Restrictions on Disposition or Use; Price Actually Paid or Payable; Dutiability of Service Fees; Related Party Transactions

HQ H301778 June 4, 2024 OT:RR:CTF:VS H301778 CATEGORY: Valuation Gail T. Cumins, Esq. Sharretts, Paley, Carter & Blauvelt, PC 75 Broad Street New York, NY 10004 RE: Restrictions on Disposition or Use; Price Actually Paid or Payable; Dutiability of Service Fees; Related Party Transactions Dear Ms. Cumins: This is in response to your letter of June 20, 2018, requesting a ruling on the valuation of goods that [ ] (“the Importer”) purchases from a related party, [ ] (“the Seller”). Specifically, you ask for confirmation: (1) that the imported goods are not subject to any restrictions on disposition or use that preclude the use of the transaction value method; (2) that certain service fees associated with retail operations in the United States are not part of the price actually paid or payable for the imported goods; and (3) that the related-party price is acceptable as transaction value for the imported goods. You have requested confidential treatment for certain information contained in your submission and in the file. 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 in your request will not be released to the public and will be withheld from published versions of this ruling. FACTS: The Seller is a parent company located in Europe. The Seller globally promotes and sells brand-name merchandise for which it owns all the intellectual property, brand names, and trade names. The merchandise includes luxury goods such as large and small leather goods, shoes, apparel, watches, jewelry, fashion accessories, and books. The Seller designs and develops the merchandise, oversees its production by both related and unrelated manufacturers located abroad and in the United States, and purchases the finished products from the manufacturers. The Importer is a subsidiary of the Seller based in the United States. The Importer acts as a corporate wholesaler that sells all its inventory to [ ] and [ ] two U.S. “Retail Groups” that are also wholly owned by the Seller. In addition to the imported goods at issue in this case, the Importer also purchases U.S.-made goods that it sells to the Retail Groups. Over the period of 2018 to 2021, U.S.-made goods accounted for between [ ]%-[ ]% of the Importer’s total purchases by value. Once the Retail Groups acquire the merchandise, whether imported or produced in the United States, they offer it to customers through their website and a network of retail stores that they own or operate in the United States. Restriction on Disposition or Use In this case, you note that the Seller provides “retrieval dates” for its products, which you characterize as “recommendations” about when certain products should be removed from the shelves in retail stores. In support of your contention that the retrieval dates are suggestions, rather than an enforceable requirement that could constitute a “restriction on disposition or use” of the goods under 19 U.S.C. § 1401a(b)(2)(A)(i), you provided a non-exhaustive table of 186 products that continued to be sold in the United States after the retrieval date specified by the seller in 2017. In your view, the fact that the Retail Groups continued to sell these products after the retrieval date demonstrates that the Seller cannot exercise control over the final disposition or use of the goods. Additionally, regarding the ultimate disposition of the goods in the United States, you acknowledge that Seller and its subsidiaries do not engage in any outlet store or discounted retail activities. Unsold merchandise from the Retail Groups is returned to the Importer, with a small percentage sold to employees via staff sales. Obsolete products are destroyed locally by the Importer, and where applicable, duty drawback is claimed. Small quantities of active sellable products are returned to the Seller’s overseas headquarters. In your view, no restriction on disposition or use should be inferred either from this business practice or from the Seller’s “recommendations” as to when certain products should be removed from the shelves in the Retail Groups’ U.S. stores. Service Fees In addition to merchandise, the Seller bills the Importer fees that relate to retail services provided to the two U.S. Retail Groups. The retail service fees cover the following eight categories: Merchandising and commercial assistance services, which include architecture, visual merchandising, and sales training; Advertising and communication services, which include advertising campaigns, media strategy, catalogues, brochures, leaflets, and tools for working with clients; Sales and marketing services, which include product launches and sales aid documents; Supply chain and logistics services, which include supply chain & products assortments and logistics, all of which relate solely to the distribution of products in the United States by the retail stores; Information systems (IS) services; Human resources (HR) services, which include HR tools and internal communication; Financial assistance services; and Administration and risk management services. You claim that the retail service fees are 100% pass-through, meaning that the Importer passes them along to the two U.S. Retail Groups in their entirety. Additionally, the Importer adds local administrative and logistics service fees for retail services provided by the Importer to the Retail Groups. The Retail Groups pay the Importer the full amount of the service fees billed by the Seller and the Importer, and the Importer passes along to the Seller the payment for the services fees paid by the Retail Groups. The Seller calculates the fees according to the following principles: Analysis of the cost centers of each department in the statutory accounting of the Seller, in order to identify: The cost centers which relate to one of the services rendered to the retail affiliates, and which thus give rise to full or partial re- invoicing; The cost centers which do not relate to the services and are not re-invoiced; Categorization of these costs per type of service (Merchandising & commercial assistance, Advertising & communication, etc.); Determination of complete costs for each category of services, through the inclusion of a portion of the Seller’s indirect costs; Application of a retail allocation percentage to this complete cost basis, in order to reflect management’s best estimate of time spent and/or costs allocated by each department to provide services to the retail business; Application of a mark-up to each category of services, reflecting the value-added component of this service, from 5% to 15%; Allocation of the full retail services charge between the retail affiliates, based on their respective contribution to the worldwide net sales; and Conversion in local currency. While there is no retail services agreement between the Seller and the Importer, you have provided a Services Agreement, dated January 1, 2012, which was executed between the Seller and one of the U.S. Retail Groups. Under the Services Agreement, the fees are invoiced as follows: During a given calendar year, the Importer is charged by the Seller with a monthly amount equal to 1/12 of the past year total charge (Advanced payments); and The service fee calculation described above is done only after the annual closure of accounts (generally in February), and the gap between the Advanced payments invoiced over the 12 months and the actual calculation gives rise to regular invoicing. You argue that the service fees should not be dutiable as part of the price actually paid or payable because the fees constitute retail-related services carried out in the United States that are “a separate flow, completely unrelated” to the sale or importation of the merchandise. Regarding the connection between the retail fees and the goods ultimately sold in the retail stores, you emphasize again that a substantial portion of the goods sold at retail are not imported; in recent years, U.S.-made goods accounted for between [ ]%-[ ]% of the Importer’s total purchases by value. Moreover, the calculation of the fee does not depend on either the purchase price or the retail price of the goods, whether imported or not. Finally, you observe that the fees accrue even when no merchandise is purchased and imported. For example, during the Covid-19 lockdowns, the Seller continued to provide the services discussed above for the benefit of the retail entities, which remained obligated to pay for the services even though the retail stores were closed at that time and the purchase and importation of merchandise was paused. Acceptability of Related-Party Prices as Transaction Value If U.S. Customs and Border Protection (“CBP”) finds that no restrictions on disposition or use of the goods exist that preclude the application of the transaction value method and that the service fees discussed above are not included in the price actually paid or payable for the goods, you argue that CBP should accept the related-party price between the Seller and the Importer as transaction value. Your argument is based on the information in a Transfer Pricing Study (“TPS”), a “Luxury Retail Industry Benchmarking Analysis,” and profitability figures from the Seller and the Importer. Transfer Pricing Study The Seller engaged an independent accounting firm, Ernst & Young, LLP, to evaluate the arm’s-length nature of the transfer pricing policy to be implemented by and between the Seller and its various distribution affiliates. Although the TPS dates from November 1993, you state that the Seller has consistently used the methodology described in the study since then and that it continues to accurately reflect the Seller’s business practices. According to the TPS, the Seller’s traditional transfer pricing policy yielded transfer prices that were a function of the production costs, currency fluctuations, marketing requirements and retail sales prices. However, to maintain control and coordination over retail prices, and to “ensure a more cogent transfer pricing policy from a global tax perspective,” the Seller restructured its transfer pricing policy to a resale price approach.” Under this approach, the calculation of the FOB transfer price from the seller under the resale price method and its corresponding retail price is: Seller’s FOB price (in foreign currency) = .[ ] x retail price including sales tax (in foreign currency). Accordingly, all of the Seller’s distributors operate with the same gross margin—namely, [ ]%. The TPS was conducted in accordance with Section 482 of the Internal Revenue Code and also contains analyses of the transfer pricing policy under the domestic law of foreign jurisdictions. You state that, since 1993, the transfer pricing policy “has been reviewed and validated by numerous national tax authorities” including the United States, Japan, the United Kingdom, Germany, Hong Kong and France. However, there is no evidence that an Advance Pricing Agreement exists between the Seller and the Internal Revenue Service. Section 482 of the Internal Revenue Code (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. As stated in the Seller’s TPS, “for purposes of the Comparable Uncontrolled Price (“CUP”) and Resale Price (“RP”) methods, the scope of this study did not permit the comparability analysis that would be necessary to rely on either of these methods as a best method.” As explained in further detail below, the search for comparables that sell “luxury goods” similar to those of the Seller resulted in three results. However, as the data available for any one of the companies was found to be insufficient for purposes of applying the CUP or RP methods, “the companies together as a comparable company sample allowed for the use of the [Comparable Profits] Method (‘CPM’) to approximate an arm’s length price.” The CPM examines whether the amount charged in a controlled transaction is an arm’s-length price by comparing the profitability of the tested party to that of comparable companies. In this case, the Importer was selected as the tested party, as it is the “entity for which it [was] easiest to find comparable companies (i.e., that entity which undertakes the simpler set of functions, has less relative risk and uses either little or no intangibles).” The search for comparable companies began by searching computer databases by using a combination of Standard Industrial Classification codes (e.g., distributor) and keywords (e.g., luxury goods, luggage, handbag, purse, accessory, etc.) based on merchandise sold by the Seller. This initial search resulted in over 1,000 comparables. Then, company descriptions were examined to determine whether the potential comparables were functionally similar to the Seller, which narrowed the field to 30 potential comparables. The TPS contains a full list of these 30 potential comparables, a description of their businesses, and notes on why companies were eliminated for further consideration in the next step of the analysis (e.g., not a wholesaler, does not sell branded merchandise, does not sell luxury merchandise, significant research and design expenses, etc.). Next, 10-K reports were reviewed to further examine comparability, which eliminated 23 further potential comparables. After performing a more detailed comparison of the potentially comparable companies, only three remained. The profit level indicator selected for purposes of the comparison was operating margin. According to the information provided, using the CPM approach, the Seller’s “1989 to 1991 average performance compared favorably to the operating margins of comparable companies.” However, the information in the TPS does not appear to have been updated since 1993 when the transfer pricing policy was first introduced. In addition to the TPS, the Importer has also provided a supplemental study, discussed immediately below. PwC Luxury Retail Industry Benchmarking Analysis The Importer engaged the services of PricewaterhouseCoopers (“PwC”) to prepare an “Assessment of transaction value for related party transactions.” The objective of the analysis is to determine whether the intercompany prices between the Seller and the Importer are at arm’s length for purposes of customs valuation. Specifically, PwC “conducted several distinct analyses to ascertain the prevailing ‘normal pricing practices of the industry’ in order to provide a complete examination of the Seller’s global intercompany pricing policy as it pertains to the Importer, as outlined [in] 19 C.F.R. § 152.103(l)(1)(ii).” 19 C.F.R. § 152.103(l)(1)(ii) provides that: If it is shown that the buyer and seller, although related, buy from and sell to each other as if they were not related, this will demonstrate that the price has not been influenced by the relationship, and the transaction value will be accepted. If the price has been settled in a manner consistent with the normal pricing practices of the industry in question, or with the way the seller settles prices for sales to buyers who are not related to him, this will demonstrate that the price has not been influenced by the relationship. Emphasis added. For purposes of identifying the relevant industry, PwC first observed the following characteristics of the Importer: Engages primarily in sales of handbags, accessories, small leather goods, and footwear; Engages in sales activity in the U.S. region; Operates as a regional distributor and retailer, through onward sales by its retail affiliates; and, Operates in the very limited luxury retail segment, which involves unique considerations, customer experience implications, and value drivers. Based on these characteristics, the PwC analysis identified “luxury retail” as a relevant industry for purposes of applying the circumstances of the sale test. In order to identify peer companies operating in this industry, PwC used S&P Capital IQ, which independently identified a proposed set of comparables based on the characteristics of the Importer. The initial list of comparables comprised nine unrelated entities engaged in sales of products similar to the Importer’s primary product categories (i.e., footwear, handbags, and to a lesser extent, fashion apparel). However, as some of the comparables focused on product groupings that were more removed from the Importer’s activities (such as jewelry, beauty and cosmetic products, and sportswear), a second, “tailored” set of results was identified. Specifically, PwC removed from the set comparables that were not primarily engaged in sales of comparable products in the Importer’s primary product categories and conducted research to identify additional comparables in the luxury market. Global Results Return on Sales (ROS)  # Company Name Wtd. Avg. 2018 2017 2016  1 [ ] [ ]% [ ]% [ ]% [ ]%  2 [ ] [ ]% [ ]% [ ]% [ ]%  3 [ ] [ ]% [ ]% [ ]% [ ]%  4 [ ] [ ]% [ ]% [ ]% [ ]%  5 [ ] [ ]% [ ]% [ ]% [ ]%  6 [ ] [ ]% [ ]% [ ]% [ ]%  7 [ ] [ ]% [ ]% [ ]% [ ]%  8 [ ] [ ]% [ ]% [ ]% [ ]%  9 [ ] [ ]% [ ]% [ ]% [ ]%  10 [ ] [ ]% [ ]% [ ]% [ ]%  11 [ ] [ ]% [ ]% [ ]% [ ]%  12 [ ] [ ]% [xxx]% [ ]% [ ]%   Next, the benchmarking study set forth the same data set narrowed to the U.S. segments of the same entities. The U.S. segment data set is set forth below. Global Results Return on Sales (ROS)  # Company Name Wtd. Avg. 2018 2017 2016  1 [ ] [ ]% [ ]% [ ]% [ ]%  2 [ ] [ ]% [ ]% [ ]% [ ]%  3 [ ] [ ]% [ ]% [ ]% [ ]%  4 [ ] [ ]% [ ]% [ ]% [ ]%  5 [ ] [ ]% [ ]% [ ]% [ ]%  6 [ ] [ ]% [ ]% [ ]% [ ]%  7 [ ] [ ]% [ ]% [ ]% [ ]%  8 [ ] [ ]% [ ]% [ ]% [ ]%  9 [ ] [ ]% [ ]% [ ]% [ ]%  10 [ ] [ ]% [ ]% [ ]% [ ]%  11 [ ] [ ]% [ ]% [ ]% [ ]%  12 [ ] [ ]% [xxx]% [ ]% [ ]%   Next, PWC proceeded to consolidate the Return on Sales U.S. segment data set for comparable retailers to provide benchmarking results, which are set forth below. Return on Sales (ROS)   Wtd. Avg. 2018 2017 2016  Count 12 12 12 12  Min [ ]% [ ]% [ ]% [ ]%  Lower [ ]% [ ]% [ ]% [ ]%  Median [ ]% [ ]% [ ]% [ ]%  Upper [ ]% [ ]% [ ]% [ ]%  Max [ ]% [ ]% [ ]% [ ]%   The benchmarking study also set forth the Importer’s Return on Sales data for fiscal years 2016 – 2018, which is set forth below. Importer Result Return on Sales   Wtd. Avg. 2018 2017 2016   [ ]% [ ]% [ ]% [ ]%   Taking the benchmarking analyses into account, PwC concluded that the Importer’s results were consistent with the financial results observed in the tailored luxury industry benchmarking set. PwC observed that in the tailored comparable set, the lower bound of the range was 10.5% with an upper bound of 34.5% (with an interquartile range of 12.6% to 20.2