines the standard and optional equipment which play a large role in driving the Manufacturer’s Suggested Retail Price (“MSRP”), and which is critical in determining whether the model will be profitable. The Importer’s role involves verification of the MSRP for potential competitors’ models and making adjustments to the MSRP based on the range of available options for each specific vehicle and motorcycle sold by a potential competitor. It also factors in the proposed profit margin range it must achieve on sales to unrelated distributors (the spread between the “ex works” (“EXW”) price paid by the Importer to the Seller and the MSRP paid by the dealer to the Importer), based on actual profit data from previous years. The Importer then prepares a sales plan over the life cycle of the proposed new vehicle and proposes to the Seller an EXW price for the new vehicle, together with the price for each option. With this information, the Seller convenes a meeting of the Board of Directors to determine if the new model will be built. All of the Seller’s stakeholders hold a seat on the Board and participate in the deliberations over this decision as follows [X]. Once the Board determines that a new model will be built, negotiations then commence to allocate the profit margin between the Seller and the Importer (or other national sales company, as applicable). The ultimate margin split (which begins with the assumption that each party will receive half of the gross profit amount) is reflected in the EXW and “Carriage Paid To” (“CPT”) prices declared to CBP for imported vehicles and motorcycles, respectively. For the Seller, the final EXW/CPT price ensures that it will receive an adequate profit as the manufacturing entity, while for the Importer, the EXW/CPT price ensures that its cost of goods sold figure will be as accurate a figure as possible to begin the calculation of its target operating profit margin under the proposed Advance Pricing Agreement (“APA”) pricing formula. Retail prices are reviewed and adjusted annually, based upon how well the model sold during the previous year and all prior years, how many years remain for the life of the model based on the original sales cycle plan, how the competitors’ prices have evolved in comparison, whether options need to be changed, and changes in manufacturing and distribution costs. Additionally, EXW prices may be adjusted during the year to account for significant fluctuations in currency exchange rates. Negotiations between the Importer and the Seller (like those for new vehicle pricing) ensure that, once these factors have been considered, the ultimate allocation of profit between the two entities is properly determined. Once the price for new models has been settled (or updated for existing models), orders for new vehicles and motorcycles are placed via one of two methods – either the dealers place orders directly with the Importer, or the Importer orders the merchandise on behalf of a dealer (which the dealer is free to refuse). The placement of the order for the vehicles and motorcycles is the first step in the sales process. The Seller accepts and fills the Importer’s orders at its various manufacturing locations. Once the vehicles and motorcycles are ready to be shipped, the Seller issues an invoice to the Importer. All vehicles and motorcycles imported by the Importer are initially brought into a Foreign Trade Zone (“FTZ”). Eventually, the vehicles and motorcycles leave the FTZ and are entered for consumption into the U.S., at which time the Importer deposits the duties owed on the declared value of the vehicles and motorcycles, which is the value listed on the commercial invoice after conversion from Euros to Dollars. The Importer remits payment for all invoiced vehicles and motorcycles on the 15th day of the second month after receiving the invoice from the Seller. You state that the automotive industry has a unique pricing approach that is consistent (with minor variations) across the industry. The starting point for determining whether an adequate profit is realized by a distributor is the MSRP – what the end customer would pay the dealer for the vehicle on the open market. This end price takes into account the dealer’s return and the distributor’s return to cover its cost of distribution to the dealers. Any remaining profit or loss goes back to the Seller. You state that the Holding Corporation voluntarily applied for a bilateral APA with the Internal Revenue Service (“IRS”) in [X] to cover all of its imported items (vehicles, motorcycles, and parts) for the years [X]. The Holding Corporation is in the process of negotiating a new APA with the IRS to cover the years [X]. The foreign Competent Authority is [X]. After negotiations, the IRS and the foreign Competent Authority approved the final APA in [X]. The [X] APA states that no adjustments were necessary during the term of the APA. The APA covers the following four “covered transaction” categories: Covered Transaction A: Sale of automotive components, parts, and subassemblies by the Seller to [X] and related intercompany services and warranty transactions. Covered Transaction B: Sale of finished vehicles by [X] to the Seller and related intercompany service and warranty transactions. Covered Transaction C: Sale of finished vehicles (including motorcycles and after-market parts) by the Seller to the Importer for wholesale distribution to dealers in the U.S. and related intercompany services and warranty transactions. Covered Transaction D: Provision by [X] to the Importer of financing and leasing services related to the Importer’s distribution activities in the U.S. Covered Transaction C is the category of transactions at issue in this ruling. The tested party for Covered Transaction C is the Importer. Section 482 of the Internal Revenue Code (“IRC”) (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 result. The application of the best method establishes an arm’s length range of prices or financial returns with which to test controlled transactions. The comparable profits method (“CPM”) for covered Transaction C was identified in the APA as the best method for evaluating the Importer’s related party or controlled transactions. 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. The profit level indicator (“PLI”) selected was the operating margin. The APA defines cumulative operating margin as the Importer’s cumulative operating profits for the APA term divided by its cumulative sales revenue for the APA term. According to the APA, the arm’s length range is between [X]%. The operating margin range proposed by the Importer to the IRS and the foreign tax authority in its Bilateral APA Submission for the APA renewal covering the term [X] through [X] is [X]%. This arm’s length range was established on the basis of objective, third-party pricing data for distributors (comparable companies), which perform similar functions and assume similar risks as the Importer. In selecting comparables for its analysis, PricewaterhouseCoopers LLP (“PWC”), an independent accounting firm, hired by the Holding Corporation, used the Standard & Poor’s Compustat (“S&P Compustat”) database of North American companies and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 5000-5999 (distribution of durable goods). For the period [X], this search generated 458 potentially comparable companies. In order to limit the search, PWC excluded companies that: did not report at least three years of required data over the most recent five-year period; reported five-year weighted average R&D to sales ratio larger than one percent; yielded revenue outside of the range between $[X] and $[X]; and had a five-year weighted average SG&A to sales ratio over 20 percent. Additionally, PWC eliminated companies that had foreign sales representing over 25 percent of total sales; had significant retail operations; and had significant sales to governmental entities. This search and selection yielded 12 comparable companies whose financial data was used to determine a target operating margin range for the Importer for the term of the proposed APA renewal. To adjust for the impact of differences in the relative levels of operating assets carried by the tested party and the comparable companies, working capital adjustments were made to the comparable companies for accounts receivables; plants, property & equipment; account payables; and inventory. It is important to note that although PWC searched for companies that fit a similar functional, risk and asset profile as the Importer, the final set of comparable companies identified do not necessarily distribute products of the same class or kind as the Importer. You state that comparables of companies which import and sell motor vehicles do not exist. For the period [X] through [X], the interquartile range of comparable North American distributors’ operating margins ranged between [X] and [X] percent at the 75th percentile level, with a median of [X] percent. You claim that the Importer’s transfer pricing policy constitutes an objective formula for purposes of applying transaction value and claiming post-importation adjustments. In support of this position, you submitted the following documents: (1) Memorandum addressing the five factors, dated March 11, 2013; (2) The APA between the Holding Corporation and the IRS covering taxable years ending (“TYE”) [X] through [X], and TYE [X]; (3) two Intercompany Memorandums (“MOU”) between the Seller and the Importer, dated February 2, 2009 and September 10, 2012; (4) [X] Transfer Pricing Principles effective [X] which set forth [X]’s global transfer pricing system; and (5) records related to the [X] adjustment. Finally, you submitted the following documents: an outline of the negotiation process for a new vehicle model between the Importer and the Seller; sample documents of representative sales transactions for a car and a motorcycle; payment documents for the two sample transactions; and the bilateral APA renewal submission dated [X]. ISSUES: Do the transactions between the Importer and the 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 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. For the sample vehicle transaction, the commercial invoice from the Seller to the Importer lists EXW term of sale. EXW is a term of sale which means that the seller fulfills its obligation to deliver when it has made the goods available at its premises to the buyer. See Incoterms 2010, International Chamber of Commerce, 15 (2010). Consequently, the buyer assumes all risk of loss or damage involved in taking the goods from the seller’s premises. Id. You state that the Seller and the Importer have no contract governing the terms of sale of the vehicles, motorcycles, and parts, but the commercial summary invoices for vehicles and motorcycles always indicate the Incoterm EXW for vehicles and parts and CPT for motorcycles. Uniform Commercial Code § 2-401(2) provides that “[u]nless otherwise explicitly agreed, title passes to the buyer at the time and place at which the seller completes his performance with reference to the physical delivery of the goods...”. As such, in the instant case, title from the Seller to the Importer passes at the Seller’s premises for the vehicle and part sales. The payment records correspond to the sample commercial invoice submitted. Accordingly, based on the description of the Importer’s sales process substantiated by the numerous documents submitted by the Importer, 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 waybill lists the port of loading as [X] and the port of discharge as California. For the sample motorcycle transaction, the commercial invoice from the Seller to the Importer lists “CPT Easton Nazareth” term of sale. “CPT” is a term of sale which means that the seller fulfills its obligation to deliver when it hands the goods over to the carrier. See Incoterms 2010, International Chamber of Commerce, 33 (2010). The buyer assumes all risk of loss or damage to the goods from the time they have been delivered to the carrier; however, the seller pays the costs of carriage necessary to bring the goods to the named place of destination. Id. In the instant case, since no contract exists governing the terms of sale for the motorcycles, title from the Seller to the Importer passes at the carrier. The payment records correspond to the price listed on the commercial invoice. Accordingly, 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 waybill lists the port of loading as [X] and the port of discharge as New York. 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 HQ 547654, dated November 8, 2001 (revoked by HQ W548314, dated May 16, 2012). Nevertheless, sometimes these adjustments w