Reconsideration of HRL 544713; Appraisement of Oyster Sauce; Related Party Transactions; Test Values; Transaction Value; 19 U.S.C. 1401a(b)

HQ W545274 March 9, 1995 VAL CO:R:C:V W545274 LPF CATEGORY: Valuation District Director U.S. Customs Service 300 S. Ferry Street Terminal Island, CA 90731 RE: Reconsideration of HRL 544713; Appraisement of Oyster Sauce; Related Party Transactions; Test Values; Transaction Value; 19 U.S.C. 1401a(b) Dear Sir: This is in response to a letter, dated October 7, 1994, from counsel, Stein Shostak Shostak & O'Hara, representing Lee Kum Kee, Inc., requesting reconsideration of Headquarters Ruling Letter (HRL) 544713, issued December 2, 1992, as an Internal Advice concerning the appraisement of oyster sauce. We also are in receipt of a submission dated January 17, 1995, presented to address final points raised during our meeting with counsel on December 6, 1994. FACTS: Lee Kum Kee (USA) Inc. (LKK-US) imports food products from a related Hong Kong company, Lee Kum Kee Co., Ltd. (LKK-HK). Because both companies have common stockholders, all concerned parties agree that the companies are related pursuant to section 402(g) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. 1401a. LKK-HK not only sells food products to LKK-US, but also to unrelated importers in the U.S., as well as Central and South America. However, the prices charged to the unrelated U.S. importers of LKK-HK's premium oyster sauce are 20 percent higher than those charged to LKK-US. Some of the parties to which LKK­US sells are the same parties to which LKK-HK sells directly. In HRL 544713 we held that LKK-US' relationship with LKK-HK influenced the price actually paid or payable for the merchandise, and the transaction value of the imported merchandise did not closely approximate a test value reflected by the price paid by the unrelated importers. In particular, it was determined that LKK-HK settled its prices for sales to unrelated buyers differently than those for related sales and that adequate proof was not submitted showing that the profit in the sales at issue was equivalent to LKK-HK's overall profit realized over a representative period in sales of merchandise of the same class or kind. Insofar as test values were concerned,o ur office concluded that LKK-US did not provide sufficient information concerning the alleged "commission" or its exact costs. Moreover, we were unable to automatically adjust the value by the amount designated as a "commission" since, based on the submitted information, we could not determine that LKK-US performed its services pursuant to a bona fide agency agreement and that the amount of the alleged commission was reasonable. Hence, we did not find that the transaction value, the price paid by LKK-US, closely approximated the transaction value of identical merchandise, the price paid by the unrelated parties. With regard to the circumstances of sale method, counsel now submits that the prices paid for the identical merchandise sold by LKK-HK to unrelated parties in countries other than the U.S. demonstrate that the relationship between LKK-US and LKK-HK did not influence the price of the merchandise. Counsel also explains that the prices LKK-HK receives from unrelated parties in Central and South America, which represent approximately five percent of the U.S. sales volume of the merchandise, are almost identical to the prices received by LKK-HK from LKK-US. Counsel also submits that the prices between LKK-HK and LKK­ US are acceptable as the transaction value of merchandise sold to LKK-US because the profits on sales by LKK-HK to unrelated purchasers in both the U.S. and overseas are either the same or lower than the profits from sales to LKK-US. Counsel explains that LKK-US has been assigned South America as its exclusive sales territory under an agreement between LKK-HK and LKK-US whereby it receives a 20 percent commission from LKK-HK on all sales which LKK-HK makes to that area. Because LKK-HK incurs the commission and, presumably, somewhat increased overhead costs, counsel states that LKK-HK realizes more profit on its sales to LKK-US than it does in sales to the unrelated South American purchasers. Likewise, counsel submits that the reduction of LKK­ HK's gross profit on sales to unrelated U.S. parties by 20 percent, to account for the amount of "commission" paid to LKK-US in those sales, results in LKK-HK realizing the same amount of profit on sales to unrelated U.S. parties as it realizes in sales to LKK-US. With regard to the test value method, it is counsel’s position that the costs incurred by LKK-HK in sales to unrelated U.S. purchasers which are not incurred by LKK-HK in sales to LKK-US may be taken into account to verify the applicability of the transaction value of the merchandise. Counsel explains that in HRL 544713, the additional costs were mischaracterized as commissions incurred by unrelated purchasers. Hence, unlike nondutiable buying commission incurred by importers, where reasonableness is a proper consideration, counsel explains that the reasonableness of LKK-HK’s costs does not enter into the test value method of appraisement. Alternatively, counsel submits that even if reasonableness is presumed to enter into the comparison of the costs incurred by LKK-HK in sales to unrelated U.S. parties versus sales to LKK-US, Customs, at a minimum, should adjust and allocate LKK-US' general and administrative expenses and profits, by the ratio of the cost of goods purchased by non-related U.S. parties from LKK-HK to the total cost of goods purchased by all U.S. parties from LKK-HK, that is 64 percent. In a subsequent submission counse l addresses the possibility of recognizing a 58 percent adjustment, a ratio recognized by the auditors, as attributable to functions performed by LKK-US on behalf of LKK-HK. I In any event, counsel provides that the 20 percent figure actually reflects the gross amount of the commission, p art of which is paid to reimburse LKK-US for expenses incurred on behalf of LKK-HK and/or unrelated U.S. purchasers of food products. In addition, counsel explains that sales from LKK-HK to unrelated U.S. purchasers include a deferred quantity discount, which is paid to the unrelated U.S. purchasers of food products in the form of merchandise supplied from LKK-US' own inventory. In fact, LKK-HK directly reimburses LKK-US for only 80 percent of this expense. Accordingly, counsel submits that a substantial portion of LKK-US' commission is paid to reimburse LKK-US for its purchase of the inventory used to pay the deferred quantity discounts and to reimburse LKK-US for the costs of advertising performed on behalf of unrelated purchasers in the U.S. In counsel's submission of January 17, 1995, they provide that the services which LKK-US performs for LKK-HK and for which it is reimbursed by the so called "commissions" also include, but are not limited to: attending shows to promote the products; obtaining and distributing recipes; demonstrating products at retail outlets; introducing and handling inquiries concerning products; replacing from its inventory, damaged merchandise received directly by non­related parties; providing LKK-HK with research and information on FDA regulations; and aiding in the designing, labeling, and packaging for products. ISSUE: Whether the submitted evidence indicates that the relationship between LKK-HK and LKK-US did not influence the price actually paid or payable, or that the transaction value represented by the price paid by LKK-US closely approximates the value of the identical merchandise sold to unrelated buyers, such that transaction value is an appropriate basis of appraisement. LAW AND ANALYSIS: As you are aware, the preferred method of appraisement is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA), codified at 19 U.S.C. 1401a. However, imported merchandise is appraised under transaction value only if the buyer and seller are not related, or if related, the transaction value is deemed to be acceptable. In this case, LKK-HK, the seller, and LKK-US, the buyer, apparently are related pursuant to section 402(g)(1)(G) of the TAA. Section 402(b)(2)(B) of the TAA provides that a transaction value between related parties will be deemed acceptable if an examination of the circumstances of sale indicates that the relationship between the parties did not influence the price actually paid or payable or where the transaction value closely approximated certain "test" values. Under the circumstances of sales approach, if the parties buy and sell from one another as if they were unrelated, transaction value will be considered acceptable. Thus, if the price is determined in a manner consistent with normal industry pricing practice, or with the way the seller deals with unrelated buyers, the price actually paid or payable will be deemed not to have been influenced by the relationship. Furthermore, the price will not be influenced if it is shown 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. Statement of Administrative Action, reprinted in Customs Valuation under the Trade Agreements Act of 1979, Department of the Treasury, U.S. Customs Service (October 1981) at 54; section 152.103(j)(2), Customs Regulations (19 CFR 152.103(j)(2)). It is apparent that LKK-HK settles its prices for sales to unrelated buyers differently than those for related sales. In particular, we understand that fixed price lists are used for unrelated sales while oral negotiations and discussions determine the price for LKK-US. Furthermore, LKK-HK's payment of the so called "commission," in general, for LKK-US' administrative, marketing, sourcing, and other costs incurred for the unrelated purchasers to which both LKK-US (via indirect sales) and LKK-HK (via direct sales) may sell, further indicates that the relationship may have influenced the price. In other words, the reimbursement of these costs by LKK-HK, which appears to include costs incurred by LKK-US not only for its unrelated sales but also for the sale of its own imports, in some cases, represents a boon to LKK-US, not customary of a transaction between unrelated parties. However, counsel submits that the sales to unrelated parties in Central and South America indicate that the relationship between the parties did not influence the price actually paid or payable. Furthermore, counsel provides that LKK-HK's profit from its sales to LKK-US was equivalent to the profit realized over a representative period by LKK-HK in sales of merchandise of the same class or kind. Our initial concerns with resorting to the Central and South America prices are that they essentially are unverified and that, in any event, such sales represent perhaps as little as five percent of the U.S. volume of goods sold. Compared to the substantial volume of merchandise sold to unrelated parties here in the U.S. at the 20 percent price differential, these foreign sales cannot allay our concerns regarding the relationship. For similar reasons, we do not agree that the sales between LKK-HK, via LKK-USA, and the Central and South American purchasers serves as prima facie evidence that LKK-HK's profit from the LKK-US sales was equivalent to the overall profit realized by LKK-HK in sales of such merchandise over a representative period. In sum, evidence has not been provided by way of profit and loss statements and the like indicating that LKK-HK actually makes an equivalent profit from its LKK-US sales. Likewise, the fact that LKK-HK's gross profit on sales to unrelated U.S. parties is reduced by 20 percent to account for the amount of “commission" paid to LKK-US in the unrelated sales is not prima facie evidence that LKK-US' profit was equivalent to the profit realized over a representative period by LKK-HK. Not only has insufficient evidence been produced in this regard, as discussed above, but we reiterate that we believe that a portion of the costs incurred by LKK-HK for the unrelated sales may also reflect costs incurred for the direct sales to LKK-US. Hence, these costs reflect a decrease of gross profit on both types of sales. Based on this evidence, we simply cannot deduce that the instant profit was equivalent to LKK-HK's overall profit. Therefore, we cannot find that the circumstances of sale indicate that the relationship between the parties did not influence the price actually paid or payable. Under the test values approach, Customs, when applying values used for comparison purposes, accounts for differences concerning the sales involved, if such differences are based on "sufficient information," in the following: commercial levels; quantity levels; the costs, commissions, values, fees, and proceeds described in section 402(b)(1); and the costs incurred by the seller in sales in which he and the buyer are not related that are not incurred by the seller in sales in which he and the buyer are related. Our initial concern, in this regard, is with the lack of evidence demonstrating: 1) that the actual commissions were additions to the price of the merchandise and 2) that the actual costs comprising the commission can be quantified. In particular, it is apparent that the costs for the actual commissions were included as part of the price actually paid or payable for the merchandise. We note that section 402(b)(2)(C)(iii) provides for adjustments concerning commissions described in 402(b)(1), that is selling commissions added to the price actually paid or payable for the merchandise. In this case, insofar as these costs are included within, as opposed to added to, the price actually paid or payable, there is no legal authority to make such adjustments in accordance with section 402(b)(2)(C)(iii). Although counsel suggests that we account for the price differential by adjusting LKK-US' general and administrative expenses and profits, we still are concerned that such amounts reflect a significant amount of costs associated with LKK-US' own imports and, thus, that such a figure may overrepresent the cost of unrelated sales. In HRL 544713 we explained that: [a] more accurate accounting of the costs of the selling agency services is required before the difference in the costs between the unrelated and related sales can be determined. Without such information, Customs cannot adjust the unrelated price downward, and the transaction value of LKK-[US'] imports will not closely approximate the test value. The submitted list of services which LKK-US performs for LKK-HK, for which it is reimbursed by the so called “commissions,” does not reveal what proportion of these costs may be accounted for within the overall 20 percentage figure. As a result, we do not possess “sufficient information” as required in section 402(b)(2)(C) to account for differences with respect to the sales involved. While we recognize that some of the costs may represent amounts by which the unrelated price may be adjusted in accordance with section 402(b)(2)(C)(iv), substantial and concrete adjustments cannot be made to the 20 percent price differential to allow us to find that the values closely approximate each other. In particular, it is unclear what amount of the costs at issue actually are incurred by LKK-HK only in unrelated sales, and not in its sales of LKK-US for its own imports. For instances, it seems probable that the costs sourcing, ordering, delivering, marketing, and advertising, although within LKK-US’ general and administrative expenses, represent substantial costs incurred by LKK-HK in both types of sales. We recognize that a portion of LKK-US’ own imports also are sole to the same unrelated parties and inevitably to the same consumers at the next commercial level. Finally, while we understand that a specific expense is incurred by LKK-US for its amounts expended for the deferred quantity discounts, we find this serves primarily as evidence that the price between LKK-HK and LKK-US is not determined in a manner consistent with the way LKK-HK deals with unrelated buyers. Therefore, we cannot find that the transaction value between LKK-HK and LKK-US closely approximates the transaction value of the identical merchandise sold to unrelated buyers. HOLDING: Based on the submitted evidence, we cannot find that the relationship between LKK-HK and LKK-US did not influence the price actually paid or payable, nor that the transaction value represented by the price paid by LKK-US closely approximates the value of the identical merchandise sold to unrelated buyers, such that transaction value is an appropriate basis of appraisement. You should advise counsel of this decision and forward them a copy. Sixty days from the date of this letter the Office of Regulations and Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act, and other public access channels. HRL 544713 is affirmed. Sincerely, Harvey B. Fox, Director Office of Regulations & Rulings