Internal Advice; Application for Further Review and Protest No. 4601-16-100197; First Sale; Related Parties; 19 U.S.C. § 1401a(b)

HQ H275235 December 20, 2017 OT:RR:CTF:VS H275235 CMR CATEGORY: Valuation U.S. Customs and Border Protection Protest & Control 1100 Raymond Boulevard Suite 402 Newark, NJ 07102 RE: Internal Advice; Application for Further Review and Protest No. 4601-16-100197; First Sale; Related Parties; 19 U.S.C. § 1401a(b) Dear Port Director: This is in response to your memorandum, dated April 19, 2016, forwarding the Application for Further Review (AFR) and Protest No. 4601-16-100197, filed on March 1, 2016, against your decision to deny the appraisement of the merchandise based on the transaction between the manufacturer and middleman, i.e., first sale. The entry for the merchandise was filed in May 2015 and liquidated on September 4, 2015. We note the protest was timely filed, involves multiple entries, and has been designated as a lead protest. Entries at issue in other protests include entries entered in 2015 and subsequent years. While this protest fails to meet the requirements for approval of AFR as the memorandum in support of the protest did not address the question of AFR and, in box 16 of the Customs and Border Protection (CBP) Form 19, i.e. “Justification for Further Review under the Criteria in 19 CFR 174.24 and 174.25,” the protestant merely cited 19 C.F.R. § 174.25(b) and the memorandum in support of the protest, this office may review this protest under 19 C.F.R. § 177.11, and provide advice to the port. As the port forwarded this protest with questions regarding the application of the all costs plus a profit method for determining whether related parties are acting at arm’s length in the absence of a parent company, we will provide the port with internal advice on this matter. This office has taken into consideration the information presented to the port and to this office. We received supplemental submissions dated, June 2, 2017, July 14, 2017, and August 4, 2017, and met with counsel for the importer on July 19, 2017. In addition, Counsel has requested confidential treatment be accorded to certain information submitted in connection with this matter. In consideration of the request and sufficient justification presented pursuant to 19 CFR 177.2(b)(7), this office will provide confidential treatment to certain information related to this matter. Information for which confidentiality is being accorded will be denoted in brackets in the confidential decision and will be redacted in any public version. FACTS: The merchandise at issue is manufactured in Sri Lanka. The parties involved in the transactions subject to the protest are the U.S. importer, the Hong Kong middleman, a related party service provider, and the related party manufacturer. The U.S. importer orders merchandise from the Sri Lanka manufacturer’s related Hong Kong middleman via the importer’s online vendor portal to which both the middleman, i.e., vendor, and its related manufacturer have access. Both related parties are able to view all of the information related to the order. After receipt of the order from the importer, the middleman places an order for the merchandise with its related manufacturer in Sri Lanka. The middleman only purchases merchandise from its related manufacturer. The middleman’s purchase order to its related manufacturer sets the price of the ordered merchandise at approximately [x]% of the importer’s purchase order price for the goods. Therefore, the middleman retains a set percentage of [y]% per order placed by the importer. Counsel submits that it is the middleman’s order to the manufacturer that triggers the manufacturer’s obligation to produce the merchandise, and not the U.S. importer’s placement of the order into its vendor portal. In addition, the importer maintains a separate website which contains “documentation for the vendor and factories on labeling, packing trim, cartons, hangers, testing, [and] contact information.” All of the importer’s vendors and factories have credentials to log into this website. In support of the use of the “first sale” between the manufacturer and the middleman, the following documents have been submitted to CBP: purchase orders, invoices, proof of payment, airway bill, packing lists, copies of the entry documents, the first sale invoice for each entry, entry data (detailing the entry line numbers, liquidation values and “first sale” values), and a financial analysis summary for the manufacturer and the middleman. Importer’s counsel submits that the manufacturer’s profit is equal to or greater than the related middleman and thus, the parties meet the all costs plus a profit test under the circumstances of the sale method for determining related party transactions to be arm’s length. Audited financial statements for 2014/2015 and internal financial statements for 2015/2016 for the related middleman and manufacturer were submitted, at CBP’s request, to support the contention that the sales between the related parties meet the arm’s length requirement of transaction value. No sales contracts between any of the parties involved were submitted to CBP, as counsel claims that none exist. The only written agreement between the parties involved in the transaction at issue that was submitted to CBP is the agreement between the middleman and the related party service provider located in Sri Lanka. The purchase order between the middleman and the manufacturer submitted in support of the protest does not indicate anything in the section for “ship mode.” It is void of shipping terms, other than an indication that the merchandise will be shipped by sea. In addition, it does not have any payment terms on it. The related parties’ commercial invoice, submitted in support of the protest, indicates “FCA . . . Factory Sri Lanka” and reflects that payment is due “T/T 14 days.” The purchase orders from the U.S. importer to the middleman indicate a column for the FOB unit cost of the merchandise being ordered and that payment is due 15 days after shipment. The screen print provided shows that the orders in “plan” stage do not have a “FOB Cost” reflected in the cost column, but once approved, a price per unit is reflected in the column. The commercial invoice between the middleman and the importer indicates payment is due “T/T 12 days” and the transport terms are “FCA Colombo Port.” Counsel for the importer initially indicated that the terms of sale between the importer and the middleman are FCA [Free Carrier] [manufacturer’s] factory Sri Lanka; and that the terms of sale between the middleman and its related manufacturer are FCA Colombo. In a supplemental submission, dated June 2, 2017, counsel now submits that this was not correct and, after discussing this issue further with the parties, the middleman and the importer both purchase the merchandise on Free-on-Board (FOB) terms. No documentation was presented to substantiate this assertion. As stated in the submission, “both parties pay a single, all-inclusive price for the purchase of the goods and for the loading of the same onto the ocean vessel destined to the United States.” It is further stated that the manufacturer pays the cost of trucking the merchandise from its factory to the port of export. The payment is to a third-party logistics company. The U.S. importer takes title and risk of loss at the port of Colombo. In the July 14, 2017, submission, counsel offered that there was no “flash” title, as would occur based on the terms provided in the June 2, 2017, submission, because under Sri Lanka law, “a contract for the sale of goods was made between [the manufacturer] and [the Hong Kong middleman] the moment the [manufacturer] accepted [the middleman’s] purchase order to produce the goods at issue pursuant to Sec. 19, Rule 1 of the [Sale of Goods Ordinance No. 11 of 1986].” Counsel asserts the middleman transfers title to [the importer] once the goods are loaded onto the ocean vessel at the Port of Colombo[.]” The importer asserts that the merchandise should be appraised for duty purposes in the entries at issue based upon the sale between the manufacturer and its related middleman. With regard to the proof of payment between the middleman and its related manufacturer, a copy of a bank statement printed from HSBCnet was submitted as evidence of payment. The statement lists multiple invoices issued by the manufacturer that are paid with one payment from the middleman. In the August 4, 2017 submission, counsel provided additional documentation to show payment by the middleman to the manufacturer for the merchandise in the entries at issue in this protest. Twenty sets of documents were submitted. Each of the first 19 sets consist of an invoice from the middleman to its related manufacturer; and, an HSBCnet page indicating a payment to the manufacturer from the middleman, indicating the beneficiary bank details, and providing a check number and list of invoice numbers covered by the payment. The last set of documents consists of a HSBC bank statement which has the middleman’s name and an address in Sri Lanka for the middleman. The statement was submitted to show a withdrawal from the middleman’s account equal to listed invoices covered by the check from the middleman to the manufacturer. The address on the middleman’s bank statement is the same address as the manufacturer in Sri Lanka. Of the 20 sets of documents, five reflected payment after the 14 day payment term. One payment was only a day late; the latest payment was 13 days past due. The rest were paid within the 14 day time frame. The proof of payment submitted with regard to the importer’s payment to the middleman consists of a payment report from the importer’s bank and pages from the middleman’s “customer balance detail” ledger which lists invoice numbers, the date the invoices were issued, the date the merchandise was on board a vessel, the date payment is due, the amount due, and the amount paid. The audited financial records for the middleman reveal that while the middleman is incorporated in Hong Kong, its principal place of business and the manufacturer’s principal place of business are identified as the same address in Sri Lanka. See page 7 of the middleman’s Audited Financial Report, submitted as Attachment 3, Counsel’s June 2, 2017, submission. The related middleman has a parent, an ultimate holding company, located outside of Hong Kong and Sri Lanka, per the 2015 financial statement. In addition, the “Accounting Policies and Explanatory Notes to the Financial Statements for the period ended 31st March 2015” (hereinafter, Notes), which is part of the audited financial statement for the middleman, indicate that the costs of goods sold consists of goods purchased from related companies. The Notes also indicate that the middleman pays a related company an office management fee. This party has been identified as a related party service provider in Sri Lanka. In regard to related party transactions, Note 13 of the Notes states: “The amounts due to related companies are unsecured, interest-free and have no fixed terms of repayment.” Counsel has explained that the middleman does not have a physical presence in Sri Lanka, but “has outsourced certain operational and management support services to another related party located in Sri Lanka.” A copy of the agreement between the related parties was submitted and indicates that the Sri Lankan company agreed: . . . to provide the operational management services and support services, including, but not limited to, Back-office support; Merchandising, Sampling, Quality Inspections, Shipping – commercial, Procurements and HR, Legal, Finance; financial reporting and analytical support; in accordance with the terms of [the] Agreement. The agreement is signed by the sole director of middleman, on behalf of his company, and the chairman of the related party service provider in Sri Lanka, on behalf of his company. The related service provider performs services only for the middleman and no other entities, related or unrelated. In exchange for providing the services described above, the Sri Lankan related party is to be paid a monthly fee based upon a fixed full time employee rate within 30 days of receipt of an invoice issued by it to the middleman. The related party service provider is located at the same address as the related manufacturer. Copies of invoices from the related party service provider to the related middleman were provided for each month of the year 2015. The invoices reflect the number of full-time employees employed by the related service provider, the rate charged per employee, and the total amount due. Based upon a review of the invoices, the related service provider employed between 70 and 94 employees during the course of 2015. The invoices also state: “We hereby debit your account for the above value.” Counsel has indicated that “[a]ccording to the parties’ accountant, [this phrase] merely reflects an accounting term denoting that the supplier ledger account has or will be debited for the value of said services.” We note that the invoices from the related service provider also reflect the bank details for the related service provider, including the SWIFT code and account numbers. Counsel also provided pages from the related party service provider’s “Invoices and Remittance schedule” to show that payments were received in response to the invoices. The audited financial statement ending 31st March, 2015, for the manufacturer and its group, indicates that the manufacturer has no ultimate parent. See Paragraph 1.3 at page 6 of the manufacturer’s “Financial Statements for the Year Ended 31st March, 2015.” It also indicates that the related party service provider employed by the middleman to provide operational management and support services to the middleman owed money to the related manufacturer. Counsel explained in the August 4, 2017 supplemental submission that the related party service provider “shares/rents space” from the related manufacturer and thus, “there are certain costs that are common and shared between the parties.” Counsel characterized the relationship between the service provider and manufacturer as a landlord-tenant relationship. With regard to transactions with related parties, Note 39.2 of the manufacturer’s 2015 audited financial statement states that they are “carried out in the ordinary course of the business. Outstanding current account balances at year end are unsecured, interest free and settlement occurs in cash.” The related companies underwent a corporate restructuring in 2016. Prior to the restructuring, the same three individuals owned the parent holding company of the middleman and owned the related party service provider employed by the middleman. The same three individuals, plus two more, owned the related manufacturer. After the restructuring, the same five individuals own the manufacturer, the related party service provider and, through ownership of the related party service provider, the Hong Kong middleman who is wholly owned by that party. Counsel submits that all three related parties are deemed equal in terms of corporate structure due to the common ownership of all three. The middleman has a single director and no employees. This director also serves as a director of the manufacturer and the related party service provider. In fact, this director is the managing director of the manufacturer and one of the five owners of the related party companies. The related party service provider has two additional directors who also serve as directors of the manufacturer. The three directors of the related party service provider are three of the five owners of the company. The manufacturer has two additional directors. Both of these additional directors are also owners of the manufacturer. Note 13 of the middleman’s 2015 Audited Financial Statement Notes states that the director of the middleman “controls both the [middleman] and the related companies” to whom the middleman owes money. ISSUE: Whether the sales between the middleman and its related factory are bona fide sales which may serve as the basis for appraisement of the goods under 19 U.S.C. § 1401a(b) under the “first sale” principle of appraisement. 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 preferred 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 certain statutory additions. 19 U.S.C. § 1401a(b)(1). First Sale Claim In accordance with Nissho Iwai, infra, and Synergy, infra, appraisement of imported merchandise based on a bona fide sale of goods for export to the U.S., prior to the last sale for export to the U.S., is a legitimate basis of appraisal and CBP will appraise merchandise for which a “first sale” claim is made when it meets the requirements for such appraisement. The importer claims that the merchandise at issue should be appraised based upon the transaction value of the sales between the Hong Kong middleman and its related manufacturer. In Nissho Iwai American Corp. v United States, 16 C.I.T. 86, 786 F. Supp. 1002, reversed in part, 982 F. 2d 505 (Fed. Cir. 1992), the Court of Appeals for the Federal Circuit reviewed the standard for determining transaction value when there is more than one sale which may be considered as being a sale for exportation to the United States. The case involved a foreign manufacturer, a middleman, and a United States purchaser. The court held that the price paid by the middleman/importer to the manufacturer was the proper basis for transaction value. The court further stated that in order for a transaction to be viable under the valuation statute, it must be a sale negotiated at arm’s length, free from any non-market influences, and involving goods clearly destined for the United States. See also, Synergy Sport International, Ltd. v. United States, 17 C.I.T. 18 (1993). In accordance with the Nissho Iwai decision and our own precedent, we presume that transaction value is based on the price paid by the importer. In further keeping with the court’s holding, we note that an importer may request appraisement based on the price paid by a middleman to a foreign manufacturer in situations where the middleman is not the importer. However, it is the importer’s responsibility to show that the “first sale” price is acceptable under the standard set forth in Nissho Iwai. That is, the importer must present sufficient evidence that the alleged sale was a bona fide “arm’s length sale,” and that it was “a sale for export to the United States” within the meaning of 19 U.S.C. § 1401a. In Treasury Decision (T.D.) 96-87, dated January 2, 1997, the Customs Service (now Customs and Border Protection (CBP)) advised that the importer must provide a description of the roles of the parties involved and must supply relevant documentation addressing each transaction that was 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. correspon- dence) 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.” T.D. 96-87 further provides that the importer must also inform CBP of any statutory additions and their amounts. If unable to do so, the sale between the middleman and the manufacturer cannot form the basis of transaction value. Bona fide sale Based on the documentation prese