Internal Advice; Related Parties; Unrelated final customer; Transaction Value

HQ H314296 August 12, 2021 OT:RR:CTF:VS H314296 AP CATEGORY: Valuation Amy Guerriero, Field Director U.S. Customs and Border Protection Regulatory Audit and Agency Advisory Services Office of Trade 10 Causeway Street, Room 895 Boston, MA 02222-1059 RE: Internal Advice; Related Parties; Unrelated final customer; Transaction Value Dear Ms. Guerriero: This is in response to your internal advice request dated October 7, 2020, initiated by counsel for [X] (the “importer” or [X]), concerning the applicability of transaction value as a method of appraisement of laser cutting machines imported into the United States via a multi-tiered transaction with related parties and the dutiability of royalty payments paid by the importer for the use of its parent company’s trademark. These questions arose as a result of a Focused Assessment Audit conducted by U.S. Customs and Border Protection’s (“CBP”) Regulatory Audit and Agency Advisory Services (“RAAAS”). Virtual meetings with the importer’s counsel and controller were held on April 30 and May 20, 2021. The importer has asked that certain information submitted in connection with this internal advice request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 C.F.R. § 177.2(b)(7), the importer’s request for confidentiality is approved. The information contained within brackets as well as all attachments to your request for internal advice forwarded to our office and the documentation submitted by the importer’s counsel will not be released to the public and will be withheld from the published version of this decision. FACTS: The importer is headquartered in the United States [X]. It designs, produces, and distributes punching machinery, laser machinery, gas and solid-state laser resonators, and laser diodes. The importer primarily operates in the Machine Tools/Power Tools and Laser Technology/Electronics business divisions of the [X] Group. The importer is a wholly-owned North American subsidiary of [X] ([X] or “parent company”) located in Germany. The parent company owns a 100 percent direct interest quota in [X] in Germany ([X] or the “middleman”), and a 100 percent indirect interest quota in [X] in Switzerland ([X] or the “manufacturer”) and in the importer. The parent company coordinates payments from all its subsidiaries and acts as a central, clearing “bank.” [X] ([X] or “Company R”) in Alabama is the unrelated final customer in the U.S. On June 6, 2017, the importer filed a claimed prior disclosure with respect to royalty payments it paid to its parent company. In its submission, the importer stated, it “believes” that the royalties “paid on imported merchandise sold in the U.S. may be dutiable.” On July 20, 2018, the importer filed another submission to perfect its claimed prior disclosure stating the subject royalties would not be dutiable as royalty payments or proceeds. On July 17, 2020, RAAAS, Boston Field Office completed a focused assessment pre-assessment survey of the importer’s processes. The scope of the RAAAS audit included imports from July 1, 2015 through June 30, 2016. RAAAS selected and reviewed entries where [X] served as the U.S. importer of record to determine whether transaction value was properly declared to CBP. Your office determined that transaction value was not an acceptable basis of appraisement between the importer [X] and its related parties. The importer did not agree with RAAAS’ determinations and initiated this internal advice request. The representative transaction that you used as an example and referred to us in your RAAAS internal advice request is entry number [X]. Transaction between the Manufacturer and the Middleman The manufacturing agreement between the related manufacturer and middleman states that the products should be made by the manufacturer to the middleman’s order and according to the middleman’s specifications. The middleman oversees the ordering and distribution process. “Unless otherwise agreed, risk and title should pass to the principal [the middleman] ex works manufacturer’s factory.” (Emphasis added). The agreement “shall be subject to the laws of the Federal Republic of Germany, excluding the law of conflicts and the UN Convention on Contracts for the International Sale of Goods (CISG).” Purchase Order (“PO”) Number (“No.”) [X] dated July 22, 2015, identifies the manufacturer as the foreign seller of laser machine [X] priced at [X] Euros (“EUR”) and delivered to the middleman on September 4, 2015. Invoice No. [X] from the manufacturer to the middleman, dated September 4, 2015, lists the middleman as the buyer in Germany and indicates delivery is to Company R in Alabama. The terms of delivery are “FCA [X],” Switzerland. The payment terms are 30 days from the time of delivery. The original merchandise price is [X] EUR. The invoice states that the “delivery is subject to retention of title at our conditions.” The revised invoice no. [X] from the manufacturer to the middleman, dated December 11, 2015, corrects the sale price of the machine by adding [X] EUR to the original price of [X] EUR, for a total cost of [X] EUR. The invoice states that the “delivery is subject to retention of title at our conditions.” Delivery Note No. [X], dated September 4, 2015, lists the middleman as the buyer, the terms of delivery of the transaction between the manufacturer and the middleman as “FCA (Free Carrier at) [X],” Switzerland and notes that the “shipping terms correspond to INCOTERMS 2010.” It shows that the manufacturer delivered the laser machinery to Company R in [X], AL. The inventory records show that on September 4, 2015, the merchandise was in the middleman’s inventory. The middleman assumed the delivery costs and risk of loss when the merchandise was loaded on the truck at the manufacturer’s premises in [X], Switzerland. The middleman paid [X], the trucking/transport company that transported the laser machinery from Switzerland to the shipping port in Germany (Invoice No. [X] dated September 9, 2015, related to bill of lading no. [X]), to deliver the machine from the manufacturer in Switzerland to [X], the container company in Hamburg, Germany that loaded the machine onto containers and onto the vessel for ocean shipment. Payment from the Middleman to the Manufacturer The [X] Group uses a multilateral netting process to make payment arrangements for intercompany transactions to eliminate the need for multiple invoicing and payments among its affiliates. The parent company serves as the netting center that offsets accounts payables and accounts receivables to determine the net receivables and net payables between its subsidiaries. All subsidiaries send a single payment to the parent company, which in turn sends payments to the subsidiaries that are due payment. The parent company paid the manufacturer a total of [X] EUR ([X] EUR + [X] EUR) for the laser machine on October 23, 2015 ([X] EUR) and on February 19, 2016 ([X] EUR). The manufacturer received the payments via bank transfers on the same days. Transaction between the Middleman and the U.S. Importer The distribution agreement between the middleman and the importer states that as a distributor, the importer can determine selling prices in North America, and can buy in its own name and for its own account. The middleman owns the licenses of all product trademarks and grants the importer the non-exclusive and non-transferable right to use its product trademarks in advertising and promotional materials for the contractual products in the contractual territory only. Under the delivery terms, “Unless otherwise agreed, delivery of contractual products shall be ex warehouse of principal [the middleman] or its contract manufacturers. The risk of transport shall be borne by the distributor [the importer].” The products delivered to the importer “remain in the legal ownership of principal [the middleman] until distributor [the importer] has fully paid all outstanding invoices of principal [the middleman] that are due for payment. As long as principal [the middleman] remains the owner of contractual products shipped to the distributor [the importer], principal [the middleman] retains the right to separate these contractual products still owned and to take them back into its own premises.” (Emphasis added). The agreement is “subject to the laws of the Federal Republic of Germany, excluding the law of conflicts and the UN Convention on Contracts for the International Sale of Goods (CISG).” The [X] U.S. Transfer Pricing Analysis Report for fiscal year ended June 30, 2016 (“FY 2016”) prepared by Deloitte Tax LLP (“Transfer Pricing Report” or “report”) states, “The title for products sold by the [X] Affiliates passes on to [the importer] as soon as they are shipped to the U.S. Similarly, the title of the products distributed by [the importer] passes on to the third parties as soon as the products leave [the importer’s] factories or warehouse.” The importer makes use of its third-party logistics and transportation network to ship and deliver products to its end customers in the U.S. Purchase Order No. [X] dated July 22, 2015, from the importer to the middleman identifies the terms of payment as 90 days month end and the terms of delivery as “EXW Ex Works.” This PO was revised twice on July 22, 2015, to change the pricing and discount of [X] percent. It replaced PO No. [X]. The country of delivery is the U.S. The gross amount of the laser machine on the purchase order is [X] EUR less a [X] percent discount of [X] EUR for a total net price of [X] EUR. The “deliver to” address is Company R, [X] AL [X]. Invoice No. [X] from the middleman to the importer dated September 7, 2015, lists the shipment location as Company R in [X], AL and states that “[t]itle will not pass until payment is received in full.” The date of delivery is “09/2015.” The terms of payment are “Up to 12/30/2015 without deduction.” The terms of delivery are “FOB German Seaport.” The total net amount of the [X] machinery is [X] EUR, which includes a [X] percent customer discount. The importer [X] paid the invoice on December 18, 2015. Sea Waybill Number [X] dated September 16, 2015, identifies the middleman as the shipper; the importer as the consignee; Hamburg, Germany, as the place of receipt and port of loading; and New York, NY, as the port of discharge and place of delivery. It lists container numbers [X]. The freight was shipped on September 16, 2015. The “Shipper’s Load & Count” identifies [X], Machine [X], and PO No. [X], and the stuffing location of the container company [X] located in Hamburg, Germany. The Packing List identifies the middleman’s head office in Germany, the delivery address of Company R in [X], AL, and Machine [X], [X], country of origin Switzerland. Invoice No. [X] dated September 22, 2015 (total value of $[X]) from [X], the international freight forwarder that handled the ocean freight, to the importer indicates that the merchandise shipped via vessel, [X], from the Port of Hamburg, Germany, to the Port of New York. The importer paid the international freight forwarder via wire transfer on September 29, 2015, through [X] Bank. The importer assumed the risk of loss once the merchandise was on board the ship under the terms FOB German Seaport listed on the invoice. The delivery order from the importer to the transportation company [X] in Connecticut dated September 21, 2015, reveals that the merchandise was forwarded to the transportation company on September 26, 2015. The invoice from the trucking company, [X], to the importer dated October 2, 2015, shows that the merchandise was delivered from Global Terminal in Jersey City, NJ to the transportation company [X] in Connecticut. The bill of lading dated October 13, 2015, lists the importer, c/o [X] in Newark, NJ, as the shipper and Company R in [X], AL as the consignee. The freight was prepaid. The importer’s broker issued three Delivery Orders for container numbers [X] with an arrival date of September 26, 2015. The containers were picked up at the Global Terminal Service in Jersey City, NJ, and delivered to the transportation company [X], CT on September 26, 2015. Container [X] was picked up by the trucking company [X] and delivered to the transportation company in [X], CT. Containers [X] were picked up by the transportation company [X] and delivered in [X] CT. A bill of lading from [X], located in Newark, NJ, shows that the merchandise was delivered to Company R in [X], AL on October 15, 2015 (prior to the importer’s payment to the middleman and the middleman’s payment to the manufacturer). The importer [X] provided Invoice No. [X] dated October 2, 2015, in the amount of $[X] from the trucking company [X] for the delivery of container [X] from the Global Terminal in Jersey City, NJ, to the warehousing company [X] in [X], CT. The trucking company [X] sent an itemized statement for all outstanding invoices, including Invoice No. [X], for $[X]. The importer paid [X] $[X] via wire transfer on October 14, 2015, through [X] Bank. The entry/immediate delivery (CBP Form 3461) filed on September 23, 2015 and the entry summary filed on September 26, 2015, indicate that [X] was the importer of record and the total value listed for the [X] was $[X]. Payment from the U.S. Importer to the Middleman The middleman’s [X] bank statement of December 18, 2015, shows that the middleman received the payment due for the merchandise from the importer on December 18, 2015. Transaction between the U.S. Importer and the Final U.S. Customer Company R Under the U.S. importer’s [X] Terms and Conditions of Services, “All [domestic] orders are FOB [Free on Board] Seller’s plant in [X], Connecticut (or FOB such warehousing facilities as Seller may establish).” The payment terms are “10% deposit with purchase order, 90% Net 30 Days from Shipment … The risk of loss passes to Buyer upon delivery of the goods to the carrier … The validity, interpretation and performance of this contract for sale shall be governed by the laws of the State of Connecticut.” The importer [X] “reserves a security interest in the goods (and the proceeds thereof) as security for the payment of the unpaid balance of the purchase price and Buyer’s performance of its other obligations hereunder. Buyer will execute and deliver to Seller such Uniform Commercial Code financing statements as Seller shall request in order to perfect such security interest … If Buyer shall not pay the full purchase price within 30 days from the date of shipment of the goods; Buyer will pay Seller thereafter an additional one and one-half percent (1-1/2%) per month on the unpaid balance of the purchase price until paid in full. Such charge shall be added to and become an additional part of the purchase price for the goods. Buyer also will pay all costs of collection incurred by Seller in collecting the purchase price for the goods and enforcing its security interest in the goods, including, without limitation, reasonable attorneys’ fees and expenses incurred by Seller.” The June 26, 2015 purchase order from Company R to the U.S. importer [X] states that the delivery date is October 1, 2015, and the shipping method is “truck.” The unit cost of the laser machine [X] is $[X]. Company R receives a special discount of $[X]. The terms of the sale are “FOB [X], CT.” The payment terms are “10% Payment with Order. Balance Net 30 Days after Delivery.” The October 13, 2015 invoice from the U.S. importer [X] to Company R states that the laser machines ships from “[X], CT, USA” to Company R’s location in “[X], AL” via [X]. The terms of delivery are “FOB [X], CT.” The payment terms are “10% Deposit, Balance Due Net 30 Days.” The invoice refers to the Terms and Conditions of Services. In the Security Agreement dated July 8, 2015, Company R grants a security interest to the U.S. importer [X] under the Uniform Commercial Code (“UCC”) in the laser machine [X]. The security interest granted to the importer [X] is collateral security for the payment of the unpaid portion of the purchase price of the equipment. Upon payment in full of the equipment, [X] the importer will consider the security interest in the machine satisfied under the UCC. Payment from the Final U.S. Customer Company R to the U.S. Importer Company R paid 10 percent of the purchase price on August 17, 2015 and the remaining 90 percent of the purchase price on October 14, 2015. Transfer Pricing Report The Transfer Pricing Report for FY 2016 analyzed the purchase of machines and parts from [X] company affiliates in Germany and Switzerland by the importer for distribution in North America. The report was based on an analysis of the facts presented and an interpretation of the regulations under title 26, Internal Revenue Code, Sections 482 and 6662(e) and (h). The report determined the best method for evaluating the instant transaction for tax purposes was the Resale Price Method (“RPM”). The report compared the importer’s gross margin (“GM”) achieved on the sale of machines and parts in North America from purchases of such tangible goods from [X] affiliates in FY 2016, to an arm’s-length interquartile range of results achieved by comparable uncontrolled North American distributors that performed similar functions, deployed similar assets, and bore similar risks to the importer. The report determined that an arm’s-length interquartile range of weighted average accounting adjusted GMs of certain claimed comparable North American distributors for the three-year period beginning the fiscal year ended June 30, 2014 (“FY 2014”) through FY 2016 to be [X] percent to [X] percent, with a median of [X] percent. For the same three-year period, the importer earned a weighted average GM on the North American sale of purchased machines and parts from [X] affiliates in Germany, Switzerland, and Austria of [X] percent, which according to the report fell within the interquartile range of accounting adjusted GMs of comparable North American distributors. The report also analyzed the importer’s aggregate operating margin (“OM”) resulting from distribution of machine and parts purchased from the relevant [X] affiliates as well as purchases of tangible goods from uncontrolled third parties. The report compared the importer’s aggregate OM from all distribution sales for FY 2014 through FY 2016, to the accounting adjusted OMs achieved from certain claimed comparable uncontrolled North American distributors for the same three-year period that perform similar functions and deploy similar assets and bear similar risks to it. The report determined an arm’s-length interquartile range of accounting adjusted OMs achieved by comparable uncontrolled North American distributors to be [X] percent to [X] percent, with a median of [X] percent for the period FY 2014 through FY 2016. For the same period, the importer earned an OM on all distribution sales of [X] percent. The report identified “suitably comparable” North American uncontrolled distributor companies that purportedly distributed comparable machine parts and spare parts to those purchased and resold by the importer from the relevant [X] affiliates. The report searched for active companies whose primary business activities were classified under SIC Code 50 – Wholesale Trade – Durable Goods and identified the following comparable companies: [1) [X] (“Company A”); 2) [X] (“Company B”); 3) [X] (“Company C”); 4) [X] (“Company D”); 5) [X] (“Company E”); and 6) [X] (“Company F”) The report did not compare the OM of companies in the same industry or companies who sold goods of the same class or kind. The report concluded that based on the application of the RPM as the best method selecting the GM as the relevant profit level indictor (“PLI”), and its corroborative analysis of t