CBP Ruling W544409

HQ W544409 November 20, 1989 CLA- 2 CO: R:C:V 544409 VLB CATEGORY: Valuation Gerry Weaver U.S. Customs Service Regulatory Audit Division 3605 Atlanta Avenue Atlanta, Georgia 30354 Dear Sir: This is in response to your memorandum dated October 12, 1989, concerning your recent audit of Ciba Vision Corporation (“CVC”). You have stated that the audit revealed that “CVC” is making undeclared royalty payments to Titmus Eurocon Kontaktlinsen GmbH, Co. KG (“Titmus”). FACTS: CVC is paying Titmus royalties pursuant to an agreement that was executed on January 31, 1980, between Ciba-Geigy Corp. (CGC) and Titmus. The rights and the obligations under the agreement were assigned by CGC to CVC. You state that CVC, CGC and Titmus are all wholly owned by Ciba-Geigy Limited, located in Basle, Switzerland. The agreement is made up of four documents: (1) the Basic Agreement; (2) the Patent License Agreement relating to Welcon 38 Lenses; (3) the Supply Agreement, and (4) the Technical Assistance/ Turnkey Agreement. The agreements are described below: (1) Basic Agreement - provides for general cooperation between the parties. Under the agreement Titmus is to provide patents, licenses, “knowhow”, supplies, and equipment to CVC in exchange for CVC's manufacture, sale, and marketing of lens products in the U.S. In addition, CVC will pay Titmus a royalty based on a percentage of “net proceeds of sales” in the U.S. The royalty is 10% for lens care products and 15% for each product. The royalties are to be paid for a period of 10 years from the date of the first sale of the products. - 2 – Finally, the products that Titmus sells to CVC are priced at Titmus’ “Actual Manufacturing Cost” which is defined as the “costs and expenses incurred by [Titmus] in producing any product … which it sells to CIBA - GEIGY (CVC) under this Agreement, but limited to [Titmus’] cost of materials used, the cost of direct labor applied and the cost of applicable manufacturing overhead… (2) Patent License Agreement relating to Wiecon 38 Lenses - licenses to CVC U.S. patents owned by Titmus relating to the Wiecon lenses. This agreement provides for a 15% royalty payable on the same terms as (and in lieu of) the royalties provided for in the Basic Agreement. Under this agreement the royalties are payable until expiration of the last covered patent. (3) Supply Agreement - provides for Titmus to supply, and CVC to purchase, CVC's total requirement of “blanks” for manufacture into Weicon 38 lenses. This agreement also provides that Titmus will supply finished lenses at “Actual Manufacturing Cost” plus shipping, up to a maximum of 100,000 lenses. (4) Technical Assistance/Turnkey Agreement - provides for Titmus to assist in the construction of CVC's contact lens factory and to provide equipment and training. Under the agreement, the equipment is to be provided at Titmus' actual acquisition cost, and training is to be provided free. ISSUES: (1) Whether transaction value is applicable in appraising merchandise that the importer purchases from a related party. (2) If transaction value is applicable, are the royalty fees the importer pays to the related party included in the transaction value of the imported merchandise. LAW AND ANALYSIS: Transaction value, the preferred method of appraisement is defined in section 402(b) (1) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (19 U.S.C. 1401a(h); TAA) as the “price actually paid or payable for merchandise when sold for exportation to the United States…“ Under section 402(g) of the TAA, Titmus and CVC are related parties. Section 402(b)(2)(B) of the TAA states the following: The transaction value between a related buyer and seller is acceptable … if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between such buyer and seller did not influence the price actually paid or payable; or if the transaction value of the imported merchandise closely approximates (one of the enumerated test values]. In the “circumstances of the sale” test, Customs examines the way in which the buyer and the seller organize their commercial relations and the way in which the price in question was arrived at, to determine whether the relationship influenced the price. See, 19 CFR 152.103(j) (2). If it is shown that the buyer and the seller, although related, buy from and sell to each other as if they were not related, then the parties have demonstrated that the price was not influenced by the relationship. Id. An example under this test is a showing that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or in the manner that the seller settles prices for sales to unrelated buyers. In addition, if the parties demonstrate that the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time, in sales of merchandise of the same class or kind, then the circumstances of the sale test has been met. In the present case, there is no information concerning the normal pricing practices in the eye care product industry. Therefore, the first example does not apply. In addition, the Basic Agreement provides for CVC to purchase finished eye care products from Titmus at Titmus' "actual manufacturing cost”, e.g, Basic Agreement, Art. 8.2. at p. 27. The “actual manufacturing cost” of the imported products does not include an amount for profit. You have indicated that you believe that the CVC's royalty payments serve as the profit in the transaction. However, in the “circumstances of the sale” test the price actually paid or payable is examined. In this case, the price actually paid or payable is the “actual manufacturing cost”, which does not include the royalty payment. Because a profit figure is not included in the price actually paid or payable, the second example does not apply to this case. Therefore, the “test value” method must be examined to determine whether the transaction value of the imported merchandise is acceptable. Under the “test value” method the transaction value of the merchandise is acceptable if it closely approximates one of the following values: the transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States: the deductive value or computed value for identical merchandise or similar merchandise. The values enumerated in (i) and (ii) can be used for comparison only if the values relate to merchandise that was exported to the U.S. at or about the same time as the imported merchandise. In the present case, CVC is acting essentially as an exclusive distributor of Titmus’ products in the U.S. Thus, Titmus does not sell identical or similar merchandise to unrelated buyers in the U.S. In addition, there is no evidence of identical or similar imported merchandise that was appraised under deductive value or computed value. As a result, no transaction values, deductive values, or computed values are available as test values. Because these values are not obtainable the “test value” method cannot be used to establish that the relationship did not influence the price of the imported merchandise. In sum, CVC cannot meet either of the two tests that verify the acceptability of the transaction value for the imported merchandise. Consequently, transaction value cannot be used to appraise the merchandise. Under the TAA it is necessary to proceed sequentially through the remaining bases of appraisement to determine the appropriate valuation method. The second appraisement method in order of statutory preference is transaction value of identical and similar merchandise under section 402(c) of the TAA. As discussed previously it appears that there are no sales of identical merchandise to unrelated parties. Also, Ed Griffin, one of the auditors involved in this case, indicated in a conversation with a member of my staff that he is not aware of any sales of similar merchandise that could be used as a basis of appraisement. The succeeding basis of appraisement is deductive value under 402(d) of the TAA. Deductive value involves appraising the merchandise on the basis of whichever of three prices, adjusted as provided in section 402 (d)(3) of the TAA, is appropriate. The appraisement depends upon when and in what condition the merchandise is sold in the U.S. The contracts that you have submitted indicate that the merchandise is resold in the U.S. Mr. Griffin has also informed my staff that the audit is focusing only on the importation of finished products. Therefore, it appears that the merchandise would be sold in the condition as imported. See, 19 CFR 152.105. If the merchandise is sold at or about the time of importation, the price is the unit price at which the merchandise is sold in the greatest aggregate quantity at or about such date. 19 CFR 152.105 (c)(1). If the merchandise is not sold at or about the date of importation, the price is the unit price at which the merchandise concerned is sold in the greatest aggregate quantity after the date of importation of the merchandise being appraised but before the close of the 90th day after the date of such importation. 19 CFR l52.105(c)(2). Once you have determined the applicable price, deductions must be made for commissions or profit and general expense addition, transportation cost, insurance costs. customs duties, and Federal taxes pursuant to sections 402(d)(3)(A)(i)-(v) of the TAA. Although deductive value appears to be the appropriate appraisement method, the importer, pursuant to 19 CFR 152.107(c), may elect for future entries to have the goods appraised under computed value in section 402(e) of the TAA. The computed value is the sum of the cost or value of the materials and fabrication, an amount profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind, any assists, and the packing costs. See, 19 CFR 152.106. Mr. Griffin has indicated that the parties have been reluctant to supply cost information. Should the importer elect to have the goods appraised under computed value, but not supply adequate information, then deductive value is the proper method of appraisement. HOLDINGS: (1) Transaction value cannot be used to appraise the merchandise. The importer cannot meet either of the two tests that establish the acceptability of the price in a related party transaction. Deductive value is the proper method of appraisement unless the importer elects to have the merchandise appraised under computed value. (2) Transaction value is not the proper method of appraisement for the merchandise. Therefore, we do not need to address the question of whether the royalty payments would be dutiable under transaction value. Sincerely, John Durant, Director Commercial Rulings Division