Internal Advice Request; Dutiability of buying commissions, fabric development charges, inspection fees, and advance payments

HQ H284364 June 13, 2017 OT:RR:CTF:VS H284364 CATEGORY: Valuation Area Port Director U.S. Customs & Border Protection 1 East Bay St. Savannah, GA 31401 RE: Internal Advice Request; Dutiability of buying commissions, fabric development charges, inspection fees, and advance payments Dear Port Director: This is in response to your memorandum dated November 20, 2015, in which you forwarded the Office of Regulatory Audit’s (“ORA”) Referral Audit Report (“Report”) on Key Apparel Inc. (“Key” or “importer”) and Key’s response to the Audit, which also included Key’s request for internal advice. Key’s response, dated September 29, 2014, was prepared in response to the Report findings on the dutiability of foreign payments to purported agents and potential indirect payments for the imported merchandise. The Report also included ORA’s rejoinder to Key’s response, dated November 19, 2014. Pursuant to section 625(c)(1), Tariff Act of 1930 (19 U.S.C. §1625(c)(1)), as amended by section 623 of Title VI, notice of the proposed modification of Headquarters Ruling Letter (HQ) H271308, dated November 30, 2016, was published on May 3, 2017, in the Customs Bulletin, Volume 51, No. 18. CBP received one comment in response to the notice. FACTS: Key is an importer, wholesaler, and manufacturer of textiles and sells its apparel to customers in the U.S. Key was referred to ORA by the Textile/Apparel Policy Division based on the potential for undervaluation. The scope of the audit included Calendar Year (“CY”) 2012 imports, and with respect to foreign payments to purported agents, the scope was expanded to include CY 2009 through CY 2012. The audit was conducted in accordance with generally accepted government auditing standards, except for the following limitations: ORA was unable to perform additional testing of Key’s accounting records to fully quantify the violations disclosed during the audit due to the unreliability and inconsistencies in Key’s responses and the financial data. Specifically, when ORA requested a Purchase Reconciliation from CBP ACS data for the importer’s purchases, Key provided a revised CY 2012 Trial Balance and made significant adjustments/reclassifications to its Purchase account. Key was unable to provide documentary evidence for purported commission payments, client reports to substantiate the accounting entries, and written agreements on advances paid to the manufacturer. Key provided inconsistent explanations as to how fees are paid to purported agents, and how the agents are involved in the import process. Further, ORA noted unaudited financial statements and found commission invoices. As a result, ORA’s loss of revenue calculation is limited to the following documents: Reconciliation of Purchases to CBP data, Commission and fabric development cost schedule, Agency agreement between Key and alleged buying agent, Shanghai Nex-T International Co. Ltd. (“SNT”), CY 2012 tax return, CY 2012 bank statements, Schedule of advance payments to Key’s related seller, Nex-T Cambodia Co. Ltd. (“NAC”), and CY 2012 Buying Expense Account. The audit found the following: 1) foreign payments to purported agents were not bona fide buying commissions, 2) foreign payments for fabric development charges were indirect payments for imported merchandise, 3) foreign payments for purported inspection fees were an undeclared indirect payment for imported merchandise, and 4) advance payments to NAC were undeclared additional payments for imported merchandise. ORA concluded that Key did not report accurate and complete transaction value information to CBP, violating 19 C.F.R. § 152.102(f) and 152.103(b). Despite the scope limitation identified, ORA identified a specified amount in undervaluation of the imported merchandise resulting in a specified loss of revenue in duty for CY 2012. ORA also identified an additional undervaluation and resultant loss of revenue in duty for CY 2009 through CY 2011. Key responded to ORA’s results on September 29, 2014 and ORA included its rejoinder in the Report, dated November 19, 2014. During the audit scope period, Key purchased merchandise from a seller in China, and NAC in Cambodia. Key used alleged related buying agents, SNT and Hong Kong Nex-T Inc. Limited (“HKNT”), located in Shanghai and Hong Kong, respectively. I. Buying Commissions ORA stated that the fees paid to SNT and HKNT were not bona fide buying commissions. ORA based this on the fact that SNT’s related party paid the salary of Key’s CEO/President. The total entered value from manufacturers related to both Key and SNT represented 70 percent of Key’s total importations, which ORA interpreted as SNT not being financially detached from the manufacturer or seller. ORA also did not find SNT to be involved in the transactions between the manufacturers and Key, but rather in the transactions between Key and its customers in the U.S. SNT had access to Key’s shared drive, which SNT used to record Key’s customers’ orders. In addition, the agency agreement between Key and SNT was not being followed: there were no commission invoices and SNT was not paid upon receipt of payment from Key’s customers. Lastly, payments were made to SNT, who is identified as a manufacturer on the Automated Commercial System (“ACS”) manufacturer report. Regarding HKNT, Key and HKNT did not have an agency agreement. ORA also found that the buying commission was based on eight percent of the merchandise resale price to Key’s U.S. customers, rather than based on the sale between Key and the sellers. Furthermore, buying commissions were pre-paid and/or carried over to subsequent years, and could not be correlated to import entries. Key states that because HKNT is SNT’s branch office, a separate agency agreement was not necessary. Key also emphasizes that there was no relationship between SNT and the sellers and the lack of reference to SNT in the commercial documents support a sale to Key from the seller, not from SNT to Key. Key submitted copies of periodic debit notices issued by SNT in lieu of commission invoices, which became due when Key received payment from its U.S. customers. With respect to the buying commission being based on the resale price to Key’s U.S. customers, Key states that while it may be unorthodox, it is not an indication that the commission is dutiable. In addition, Key states that pre-payment or late payment is nothing more than an element of commercial dealings of the parties, which has no effect on the bona fides of the principal-buying agent relationship. Lastly, Key states that the fact that commission payments cannot be tied to entries is of no consequence. ORA states that debit notes in lieu of commission invoices were not mentioned or referenced prior to Key’s response to the Report. In addition, the debit notes provided with Key’s response state that payment should be made to the account of “HK Jak Factory Limited,” and Key was unable to explain the entity’s involvement in the import transactions. ORA’s review of the CY 2012 Trial Balance Account also did not disclose debit notes. ORA found that SNT was in control of the import transaction. SNT received Key’s customers’ orders and instructed Key when to remit the commission payments. Furthermore, through discussions with Key personnel, ORA found that Key did not have extensive knowledge of the import transaction and its role was to receive the customers’ payment and record the payment details onto an excel spreadsheet maintained on a shared drive accessible by Key and SNT. II. Indirect Payments Fabric Development Charges ORA states that foreign payments made by Key to HKNT for fabric development were not for garment samples, but undeclared indirect payments to HKNT. ORA traced the payments identified in Key’s commission payment schedule and the trial balance sample development cost payable account, directly to HKNT. ORA requested invoices and entries to verify whether the payments were declared to CBP as sample merchandise; however, Key was unable to provide them. ORA concluded that the evidence submitted did not support that the payments relate to fabric development costs for imported mutilated samples. ORA’s review also disclosed that Key did not pay the manufacturers the amount due and the amounts were often rounded up or down, and commercial invoice amounts were carried over and payable the following year. Key also did not furnish evidence that duty was paid on left over fabric used in production of imported merchandise. Key states that the fabric used in samples were all mutilated and therefore classified under subheading 9811.00.60, Harmonized Tariff Schedule of the United States (“HTSUS”) and duty free. According to Key, just because it could not provide entry documents for this fabric did not mean the merchandise should be dutiable. Key explained that samples were typically imported by means of a courier who made entry, and Key did not have access to entry information. Key states that the payments were booked to Sample Development Costs because they related to samples, and because the sample garments were mutilated and not subject to duty, there was no loss of revenue. Key also referenced the prior disclosure, filed on May 9, 2013 by Key, that addressed the fabric development fee. Key did not provide any additional supporting documents. ORA reviewed the CBP entry data, and found that Key did not enter goods under 9811.00.60, HTSUS, during the scope period. ORA did see mutilated sample garments at Key’s office, but according to Key, some of the samples were purchased domestically. ORA was unable to correlate any of the sample garments to import documentation. ORA was not advised that the overseas development costs were related to the merchandise in any way, and could not find entries/invoices for samples. Further, the evidence did not demonstrate that the payments related to fabric development costs for imported mutilated samples. With regard to Key’s May 9, 2013 prior disclosure, ORA states that Key did not tender the loss of revenue relating to the subject prior disclosure. The prior disclosure only included lump sum totals in regard to assists, and did not provide supporting schedules or documentation. Therefore, ORA was unable to verify that the payments made to HKNT during the scope period were included in the disclosure. Inspection Fees ORA also found that Key made undeclared payments to Empire, a third party, for inspection fees on behalf of Key’s customer, Kandy Kiss. Key was unable to provide any contracts regarding the purported inspection fee for merchandise entered for sale to Kandy Kiss. ORA found that Key recorded the inspection fee in its commission account, even though the payment was not made to SNT or HKNT. ORA reviewed an invoice from Empire to Key, showing a charge of five cents per piece, which Key explained was for the post import charge and commission paid to Empire for inspection services on behalf of Kandy Kiss. Key submitted an e-mail from Kandy Kiss from August 2013, in which Kandy Kiss stated that Empire provided garment and factory inspection for Kandy Kiss, and Key was required to pay Empire. Key states that because Kandy Kiss is no longer a customer, they are not able to obtain supporting documentation. The e-mail string shows that Key wrote to Kandy Kiss on August 8, 2013, but Kandy Kiss’s response was sent on August 7, 2013, which is also the date that ORA received the e-mails from Key. ORA determined that the date of the e-mails is questionable and concluded that Key was unable to provide sufficient and appropriate evidence to support that the payments related to inspection fees, and, as such, they should be dutiable as an undeclared indirect payment. Key responded by repeating that the payments to Empire were required by Kandy Kiss and the inspection fee was built into Key’s price to Kandy Kiss. Key did not provide additional documents aside from the August 2013 e-mails between Key and Kandy Kiss. Advance to a Manufacturer ORA found that Key made advance payments to NAC, a related seller. Key did not have any written agreements regarding “advances,” the invoices did not identify the payments as “advances,” and advance payments were also recorded in Key’s purchase account. Key admitted that they did not have a written agreement, but an oral agreement. Key states that it determined it was best that NAC remained a viable supplier while NAC was experiencing difficulty with labor strikes; therefore, advance payments were made. In support of their oral agreement, Key submitted a statement from NAC stating that it received the advances from Key and acknowledging its obligation to repay Key. NAC began to amortize the advance by shipping merchandise without requiring payment or accepting partial payment. An amortization schedule, with invoice numbers, was provided to ORA. Key states that amortization was suspended because of the labor strike that persisted up until 2014. ORA reviewed the advance set-offs which included four invoices that were also listed on the schedule of advances provided by Key, which disclosed that the offsetting was not identified on the invoices. Based on the lack of documentation of the advances and repayment of the advances, ORA concluded that the advances made to NAC were undeclared indirect payments. Key repeated their reason for making payments to NAC and provided related news articles and pictures of the strike causing NAC’s difficulties. Key also submitted an undated amortization schedule and three NAC invoices from July 2013, each set-off against the advance. ISSUES: Whether the commission payments made by the importer to its agents are bona fide buying commissions. Whether the payment for fabric development, inspection fees, and advance payments are indirect payments for the imported merchandise. 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 five enumerated additions. 19 U.S.C. § 1401a(b)(1). The price actually paid or payable shall be increased by the amounts attributable to the five statutory additions enumerated in 19 U.S.C. § 1401a(b)(1)(A) through (E) only to the extent that each such amount is not otherwise included within the price actually paid or payable. 19 U.S.C. § 1401a(b)(1). The term “price actually paid or payable” is defined in pertinent part as “the total payment (whether direct or indirect...) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller.” 19 U.S.C. § 1401a(b)(4). I. Buying Commissions The enumerated additions to the price actually paid or payable include the value of any selling commissions incurred by the buyer with respect to the imported merchandise. A “selling commission” is any commission paid to the seller’s agent, who is related to or controlled by, or works for or on behalf of, the manufacturer or the seller. 19 C.F.R. § 152.102(b). Bona fide buying commissions, however, are not included in transaction value as part of the price actually paid or payable or as an addition thereto. See Pier 1 Imports, Inc. v. United States, 708 F. Supp. 351, 354 (CIT 1989); Rosenthal-Netter, Inc. v. United States, 679 F. Supp. 21, 23 (CIT 1988), aff'd, 861 F.2d 261 (Fed. Cir. 1988); and Jay-Arr Slimwear, Inc. v. United States, 681 F. Supp. 875, 878 (CIT 1988). The existence of a bona fide buying commission depends upon the relevant factors of the individual case. J.C. Penney Purchasing Corp. v. United States, 451 F. Supp. 973, 983 (Cust. Ct. 1978). However, the importer has the burden of proving that a bona fide agency relationship exists and that payments to the agent constitute bona fide buying commissions. Pier 1 Imports, Inc., 13 Ct. Int'l Trade at 164; Rosenthal-Netter, Inc., 12 Ct. Int'l Trade at 78; and New Trends, Inc. v. United States, 645 F. Supp. 957, 960 (CIT 1986). The totality of the evidence must demonstrate that the purported agent is in fact a bona fide buying agent and not a selling agent or an independent seller. Headquarters Ruling Letter (“HQ”) 542141, dated September 29, 1980, also cited as TAA No. 7. Although no single factor is determinative, the primary consideration in determining whether an agency relationship exists is the right of the principal to control the agent’s conduct with respect to those matters entrusted to the agent. Pier 1 Imports, Inc., 13 Ct. Int'l Trade at 164; Rosenthal-Netter, Inc., 12 Ct. Int'l Trade at 79; and Jay-Arr Slimwear, 12 Ct. Int'l Trade at 138. In addition, the courts have examined such factors as the existence of a buying agency agreement; whether the importer could have purchased directly from the manufacturers without employing an agent; whether the agent was financially detached from the manufacturer of the merchandise; and the transaction documents. See J.C. Penney Purchasing Corp., 80 Cust. Ct. at 95-98. The courts have also examined whether the purported agent's actions were primarily for the benefit of the principal; whether the agent bore the risk of loss for damaged, lost or defective merchandise; whether the agent was responsible for the shipping and handling and the costs thereof; and whether the intermediary was operating an independent business, primarily for its own benefit. See New Trends, Inc., 10 Ct. Int'l Trade 640-643. In the instant case, the transaction documents indicate that Key did not control the agent’s conduct. As previously noted, the agency agreement between Key and SNT was provided. The agreement specifies that SNT will bill Key and Key shall pay SNT 15 days after Key’s receipt of the merchandise. However, SNT issued periodic debit notes in lieu of commission invoices. The debit notes provided by Key covered two to three month periods of “collections,” which were the sale prices of all merchandise sold to Key’s U.S. customers, and SNT required payment of eight percent of the collections, in accordance with the agency agreement, as the service charge. The debit notes state that payment should be made to the account of “HK Jak Factory Limited,” a party who was not identified in any of Key’s submissions. Furthermore, the fact that the service charge is based on the resale price to Key’s U.S. customer suggests that the purported agent’s actions were not primarily for the benefit of the principal, but for itself as well. See New Trends, Inc., 10 Ct. Int'l Trade 640-643; and HQ 544423, dated June 3, 1992. We disagree with Key’s argument that a buying commission based on the resale price to Key’s customers has no bearing on the bona fides of the principal-agent relationship. As stated above, SNT was in control of receiving Key’s customers’ orders and issued debit notes to Key based on the customer orders. SNT’s involvement with Key’s resale of the merchandise shows that SNT was involved in other aspects of Key’s business, and their relationship exceeded that of a principal-buying agent relationship. Counsel cites to CBP’s “Buying and Selling Commissions” ICP, which states that one of the services of a buying agent is “informing the seller of the desires of the buyer,” as a justification for SNT’s access to Key’s shared drive. A buying agent acts on behalf of the buyer. Counsel quotes the ICP to address SNT’s access to the shared drive with Key, and asserts that having access to the shared computer drive and having Key’s customers’ purchase orders assisted SNT in carrying out its responsibilities as a buying agent. However, the shared drive was also used to record the resale of merchandise to