Protest and Application for Further Review of 2801-19-100144; Reconciliation of Transfer Prices

H304841 April 23, 2021 OT:RR:CTF:VS H304841 JMV CATEGORY: Valuation Director U.S. Customs and Border Protection Electronics Center of Excellence and Expertise 301 E. Ocean Blvd. Suite 1400 Long Beach, CA 90802 RE: Protest and Application for Further Review of 2801-19-100144; Reconciliation of Transfer Prices Dear Director, This is in response to the Application for Further Review (“AFR”) of Protest No. 2801-19-100144, dated June 14, 2019, filed against Custom and Border Protection’s (“CBP”) decision to liquidate the merchandise at issue based on the value declared at entry. The Protestant, Hanwha Q CELLS America, Inc. (“HQCA”) seeks reliquidation at the value adjusted pursuant to its transfer pricing policy. FACTS: HQCA, a photovoltaic products distributor located in Irvine, California, primarily purchases solar module products from its related entity Hanwha Q CELLS Corporation Korea (“HQC KR”) for resale in the United States. As of November 1, 2018, HQC KR merged with Hanwha Advanced Materials Corporation and became Hanwha Q CELLS & Advanced Materials Co. Ltd. (“HQC AM”). HQC AM manufactures the solar modules at its facilities in Malaysia and South Korea. The ultimate parent company for HQCA, HQC AM, and all other Hanwha entities (collectively “Hanwha Group”) is Hanwha Corporation (“HC”). HC engages in a wide range of businesses including manufacturing, construction, finance, services, and leisure industries with more than 400 affiliates around the globe. The Hanwha Group entered in the photovoltaic equipment market with its thermal, automation, and precision processing technologies more than a half century ago. The various Hanwha entities in the solar system business are named as “Hanwha Q CELLS” after its proprietary “Q.ANTUM Solar Cells” technology and are located in multiple countries including the United States, Malaysia and South Korea. The products that are subject to the transactions at issue are solar modules classified under subheading 8541.40.60 of the Harmonized Tariff Schedule of the United States (“HTSUS”). You state that the solar modules are a packaged, connected assembly of solar cells that generates and supplies solar electricity in both commercial and residential applications. A photovoltaic system typically includes a panel or an array of solar modules, a solar inverter, and sometimes a battery and/or solar tracker and interconnection wiring. Solar modules classified under subheading 8541.40.60, HTSUS are subject to a 0% general duty rate, but subject to 30% tariffs under Section 201 of the Trade Act of 1974 (19 U.S.C. §2251) on certain Crystalline Silicon Photovoltaic cells (“Solar Cells”) classified in the subheadings enumerated in Section XXII, Chapter 99. Upon entry of the solar cells, HQCA declared the transaction value on the sale from its related party. Now, HQCA is protesting the liquidated entered value of its imported solar modules after its intercompany transfer pricing adjustment, which impacts the dutiable value of the subject products. HQCA provided our office with the following documents to review: A schedule of affected entries, Supply and Purchase Agreements between HQCA and both sellers, An income statement-to-income statement comparison of profits, Profit margins of 15 sample transactions, An organizational chart, Purchase orders, Invoices, Proofs of payment and payment journal entries, Bills of Lading, Packing Lists, A 2018 Transfer Price Operation Plan, dated February 20, 2017, Transfer Pricing Studies for 2017 and 2018, and A 2018 Transfer Price Adjustment Approval (“2018 Adjustment Approval”). HQCA states that the “Supply and Purchase Agreements” (the “Agreements”) between HQCA and the Sellers (i.e., HQC KR and later, HQC AM), dated January 1, 2018 and November 1, 2018, respectively, constitute the Company’s written transfer pricing policy in effect at the time of importation of the merchandise subject to this protest. The agreements state: Upon the completion of each transaction pursuant to the terms of this Agreement, Buyer shall provide to Seller a financial result of completing such transaction (the “Financial Result”). In the event that such Financial Result demonstrates[] the Purchase Price does not cover cost plus arm’s length markup[,] [t]he Parties agree that the Seller is entitled to make a financial adjustment in order to ensure that the Financial Result of the transaction is consistent with the Transfer Pricing Policy. Initially, HQCA stated that “the ‘Transfer Pricing Policy’ referenced in the Agreements implies the annual Transfer Pricing Report” and that the transfer pricing policy is set out in the Transfer Pricing Report to ensure the intercompany purchase prices allow HQCA to earn an arm’s-length profit based on its functions performed, assets employed, and risks borne. HQCA states that the arm’s length profits are determined based on the benchmark analysis of functionally comparable U.S. companies with similar metrics conducted annually based on the previous year’s data, in accordance with IRC §482 regulations. HQCA later stated that the 2018 Transfer Price Operation Plan, dated February 20, 2017 indicated that the transfer price is determined through a formula: total factory costs + markup + cost adder if applicable. HQCA indicated that the cost adder is applied in the case unforeseen costs are incurred. In those instances, the cost adder is applied if the additional costs exceed 5% of the total factory costs. HQCA provided this office with a comparison of Hanwa Corporation’s and the sellers’ profits in an income statement-to-income statement comparison. After further conversations with this office, HQCA provided the profit data at the transactional level. Specifically, HQCA provided operating profit margins (“OPM”) for ten sample transactions from fiscal year (“FY”) 2018, which were selected from over 2,300 sale transactions from HQC AM and HQC KR to HQCA. The OPM’s for the selected transactions range between 10% and 17%. HQCA further states that the OPMs of all transactions, including the selected transactions, range between 1.42% and 19.8%. The sellers’ aggregate OPMs, which include all sales of merchandise of the same class or kind, are 9.53% and 2.04% for HQC KR and HQC AM, respectively. According to HQCA, the OPMs of HQC AM and HQC KR at both the transactional and aggregate levels are higher than Hanwha Corporation’s overall OPM of -0.61% in sales of products related to sunlight and photovoltaic power generation for FY 2018. Finally, HQCA provided its Transfer Pricing Studies for 2017 and 2018 and its 2018 Adjustment Approval, which includes an arm’s length range different than the range in the transfer pricing studies. The range in the 2018 Adjustment Approval is narrower than that in the transfer pricing studies and the upper and lower bounds fall within the arm’s length range found in both the 2017 and 2018 transfer pricing studies. HQCA explained that these ranges are different because “they are two different studies that consider different economic factors.” The transfer pricing studies are conducted by a third party to identify the arm’s length range though analyzing comparable external entities and margins. The transfer pricing studies consider HQCA’s “functions and risks, and other external factors, such as margins of comparable unrelated entities.” The 2018 Adjustment Approval on the other hand, is prepared internally to identify adjustments between the Company’s related entities to ensure their arm’s length nature. HQCA further stated that the Adjustment Approval considers not only the transfer pricing study, but also many internal factors, such as health of the related entities, tax implications of those entities, internal policies and projections. ISSUE: Whether the related party price is fixed or determinable pursuant to an objective formula at the time of importation for purposes of determining transaction value. LAW AND ANALYSIS: Merchandise imported into the United States is appraised for customs purposes 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). As provided in 19 U.S.C. §1401a(b)(4): (A) The term “price actually paid or payable” means the total payment (whether direct or indirect, and exclusive of any costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the United States) made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller. Section 152.103(a)(1), CBP Regulations (19 CFR §152.103(a)(1)) provides, in pertinent part, as follows: In determining transaction value, the price actually paid or payable will be considered without regard to its method of derivation. It may be the result of discounts, increases, or negotiations, or may be arrived at by the application of a formula, such as the price in effect on the date of export in the London Commodity Market. However, rebates, or any other decrease in the price actually paid or payable made or effected after the date of importation are to be disregarded for the purposes of determining transaction value. 19 U.S.C. §1401a(b)(4)(B). CBP has determined that where the price is not fixed at the time of importation, transaction value is not applicable. See e.g., HQ 545618, dated August 23, 1996; HQ 545242, dated April 16, 1995; HQ 545798, dated October 28, 1994; HQ 546231, dated February 10, 1997; and HQ 546421, dated March 27, 1998. CBP has determined that the fixed price rule is satisfied when the price is determinable by an objective formula agreed upon prior to importation. In applying this provision, CBP ruled in HQ 542701, dated April 28, 1982, TAA No. 47, and in subsequent rulings, that in situations in which the price paid or payable is determined pursuant to a formula, a firm price need not be known or ascertainable at the time of importation. Nevertheless, it is necessary for the formula to be fixed at importation so that a final sales price can be determined at a later time on the basis of some event or occurrence over which neither the seller nor the buyer has any control. See also HQ 545622, dated April 28, 1994. 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 (and incorporating Headquarters’ Ruling (“HQ”) W548314, dated May 16, 2012). In HQ W548314, CBP established a broader interpretation of what is permitted under transaction value to allow a transfer pricing policy/APA to be considered a “formula” in the transfer pricing context provided certain criteria are met. HQ W548314 specifically referred to the adjustments made pursuant to a company’s formal transfer pricing policy or APA. In order to claim the post-importation adjustments (upward and downward), all of the following factors must be met: A written transfer pricing policy is in place prior to importation and the policy is prepared taking IRS code section 482 into account; The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return; The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted; The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and, No other conditions exist that may affect the acceptance of the transfer price by CBP. In support of the argument that the parties had a written transfer pricing policy in affect prior to the importation of the goods, HQCA first provided Supply Agreements and a transfer pricing study. Both Supply Agreements state: Transfer Price. Upon the completion of each transaction pursuant to the terms of this Agreement, Buyer shall provide to Seller a financial result of completing such transaction (the “Financial Result”). In the event that such Financial Result demonstrates[] the Purchase Price does not cover cost plus arm’s length markup[,] [t]he Parties agree that the Seller is entitled to make a financial adjustment in order to ensure that the Financial Result of the transaction is consistent with the Transfer Pricing Policy. Emphasis added. HQCA stated that “Transfer Pricing Policy” implies the annual Transfer Pricing Study. However, there is no indication in any of the documents provided that the “transfer pricing policy” refers to the transfer pricing study. The importer argues that the term “transfer pricing policy” in the excerpt from the Supply Agreement above by definition includes the transfer pricing study. The importer supports their assertion by referencing H018314, dated March 18, 2013, wherein CBP stated that “[t]he term ‘transfer pricing policy’ refers to Advance Pricing Agreements (‘APA’s), transfer pricing studies prepared in accordance with 26 U.S.C. §482 (the IRS transfer pricing statute) or its foreign equivalent, and/or legally binding inter-company agreements/memoranda.” Although a transfer pricing policy may include a transfer pricing study, this does not necessarily mean that the transfer pricing policy inherently qualifies as a formula within the meaning on 19 CFR §152.103(a)(1). For example, in HQ H157795 dated June 29, 2015, CBP found that the transfer pricing study and an Intercompany Transfer Pricing Determination Policy did not constitute a formula for the purposes of post-importation price adjustments. HQCA further asserts that the transfer pricing studies alone, which look at HQCA’s profits, sufficiently constitute a formula in the transfer pricing context as CBP has accepted a transfer pricing study as sufficient in HQ H219515, dated October 22, 2012. While CBP has looked to transfer pricing studies as evidence that transfer pricing policies are representative of arm’s length transactions, CBP has not found that a transfer pricing study that simply compares profit margins to be a “formula agreed to prior to importation.” The transfer pricing study in HQ H219515 went into much more detail than the studies here. The transfer price in HQ H219515 was based on a stated U.S. list price, upon which the parties applied a standard percentage discount for sales of all products within each product center. The Importer’s product managers set U.S. list prices when the product was being introduced based on an evaluation of the market that determined what the market could bear. The Importer submitted its transfer pricing matrix, illustrating its discounts by product center, in support of this statement. The importer in that case also noted that the allocation of adjustments would be proportionate for each product center so that each product center’s gross margin conformed to the adjusted overall gross margin of the Importer’s U.S. distribution. Here, the transfer pricing study does not explain how the transfer prices are initially determined or how adjustments are allocated. HQCA also argues that the transactions at issue are the same as those considered in HQ H176775, dated March 6, 2014 as both involve prices that were initially set at seller’s costs plus a margin and then adjusted to bring the importer/distributor’s profit in line with a transfer pricing study. However, the prices declared at entry in HQ H176775 were essentially place holders that were flagged for reconciliation after the final price was calculated pursuant to the terms outlined in the distribution agreement between the related parties. In fact, the mark-up on costs was added at entry only at the insistence of the CBP port of entry. The actual transfer prices in HQ H176775 were calculated on a monthly basis based on the sale price to the U.S. customer and the importer/distributor’s actual costs plus an “Agreed Margin.” The Agreed Margin was negotiated between the two parties to allow each to earn an arm’s length profit. The Agreed Margin was also determined to be within an interquartile range of operating margins of comparable companies according to transfer pricing studies. Therefore, the formula in HQ H176775 was based on the importer/distributor’s costs and profits and prices and could be adjusted accordingly. However, here the formula considers the seller’s profit and costs and therefore adjustments made based on the buyer’s profits are not made pursuant to the transfer pricing policy. The facts in the case at hand are more similar to those of HQ H157795. In HQ H157795, CBP found that an intercompany agreement was not a transfer pricing policy with sufficient detail so that it may meet the requirement of a pricing formula. In making this decision, CBP noted that there was “no specificity regarding how adjustments [would] be made with regard to the prices for sales of spare parts from the related supplier to the importer.” The transfer pricing studies submitted in that case also did not offer any specificity regarding how adjustments were made. The transfer pricing studies merely provided the opinion of the independent accounting companies based on information provided by the related parties to determine whether the prices for the sales of goods between the related parties reflected an arm’s length price and would be appropriate from a tax perspective. Similarly, the transfer pricing studies in the case at issue merely provide the opinion of an independent accounting company on whether the prices in the sales of goods between the related parties reflected an arm’s length price and whether the sales profits would be appropriate from a tax perspective. The 2017 and 2018 studies make no mention as to how prices are determined or how adjustments are allocated. Additionally, the studies compare HQCA to companies that are similar to HQCA in functions and risks, meaning the comparable companies in the transfer pricing studies were other distributors outside of the photovoltaic cell industry. However, the solar panels, which are the subject of the sales at issue, were subject to an additional 30% tariff during this time. Even though these additional tariffs will inevitably affect HQCA’s profits, this additional tariff is not contemplated in either of the transfer pricing studies in relation to the profits of the comparable companies in industries that are not subject to the additional tariff. Therefore, it is unclear whether the interquartile range provided in the studies is actually representative of an “arm’s length range.” Even more confounding is that HQCA stated that the transfer pricing studies, and the adjustment approval plan are based on different considerations. The interquartile range for the 2018 transfer pricing study is 1.0-4.0%, for the 2017 transfer pricing study it is 0.7-4.3%, and both differ from the range in the Adjustment Approval Plan, which is 2.05-2.78%. HQCA argues that the range in the Adjustment Approval Plan is more narrow than, and fits within the range outlined in the 2018 transfer pricing study. However, the fact that the “arm’s length range” in the Adjustment Approval Plan is different than the transfer pricing study suggests that the transfer pricing study is not actually used for calculating adjustments. In fact, when asked about this difference, HQCA stated that the interquartile range in the transfer pricing study originally provided is different from the range in the Adjustment Approval Plan because they are two different studies that consider different economic factors. HQCA continued, The [transfer pricing study] is conducted by a third party to identify HQCA’s interquartile range via analyzing comparable external entities and margins. This study considers HQCA’s functions and risks, and other external factors, such as margins of comparable unrelated entities. The 2018 Approval Plan on the other hand, is prepared internally in order to identify adjustments between the Company’s related entities in order to satisfy their arm’s length nature. This Plan considers, not only the [transfer pricing study], but also many of the internal factors, such as health of the related entities, tax implications of those entities, internal policies and projections. Because the transfer pricing study does not include an analysis of any of these additional factors, and because the interquartile range in the Adjustment Approval Plan is different than that in the transfer pricing study, we find the argument that the adjustments are made pursuant to a formula within the meaning of 19 CFR §152.102(a)(1) even more unconvincing. HQCA also provided a 2018 Transfer Price Operation Plan, which HQCA stated illustrates that Hanwa Group had a transfer pricing policy of setting prices at total factory costs + markup + cost adder if applicable. However, this formula was not specifically defined as the transfer pricing policy in the 2018 Transfer Price Operation Plan. The words “mark-up” only appear in two of the three examples and none of the documents define what the “mark-up” is or how it is determined. Only after this was pointed out did HQCA provide a 2017 Transfer Pricing Operation Plan dated December 2016, which HQCA states was the pricing plan in place for the taxable years ending December 31, 2017, and December 31, 2018. The 2017 Transfer Pricing Operation Plan defined the mark-up as 5%. The reading of the 2018 and 2017 Transfer Pricing Operation Plans in combination with the Supply Agreement, which requires the buyer to pay a purchase price that will “cover cost plus arm’s length markup,” suggests that the parties do have a written transfer pricing policy in place. HQCA asserts that the “language of the agreement clearly contemplates that the parties will make adjustments to prices only if the adjustment clause is triggered by virtue of the arm’s length pre-condition not having been satisfied, and further directs the parties to ‘the Transfer Price Policy.’” Yet, nothing in these three documents indicates how adjustments should be made. Further, HQCA’s position is that CBP should accept adjustments based on the importer’s profits—to bring the importer’s profits in line with the transfer pricing study. However, the Supply Agreement and the transfer price operation plans only refer to costs and mark-up, which is a percentage of those costs, that the buyer provides to the seller. None of these documents mention any value arrived at by looking at the buyer’s profits. Therefore, the adjustments based on the importer’s profits cannot be pursuant to a transfer pricing policy that makes no mention of the importer’s profits. Additionally, the Supply Agreement provided by HQCA states that the Seller is “entitled to make a financial adjustment . . .” The Merriam Webster Dictionary defines “entitled” as “having a right to certain benefits or privileges.” Therefore, the seller has the right to make adjustments to prices but is under no obligation to do so. Finally, HQCA argues that prospective uncertainty over future financial results explains why there is a need for retroactive adjustments to prices and for the reconciliation of customs values, notwithstanding that the initial price was set on the basis a formula that was in place prior to import. HQCA notes that the arm’s length range benchmark is generally determined in compliance with the local tax laws of the tested taxpayer (in this case, compliance with IRS § 482, as the tested party is the U.S. entity), which is confirmed by the transfer pricing studies. HQCA states this is how the parties set their transfer price and the adjustment in 2018. HQCA argues that it is axiomatic that “adjustments” established by post-import transfer pricing studies like those in HQ H219515, HQ H018314 and HQ H176775, targeting the buyer’s margin, will retroactively recompute the selling price and, in turn, the seller’s profit margins. This is necessary because in the case where the tested buyer’s profit margin is determined to fall outside of the comparable arm’s length, range or target, the seller’s price or margin must change. HQCA argues that if it stayed the same, it would lead to a result that is not arm’s length for the tested buyer, in contravention of §482 regulations. While CBP recognizes that adjustments to the profit margin for one party also adjusts the profit margin to the other, this does not necessarily mean that one party will be left with a profit margin that falls outside of the arm’s length range for that party. The five factors originally outlined in W548314 were developed to determine whether an objective formula is in place prior to importation for purposes of determining the price within the meaning of 19 CFR §152.103(a)(1). One of the requirements of a formula is that the formula must be based on be an objective standard not under the control of the buyer or seller. However, according to the Supply Agreement, whether prices are adjusted is under the seller’s discretion. Additionally, the five factors require that the transfer pricing policy establish how adjustments are to be made. Here, the importer is claiming downward adjustments based on the importer’s profits, which are not considered in the transfer pricing policy. Therefore, we cannot find that the adjustments are made pursuant to a transfer pricing policy. Even if the transfer pricing studies were sufficient to constitute a transfer pricing policy, none of the companies in the transfer pricing studies were subject to an additional 30% tariff, as were the subject solar panels, which was not considered in the transfer pricing studies. We find that the adjustments are not based on an objective formula and the transaction value originally declared may not be adjusted. HOLDING: Based on the above discussion, the protest should be denied. Because the transfer pricing policy was not based on an objective formula, we find no basis upon which to grant the Protestant’s request to reconcile the transaction value initially declared. In accordance with the Protest/Petition Processing Handbook (CIS HB 3500-08A, December 2007, pp. 24 and 26), you are to mail this decision, together with the CBP Form 19, to the protestant no later than 60 days from the date of this letter. Any reliquidation of the entry in accordance with this decision must be accomplished prior to mailing of the decision. Sixty days from the date of the decision, the Office of Trade, Regulations and Rulings will make the decision available to CBP personnel, and to the public on the Customs Rulings Online Search System (CROSS) at https://rulings.cbp.gov/ which can be found on the U.S. Customs and Border Protection website at http://www.cbp.gov and other methods of public distribution. Sincerely, For Craig T. Clark, Director Commercial and Trade Facilitation Division