• HQ H018314
• Mar 18, 2013

• Type : Valuation • HTSUS :
•  Related:   548239; 545705; 545618; 545242; 545798; 546231; 546421; 542701; 545622; 544680; 545388; 547654; 544845; 546998; W548314; H005222; H029658; H106603; H065015; H065024; H037375   

HQ H018314

OT:RR:CTF:VS H018314 YAG

Port Director
U.S. Customs and Border Protection
Port of Boston, Massachusetts
10 Causeway Street - Room 603Boston, MA 02222

RE: Application for Further Review (“AFR”) of Protest 0401-07-100180; Transaction Value; Related Party Transactions; Post-Importation Adjustments

Dear Port Director:

This is in response to your correspondence, dated September 13, 2007, forwarding the Application for Further Review (“AFR”) of Protest 0401-07-100180, timely filed by [***] (“Protestant”). We regret the delay in responding.

Protestant has asked that certain information submitted in connection with this AFR be treated as confidential. Inasmuch as this request conforms to the requirements of 19 CFR §177.2(b)(7), the request for confidentiality is approved. The information contained within brackets and all attachments to this ruling request, forwarded to our office, will not be released to the public and will be withheld from published versions of this decision.

FACTS:

Protestant is a U.S. based company with headquarters in [***]. Protestant imports contact lenses into the United States and declares import values based on the transaction value method of appraisement. The contact lenses imported by the Protestant are subject to multiple sales overseas: Protestant places orders for contact lenses with [***], a related Barbados holding company, which in turn fulfills the orders from [***], a related contract manufacturer, located in the United Kingdom. All companies to this transaction are related parties within 19 U.S.C. §1401a(b). A related company in Barbados from which Protestant purchases the contact lenses does not produce the merchandise but serves as the “middleman” in the transaction. Protestant does not purchase the imported contact lenses from any other parties; however, the middleman in Barbados sells the same contact lenses to an unrelated party in Japan. Transaction value is declared based on the related party sale between the middleman and Protestant.

The export sales price from the manufacturer to the middleman is determined by a cost-plus methodology, or a total of the standard production cost plus an operating profit margin of approximately [***]%. Further, the transfer prices between the middleman and the Protestant (importer) are set at the beginning of each fiscal year based on the budgeted financials. The transfer prices are set so that Protestant earns a return consistent with its annual transfer pricing study. A copy of Protestant’s (importer’s) transfer pricing study, dated October 31, 2005, prepared by the Ballentine Barbera Group (“Ballentine”) is provided by the Protestant for our review and consideration.

The transfer pricing study, prepared by Ballentine, covers Protestant’s purchase of contact lenses from the middleman for subsequent resale into the U.S. market. With respect to Protestant’s distribution activities, the Comparable Profits Method (“CPM”) was chosen as appropriate for analyzing the arm’s length nature of the transaction. The CPM examines whether the amount charged in a controlled transaction is an arm’s length price for tax purposes, by comparing the profitability of the tested party to that of comparable companies. Protestant was chosen as a tested party because the middleman in Barbados owns significant valuable non-routine intangibles. The profit level indicator selected was the operating margin. Protestant’s operating margin is calculated as follows: operating profit divided by net sales.

Under the CPM, Protestant’s operating profit of [***]% on its distribution activities falls within the interquartile range of comparable companies’ operating profit results of 1.5% to 4.7%, with a median of 2.9%. This arm’s length range was established on the basis of an objective, third-pricing data for distributors (comparable companies), which perform similar functions and assume similar risks as the Protestant. In selecting comparables for its analysis, Ballentine searched Standard & Poor’s Compustat database and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 5040 (professional and commercial equipment); 5046 (commercial equipment, not elsewhere classified); 5047 (medical, dental, hospital equipment and supplies); 5048 (opthamalic goods); 5049 (professional equipment and supplies, not elsewhere classified); 512X (drugs, drug proprietaries, and druggist’s sundries); 5160 (chemical and allied products); 5162 (plastic materials and basic forms and shapes); and, 5169 (chemicals and allied products, not elsewhere classified). This search generated a set of 64 unique companies out of which a final set of 6 comparable companies was selected, whose financial data was used to determine a target operating margin range for the Protestant. The final set of comparable companies represents a set of companies that sell pharmaceutical products, disposable medical, dental, veterinary supplies, health and beauty aids, and surgical supplies.

According to the Protestant, the middleman invoices the Protestant for products on a monthly basis. On a fiscal quarterly basis, the prices charged for the goods sold to the Protestant are recomputed to take into account fluctuations in market prices or operating costs. It is stated that the Protestant settles prices with its middleman through an inter-company “netting” process based on the results of the “true-up.” The “true up” is an adjustment from the original invoiced price to the final purchase price, made in order to realize the operating profit of [***]%, as referenced in Protestant’s transfer pricing study, which provides Protestant with the operating margins it should maintain for that fiscal year. The “true up” is completed on a quarterly basis and is reflected as part of reconciliation. Thus, Protestant submits quarterly reconciliations to adjust for the differences between the price used for importation and the price actually paid to its middleman. In this case, Protestant claims downward post-importation adjustments to the price declared to CBP. These adjustments are booked as a credit to the Protestant’s Cost of Goods Sold (“COGS”) and as a debit to the middleman. However, according to the Protestant, due to the business constraints of changing the price in the Protestant’s system every quarter, as the adjustments are minimal on a per unit level, the invoiced price to the Protestant remains unchanged after the reconciliation (even though all adjustments to value of the contact lenses imported from the middleman take place and are reported to both the Internal Revenue Service (“IRS”) and the U.S. Customs and Border Protection (“CBP”)).

On March 9, 2007, Protestant received a Notice of Action from CBP, questioning the sufficiency of documentation to support the use of transaction value as a basis for valuing the imported merchandise. On September 13, 2007, Protestant filed this Protest with the Port of Boston, which was forwarded to our office for further review on October 4, 2007. The company is protesting CBP’s decision to liquidate six (6) reconciliation entries without taking into account the downward post-importation adjustments on the reconciliation entries. Entry No. [***], the subject of this protest, was randomly selected by Protestant to form the basis of this protest under 19 CFR §174.13(b). This Entry was filed with CBP on June 10, 2005 and liquidated on March 23, 2007. It is Protestant’s position that these downward post-importation adjustments are all part of an objective formula used to determine transaction value and as such should be allowed to reduce the entered value on the underlying entry summaries. In support of its position, Protestant submitted the following documents: (1) Protestant’s powerpoint presentation prepared for the CBP meeting held on April 19, 2007; (2) Purchase orders; (3) Entry Summary (Entry No. [***]); (4) Commercial invoices; (5) KPMG Submission, dated July 29, 2003; (6) Transfer Pricing Analysis (study), for the fiscal year ending October 31, 2005, prepared by Ballentine; (7) November 1, 2002 Amendment to Distributor Agreement, dated August 1, 1999 between the middleman and Protestant; (8) Manufacturing Service Agreement between Protestant and the middleman; (9) Third Amendment to Manufacturing Agreement between the middleman and Protestant; (10) Copy of Reconciliation Entry No. [***]; (11) Copy of Reconciliation Entry No. [***]; and, (12) copy of Section 1.1059A of the Tax Code.

Additionally, Protestant provided a document, entitled “Memorandum of Understanding” (“MOU”), dated May 1, 2007. This document memorializes an agreement that allegedly has been in effect since August 1, 1999 between the Protestant and its middleman. The MOU specifies the formula the companies use to set the transfer price. The equation to calculate the transfer price is as follows: transfer price = sales – operating expense – target return. Protestant states that it did not have the written documentation regarding the formula specified in the MOU until requested by the reconciliation team in Boston. However, Protestant claims that the MOU merely documented the Protestant’s existing practice concerning formula returns.

Moreover, in order to claim the post-importation adjustments, Protestant provided the following documentation in order to satisfy the criteria, enumerated by CBP in Headquarters Ruling Letter (“HRL”) W548314, dated May 16, 2012: (1) Memorandum from Ernst &Young, addressing the 5 factors, dated August 13, 2012; (2) Excerpts from Protestant’s Transfer Pricing Report (Study) for the Fiscal Year Ending October 31, 2005; (3) Excerpts from Protestant’s transfer pricing reports for 2005, 2006, and 2007 specifying how the transfer price and any adjustments are determined with respect to contact lenses for which the value is to be adjusted; (4) November 1, 2002 Amendment to the Distributor Agreement, originally dated August 1, 1999, which references the annual transfer pricing reports; (5) Global Trading Arrangement, dated June 3, 2004; (6) Relevant pages of the Customs Compliance Manual; and, (7) Protestant’s accounting details from its books and/or financial statements to support the claimed adjustments.

In response to CBP’s request for additional information, Protestant further provided an explanation of how the post-importation adjustments are allocated, along with the spreadsheet from the broker, [***], showing the allocations for the first quarter of 2007, as an example. Finally, on August 29, 2012, Protestant provided the financial and tax documents (for fiscal years 2005, 2006, and 2007) to demonstrate that the adjusted cost of goods sold (adjusted prices) was used to prepare the company’s tax returns and was reported to the IRS.

Furthermore, Protestant engaged Ernst & Young LLP (“E&Y”) to assess the sufficiency of documentation supporting the Protestant’s position that the adjusted or final price charged by the middleman to Protestant is at arm’s length for customs purposes and qualifies for transaction value. On March 31, 2009, Protestant submitted a detailed memorandum, issued by E&Y, describing the Protestant’s transaction flow and identifying the relevant information in support of Protestant’s position. This memorandum was accompanied by detailed charts and documentation (including income statements and financial/accounting data used to support transaction value under the all costs plus a profit methodology) supporting the Protestant’s arguments that the relationship of the parties did not influence the price.

Finally, Protestant submits the following documents to substantiate a bona fide sale in this case: (1) 2006 sample entry packet, which includes a purchase order, commercial invoice, entry summary, summary of shipments, tied to the invoices, accounting documents, an intercompany reconciliation document, and a bank statement reflecting the payment for the imported goods; (2) 2009 sample entry packet; and (3) the Distributor Agreement between the middleman and Protestant, reflecting the terms of sale of the imported merchandise. ISSUES:

Do transactions between the middleman in Barbados and the Protestant/Importer constitute bona fide sales?

Is the related party price fixed or determinable pursuant to an objective formula at the time of importation for purposes of determining transaction value?

Do the circumstances of the sale establish that the adjusted price actually paid or payable by the Protestant/Importer to the middleman was not influenced by the relationship of the parties and is acceptable for purposes of 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). Further, in order to use transaction value, there must be a bona fide sale for exportation to the United States.

Do transactions between the middleman in Barbados and the Protestant/Importer constitute bona fide sales?

Several factors are relied on to determine whether a bona fide sale exists. See Headquarters Ruling Letter (“HRL”) 546067, dated October 31, 1996. In VWP of America, Inc. v. United States, 175 F.3d 1327 (Fed.Cir. 1999), the Court of Appeals for the Federal Circuit found that the term “sold” for purposes of 19 U.S.C. §1401a(b)(1) means a transfer of title from one party to another for consideration (citing J.L. Wood vs. United States, 62 CCPA, 25, 33, C.A.D. 1139, 505 F.2d 1400, 1406 (1974)).

No single factor is decisive in determining whether a bona fide sale has occurred. See HRL 548239, dated June 5, 2003. CBP will consider such factors as to whether the purported buyer assumed the risk of loss for, and acquired title to, the imported merchandise. Evidence to establish that consideration has passed includes payment by check, bank transfer, or payment by any other commercially acceptable means. Payment must be made for the imported merchandise at issue; a general transfer of money from one corporate entity to another, which cannot be linked to a specific import transaction, does not demonstrate passage of consideration. See HRL 545705, dated January 27, 1995.

In addition, CBP may examine whether the purported buyer paid for the goods, and whether, in general, the roles of the parties and the circumstances of the transaction indicate that the parties are functioning as buyer and seller. See HRL H005222, dated June 13, 2007.

Finally, pursuant to the CBP’s Informed Compliance Publication, entitled “Bona Fide Sales and Sales for Exportation,” CBP will consider whether the buyer provided or could provide instructions to the seller, was free to sell the transferred item at any price he or she desired, selected or could select its own downstream customers without consulting with the seller, and could order the imported merchandise and have it delivered for its own inventory.

As noted in the FACTS portion of this ruling, Protestant provided numerous documents to substantiate its claim that there was a bona fide sale between the middleman in Barbados and the Protestant/Importer. In accordance to Section 2.2 of the Amendment to the Distributor Agreement, the risk of loss passes from the middleman to Protestant on the basis of FCA (Free Carrier) (shipping point). Protestant bears all costs of freight and insurance and is responsible for clearance of the imported goods into the United States. FCA terms of sale are also indicated on the purchase order and commercial review submitted for our review. Protestant acquires title to the imported merchandise in accordance with Section 4.4 of the Distributor Agreement, which states that “upon receipt of the products from [***], Distributor [***] shall, within a reasonable period of time, signify its acceptance in writing to [***]. Such written acceptance shall effect transfer of title to goods from [***] to Distributor.”

Protestant makes monthly payments to the middleman for imported merchandise. Even though Protestant was unable to locate the necessary payment registers from periods more than 5 years old, Protestant provided us with a sample 2009 entry packet (including purchase orders and documents reconciling shipments to payments), which clearly matched each payment with the corresponding shipments.

Protestant always buys the imported merchandise to have it delivered for its own inventory. Section 4.1 of the Distributor Agreement states that the imported goods are delivered by the middleman to Protestant pursuant to written delivery requests placed by Protestant during the term of this Agreement. Additionally, Protestant is free to sell the imported merchandise at any price desired. Specifically, Section 5.2 of the Distributor Agreement states that Protestant is free to set its prices for the Products in its sole discretion. Finally, Protestant is free to select its downstream customers without consulting the seller. Section 2.2 of the Distributor Agreement specifies that Protestant acts as an independent contractor under the terms of the Distributor Agreement. Accordingly, based on the description of the Protestant’s sales process, substantiated by the documents submitted by Protestant, we find that Protestant sufficiently proved the existence of a bona fide sale between Protestant/Importer and the middleman.

Is the related party price fixed or determinable pursuant to an objective formula at the time of importation for purposes of determining transaction value?

Related party transactions involve initial transfer prices that may be subject to adjustment after importation. It is common for the transfer price to be determined in accordance with the company’s transfer pricing policy. The 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. Oftentimes such policies provide the method for determining the transfer price, which may include the setting of an initial price and then making various adjustments to the price after the importation based on specified criteria. In this case, Protestant sets its preliminary prices based on budgeted financials and in accordance with the MOU, dated May 1, 2007. Protestant’s prices are later adjusted so that Protestant can realize the targeted operating margin of [***]%, consistent with the range set in the Protestant’s formal transfer pricing study. The Protestant’s formal transfer pricing study sets the adjusted (final) transfer prices and determines whether such prices are at arm’s length for tax purposes.

CBP has determined that where the price is not fixed at the time of importation, transaction value is not applicable. See e.g., HRL 545618, dated August 23, 1996; HRL 545242, dated April 16, 1995; HRL 545798, dated October 28, 1994; HRL 546231, dated February 10, 1997; and HRL 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 HRL 542701, dated April 28, 1982, TAA No. 47, and 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 HRL 545622, dated April 28, 1994.

CBP has previously determined that if a transfer price is subject to post-importation adjustments and those adjustments are within the control of either the buyer or the seller, the formula exception to the fixed price rule would not apply. See HRL 544680, dated June 26, 1992 (CBP did not consider the parties’ arrangement to be a “formula” because the final determination to make additional payments depended on a subjective factor within the control of the importer, i.e., importer’s inspection of the imported merchandise). See also HRL 545388, dated October 21, 1994 (the parties entered into a supplemental agreement after the importation decreasing certain royalty payments; CBP found that this was a decrease in the price that was “made or otherwise effected...after the date of importation...” and should be disregarded).

In many cases, the events in the transfer pricing policies that trigger the post-importation price adjustments (for example, as in this case, where the Protestant’s operating profit falls outside of the interquartile range specified in the transfer pricing study) are to some extent within the control of the buyer and/or the seller. Accordingly, based on these prior rulings, CBP previously found that many transfer pricing policies would not qualify as formulas within the meaning of 19 CFR §152.103(a)(1). In those cases, transaction value determined under 19 U.S.C. §1401a(b) could not be applied, even if the relationship between the parties did not affect the price. This result is not consistent with transaction value being the preferred method of appraisement.

Further, when transaction value cannot be applied, the merchandise must be appraised using one of the other valuation methods in 19 U.S.C. §1401a. In a few cases, CBP has determined that when transaction value could not be applied because the transfer price was not “fixed,” the merchandise should be appraised using a modified transaction value under the fallback method, e.g., HRL 545618, dated August 23, 1996; HRL 547654, dated November 8, 2001; and, HRL 544845, dated November 9, 1993. However, under the customs value law, the fallback method may only be used when all previous valuation methods cannot be applied. In HRL 545618, HRL 547654, and HRL 544845, CBP applied the fallback method of appraisement and permitted the importers to claim upward and downward post-importation adjustments because the information about the applicability of other methods was not available.

CBP recently re-examined the issue of claiming post-importation adjustments to value in related-party sales. Specifically, in HRL W548314, dated May 16, 2012, CBP held that companies may claim “compensating adjustments” and other post-importation adjustments based on tax transfer pricing documentation and APAs. In HRL W548314, CBP found that the Importer’s transfer pricing policy constituted an objective formula provided the company’s transfer pricing policy meets certain factors. Thus, effective July 30, 2012, CBP allows both upward and downward post-importation adjustments to related-party sales prices made pursuant to a formal transfer pricing policy that meet the following criteria:

A written “Intercompany Transfer Pricing Determination 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.

An adjustment formula must satisfy all five criteria in order for CBP to accept it as objective. In this case, Protestant provided detailed information to satisfy the above-referenced criteria.

A written transfer pricing policy is in place prior to importation and the policy is prepared taking IRS code section 482 into account

The protest in question involves merchandise imported into the United States between June 2005 and February 2007. We note that the MOU provided for our review and dated May 1, 2007, specifying the equation to calculate the transfer price, is of little relevance to the first factor as the first factor must relate to merchandise imported in 2005 and 2006. The MOU did not exist in writing until 2007, when, according to the Protestant’s admission, it was created in response to the request for information from the Port of Boston. However, the MOU documented the company’s practice and may be taken into account for Protestant’s entries in 2007 onward.

Moreover, Protestant’s Transfer Pricing Report prepared by Ballentine covers Fiscal Year 2005. The transfer pricing study provides a mechanism for setting the related party prices by requiring Protestant to earn a return consistent with this study. Specifically, the transfer pricing study (Introduction and the Executive Summary Section) states as follows:

This analysis covers FY05 and was conducted in accordance with section §482 of the Internal Revenue Code (“Code”). This report, combined with other Company documents, represents documentation of [***] intercompany pricing policies for purposes of §6662 of the Code.

Subsequent year reports (2006 and 2007) contain similar language (the relevant portions of these reports were provided for our review). Finally, Section 2.4 of the Amendment to the Distributor Agreement, dated November 1, 2002, states that the middleman “shall charge to Distributor (Protestant), during the term of this agreement, arm’s length prices for the products as determined in accordance with the global transfer pricing study in effect on the date of invoice for the Protestant and its affiliates.” In addition to the Transfer Pricing Report, which covers the 2005 fiscal year, as well as the pages from subsequent reports for fiscal years 2006 and 2007, the Amendment to the Distributor Agreement further supports Protestant’s assertion that it had a written transfer pricing policy in place prior to importation, and that it was prepared in accordance with IRS code section 482.

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

In this case, necessary adjustments are made on a quarterly basis. We note that the formula had an impact on reported Customs values. Since the adjustments are reported in the Protestant’s accounting books as adjustments to COGS for the quarter, these adjustments affect the profit margins of the imported goods and specifically result in lower declared values for the merchandise. In each case, at the end of the year the transfer pricing study confirms that the prices, as adjusted, are within the arm’s length range determined by the transfer pricing study. Consequently, it is the adjusted prices that are actually used for both financial accounting and income tax purposes. To support this assertion, Protestant provided excerpts from the transfer pricing studies of fiscal years 2005, 2006, and 2007, each confirming that the year-end adjusted operating margin falls within the interquartile range of comparable firms’ operating margin. Protestant uses the final financial numbers in preparing the tax returns. Protestant provided financial and tax documents for fiscal years 2005, 2006, and 2007 to demonstrate that the adjusted COGS (prices) are used to prepare its tax returns. The following documents were provided: (1) the applicable debit/credit notes; (2) the accounting entry (account #[***]) (there are 2 journal entries for the second quarter in 2006, one that was done incorrectly and one to correct the error); (3) the ledger showing the ending balance for account #[***]; (4) the closing trial balance, which uses the same ending COGS balance as on the ledger to arrive at book income; (5) book income reconciliation that provides the book income used in the tax return; (6) schedule M-1 of the tax return, which reconciles book income to tax income, including the details of all of the adjustments made on Schedule M-1; and, (7) the first page of the tax return, which shows the same taxable income number as on Schedule M-1 and that is computed using the COGS referenced on the tax return.

Upon review of the documents submitted by Protestant, we find that there is a link between the adjusted COGS and the tax returns, the company indeed uses its transfer pricing policy in filing its income tax returns, and the adjustments are reported to the IRS and used by the Protestant 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

In this case, based on the information provided by the Protestant, the related party price (and the adjustments thereto) are determined pursuant to the company’s transfer pricing policy. Protestant provided CBP with documentation that showed what adjustments are made on an entry-by-entry basis; therefore, adjustments are related to specific entries. Additionally, the transfer pricing reports for 2005, 2006 and 2007 confirm that Protestant’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 (i.e. contact lenses purchased by the Protestant from the middleman) for which the value is to be adjusted. In addition, the 2006 and 2007 transfer pricing reports elaborate on the way prices are initially set and adjustments determined (relevant portions of these transfer pricing studies were provided for our review).

Moreover, the Amendment to the Distributor Agreement, dated November 1, 2002, refers to the annual transfer pricing reports, and covers all imported products for which adjustments were made. It further confirms Protestant’s transfer pricing policy, as outlined in the relevant transfer pricing studies.

Furthermore, page 3 of the Global Trading Arrangement, dated June 3, 2004, provides for direct reference to the Distributor Agreement between the middleman and Protestant, dated August 1, 1999 (provided for our review). Paragraph 9 of the Global Trading Arrangement also specifies how “true-ups” are calculated:

Quarterly true-up: on a quarterly basis, the price charged for the goods shipped to Protestant (i.e. Protestant’s cost of goods sold) is recomputed in order to give Protestant its arm’s length return . . . For customs purposes, the originally declared value must be reconciled with the final “trued-up” price paid or payable.

Appendix 3 of the Global Trade Arrangement provides for arm’s length returns as of June 2003 in the amount of [***]% of operating income. The adjustments for later periods were targeted to be more comfortably within the ranges established by subsequent transfer pricing studies (e.g., [***]%).

Moreover, both the Valuation and Reconciliation chapters of the Protestant’s Customs Compliance Manual (“Manual”) also contain confirming language. Protestant makes regular updates to the manual and while Protestant does not have prior versions, Protestant states that the pages of the Manual provided for our review have been in place since the original manuals were written in 2003. The Protestant’s Customs Compliance Manual, Chapter “Valuation of the Imported Merchandise,” provides for the description of the “true up policy.” According to the Manual, Protestant is obligated to pay the middleman’s invoices for the purchased goods on a monthly basis. However, Protestant also pays the true-up invoices quarterly. Protestant references the middleman’s invoice numbers in its payment records so that each invoice can be linked directly with associated payments. Where accounts payable are netted against accounts receivable, Protestant notes in its accounts payable records the specific receivables against which the Protestant’s invoices are netted. The Manual states that the Protestant’s Financial Reporting Manager is responsible for quarterly true-up so that the price charged for the goods shipped to Protestant is recomputed in order to give Protestant its arm’s length return. Protestant is responsible for the customs reconciliation of values reported, duties paid, merchandise processing fees, and the calculation of the amounts owed to CBP or refunds owed by CBP. The Manual also provides a reference to the annual Transfer Pricing studies and the Global Trading Arrangement. Chapter “Entry Reconciliation Program” of the Manual provides a reference to the “true up policy” as well.

The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States

Protestant provided numerous financial and accounting records to support the claimed adjustments, as well as the detailed description of the profit allocation to individual products. The adjustments are allocated equally to all imports for the quarter. Every quarter Protestant receives a spreadsheet of its quarterly entries from its broker, [***]. Protestant deletes extraneous columns of data, removes any line items/entries that are not subject to its quarterly COGS (i.e., raw materials, lenses imported on a trial basis, using Chapter 98 tariff provision, etc.) so that Protestant can determine the total number of individual units of lenses it needs to divide the total COGS amount into for the quarter. Protestant provided an example of its allocation and the spreadsheet for the 1st quarter of 2007. The spreadsheet states the total units of lenses for the first quarter of 2007. This allows Protestant to determine the “actual” price of a single contact lens. In this particular case, since all lenses are imported at the same transfer price, the allocation is a fairly simple one. The total COGS adjustment for the quarter was $[***], but it included lenses Protestant purchased from the middleman that were manufactured in both its United Kingdom and Puerto Rico facilities. Since Protestant only needs to adjust values for the lenses manufactured in the United Kingdom, Protestant obtained the breakdown of lenses for the quarter from the two manufacturing sites, and adjusted the COGS accordingly to account for the [***]% operating profit. For the 1st quarter in 2007, the COGS adjustment for the lenses manufactured in the United Kingdom was $[***]. The spreadsheet provided to CBP contains (1) the total entered value for the quarter at the time of original importation, which is used in calculating the transfer price per lens; (2) the total entered adjusted value per COGS; and, (3) the total amount of the COGS for the quarter (achieved by subtracting the total adjusted value from the total declared value). Once Protestant completed adjusting the line items for all underlying entries, Protestant calculated per line item how much it over or underpaid in duties and sent the spreadsheet back to its broker, [***].

For fiscal year 2005, Protestant provided its COGS calculation, which was used to reach the [***]% operating income. The company also provided an intercompany debit note to the middleman in the amount of the adjustment, dated November 16, 2005 as well as financial statements supporting the calculations and reflecting the amount on the debit note to the middleman.

For fiscal year 2006, Protestant provided its consolidated statements of earnings, one for each quarter of the 2006 fiscal year, showing the true up amount and leading to the targeted operating income within the range. The corresponding debit/credit notes for each quarter of the 2006 fiscal year were also provided. For the first three quarters the adjustments are downward, reducing cost of goods sold, and resulting in debit notes. For the fourth quarter, the adjustment is upward, increasing cost of goods sold, and resulting in a credit note.

For fiscal year 2007, Protestant provided its consolidated statement of earnings for the 1st quarter in 2007, showing the adjustment and the corresponding debit note.

No other conditions exist that may affect the acceptance of the transfer price by CBP

Upon our review of the information provided by Protestant, we determine that the transactions in question are not subject to any other considerations or conditions that may affect transaction value.

While the allocation of profit between the related parties might be considered to be within the “control” of the parties under the prior understanding of “control” in CBP’s previous decisions, the satisfaction of the criteria in W548314 reduces the possibility of price manipulation and subjectivity in claiming post-importation adjustments. Here, the operating profit the companies have to earn is set in advance and later allocated to individual entries. Further, Protestant verifies the results quarterly by comparing the value on the commercial invoice with the value reported to CBP on the CF 7501 and with the purchase orders and freight invoices. Therefore, since Protestant satisfied the criteria specified in W548314 to claim the post-importation adjustments, we conclude that in this particular case and based on the above referenced factors, Protestant’s transfer pricing policy may be considered an objective formula in place prior to importation for purposes of determining the price within the meaning of 19 CFR §152.103(a)(1).

Accordingly, CBP is of the view that post-importation adjustments (both upward and downward), to the extent they occur, may be taken into account in determining the transaction value under 19 U.S.C. §1401a(b). Further, similar to our analysis in W548314, we find the downward adjustments in the transfer price made pursuant to the valid transfer pricing study are not rebates of, or other decreases in, the price actually paid or payable that are made or otherwise effected between the buyer and seller after the date of importation of the merchandise into the United States (see 19 U.S.C. §1401a(b)(4)(B)). Instead, the post-importation adjustments represent an element of the determination of the price actually paid or payable in accordance with 19 CFR §152.103(a)(1). Therefore, the post-importation adjustments made pursuant to the transfer pricing policy in this case simply reflect what should have been reported as the invoice price upon entry, had the exact pricing information of the imported merchandise been available at the time. See W548314, dated May 16, 2012.

In this particular case, Protestant uses Reconciliation to report upward and downward post-importation adjustments to the value initially declared upon the importation of the merchandise. In our view, Reconciliation is an ideal vehicle in this case to declare all upward or downward post-importation adjustments within the timeframe allowed by the transfer pricing study that directly relate to the value of the merchandise. Thus, Protestant should continue to report all of its adjustments to CBP via Reconciliation.

Do the circumstances of the sale establish that the adjusted price actually paid or payable by the Protestant/Importer to the middleman was not influenced by the relationship of the parties and is acceptable for purposes of transaction value?

Having established that the Protestant’s transfer pricing policy constitutes a formula and that there is a bona fide sale for exportation to the United States in this case, we must determine whether the imported merchandise may be appraised under transaction value. There are special rules that apply when the buyer and seller are related parties, as defined in 19 U.S.C. §1401a(g). Specifically, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, an examination of the circumstances of the sale indicates that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain “test values.” 19 U.S.C. §1401a(b)(2)(B); 19 CFR §152.103(l). In this case, Protestant provided information regarding the circumstances of the sale.

Under this approach, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The Customs Regulations specified in 19 CFR Part 152 set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, Customs will examine the manner in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 CFR §152.103(l)(1)(i)-(ii). In addition, Customs will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. 19 CFR §152.103(l)(1)(iii). These are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well. See HRL H029658, dated December 8, 2009.

On March 31, 2009, upon our request for information to support the circumstances of the sale test Protestant submitted a detailed memorandum, prepared by E&Y, outlining the Protestant’s position that the price charged by the middleman to Protestant is at arm’s length and qualifies for transaction value. On April 20, 2009, Protestant provided an Excel file, supporting the E&Y memorandum, which contained the excerpts from the Protestant’s financial statements.

In its submission, Protestant argues that the price was settled in a manner consistent with the way the seller settled prices for sales to buyers who are not related to it. Moreover, Protestant argues that the price between the middleman and protestant is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm’s overall profit realized over the representative period of time in sales of merchandise of the same class or kind. We address each argument in turn.

Sales to the unrelated parties

This example applies to situations in which the seller sells the same merchandise to both related and unrelated parties and determines the price in a consistent way. According to Protestant’s submission, the middleman in Barbados also sells lenses to an unrelated party in Japan. This company in Japan is the only unrelated party to which the middleman sells and serves as the only benchmark for this analysis.

Although CBP generally requires that the comparison sales to unrelated buyers be sales to buyers in the United States, CBP will consider evidence regarding sales to unrelated buyers in other countries, provided the importer presents an adequate explanation as to why it is relevant to the transactions at issue. See W548314, dated May 16, 2012. Protestant states that the approach to establish prices between the related parties and the unrelated party in Japan is product specific pricing, whereas pricing to the Protestant is based on aggregate product pricing. Nevertheless, Protestant claims that it is possible to compare the actual prices charged to each entity as it is for identical merchandise.

Protestant provided sales prices per lens for the particular contact lenses that the middleman sells to Protestant and to the unrelated company in Japan. In order to compare the per lens prices sold to the unrelated company in Japan to those sold to Protestant, a weighted average approach was used based on sales volume data provided by the Protestant. Each product’s price was weighted against its relative volume. Upon review of the information provided by the Protestant, we observe that for 2007 and 2008, the weighted average prices charged to the unrelated company in Japan are virtually identical to the prices charged to Protestant. However, we note that for 2006, the middleman’s charges to the unrelated company in Japan were, on a weighted average basis, [***]% higher than prices charged to Protestant. Protestant claims that this difference remains within a reasonable tolerance considering the market and volume differences. Nonetheless, it is evident that in 2007 and 2008, the middleman reduced its price to the unrelated company in Japan to the level of prices paid by the Protestant, which could be indicative that the price charged to Protestant is in fact at arm’s length for 2007 and 2008. Accordingly, while the middleman’s approach to establishing prices with the unrelated company in Japan differs from the approach to establishing prices with Protestant, the actual prices charged for 2007 and 2008 appear to be consistent.

All costs plus a profit

Moreover, Protestant also contends that it has satisfied the “all costs plus a profit” methodology to show that the adjusted prices are not influenced by the relationship of the parties. 19 CFR §152.103(l)(1)(iii) states that “if it is shown that the price is adequate to ensure recovery of all costs plus a profit which is equivalent to the firm’s overall profit realized over a representative period of time (e.g., on an annual basis), in sales of merchandise of the same class or kind, this would demonstrate that the price has not been influenced.” In other words, the “all costs plus a profit” methodology examines whether a related party price compensates the seller for all its costs plus a specified amount of profit.

A very important consideration in the all costs plus a profit example is the “firm’s” overall profit. In applying the all costs plus a profit test, CBP normally considers the “firm’s” overall profit to be the profit of the parent company. Thus, if the seller of the imported goods is a subsidiary of the parent company, the price must be adequate to ensure recovery of all the seller’s costs plus a profit that is equivalent to the parent company’s overall profit. See HRL 546998, dated January 19, 2000. The regulations do not give us the definition of “equivalent” profit; however, if the profit of the seller is equal to or higher on the U.S. imports than the firm’s overall profit, the purchase price would not be artificially low for Custom’s purposes. See HRL H106603, dated July 25, 2011; HRL H065015, dated April 14, 2011; and, HRL H065024, dated July 28, 2011. Finally, CBP Regulations do not define what profit we are to consider – gross profit or operating profit. However, CBP is of the view that the operating profit margin is a more accurate measure of a company’s real profitability because it reveals what the company actually earns on its sales once all associated expenses have been paid. Nevertheless, in certain circumstances, gross profit can be considered. See HRL H037375, dated December 11, 2009.

In this case, Protestant presented the operating profit of the middleman in Barbados. However, the middleman is the principal in a contract manufacturing arrangement with the manufacturer in the United Kingdom. Consequently, Protestant argues that it is important to consider the profits of both the middleman and the manufacturer in conducting the “all costs plus a profit” analysis. Therefore, Protestant presented a separate calculation which was performed to include the profit of the contract manufacturer, in the profit calculation of the middleman in order to represent the total profit attributable to the imported lenses. We note the addition of the contract manufacturer’s profit raises the combined profit on the imported lenses over the operating profit of the middleman roughly one percentage point. Both the middleman’s and combined (middleman’s and contract manufacturer’s) profits are noted in a table provided for our review (the table is based on the financial statements provided by Protestant to E&Y and CBP for review). Furthermore, Protestant provided the global operating profit of its parent company on contact lenses.

We compared the seller’s operating profit on the imported lenses (we separately compared the operating profit of the middleman only and combined with the contract manufacturer’s operating profit) to both the global operating margin of the parent company on contact lenses, and to the global operating margin of the middleman on contact lenses, over a four-year period (for fiscal years of 2005, 2006, 2007, and 2008). In every instance the middleman’s operating profit on the imported lenses, with or without the inclusion of the contract manufacturer’s profit, exceeds both the operating margin of the parent company and of the middleman’s profit in global sales in goods of the same class or kind. Therefore, the profits earned by the middleman (independently, or in conjunction with the contract manufacturer) on sales to the Protestant exceed the global profits earned by both the middleman and the parent company on sales of contact lenses.

We note Protestant is not using its transfer pricing study to argue that its prices are at arm’s length; however, Protestant is able to establish by other means that the adjusted prices are at arm’s length. In view of the information submitted by the Protestant concerning the prices of the lenses sold by the middleman to the unrelated party in Japan compared to the related Protestant and the examination of the all costs plus a profit method, supported by the MOU and E&Y transfer pricing study, CBP finds the use of the transfer pricing study (prepared for tax purposes) to satisfy the circumstances of the sale test to be unnecessary. Protestant sufficiently explained the differences in prices between the related and unrelated parties and provided the necessary evidence to show that taking the adjusted prices into account, the seller’s operating profit was higher than the profit of the parent company. Thus, Protestant has satisfied the circumstances of the sale test. Accordingly, the transaction value is an acceptable method of appraisement in the instant case.

HOLDING:

The protest is granted.

In accordance with Section 3A(11)(b) of Customs Directive 099 3550-065, dated August 4, 1993, Subject: Revised Protest Directive, you are to mail this decision, together with the Customs Form 19, to the Protestant no later than sixty (60) days from the date of this letter. Any re-liquidation of the entry or entries in accordance with the decision should be accomplished prior to mailing of this decision. Sixty (60) days from the date of this decision, the Office of International Trade; Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.

Sincerely,

Myles B. Harmon, Director
Commercial & Trade Facilitation Division