OT:RR:CTF:VS H065015 YAG
Ms. Betty C. Williams, Field Director
Office of International Trade
Regulatory Audit
555 Battery Street, Room 313 San Francisco, CA 94111
Re: Internal Advice Request; Applicability of Transaction Value; Related Party Transactions
Dear Ms. Williams:
This is in response to the internal advice request, initiated by [***] (the “Company”) transmitted to our office on June 10, 2009, regarding the proper method of appraisement of merchandise imported by the Company from its two foreign affiliates, [***], located in Singapore and [***], located in the United Kingdom. We regret the delay in responding.
The Company [***] has asked that certain information submitted in connection with this internal advice be treated as confidential. Inasmuch as the request conforms to the requirements of 19 CFR §177.2(b)(7), the company’s request for confidentiality is approved. The information contained within brackets and all attachments to the internal advice request, forwarded to our office, will not be released to the public and will be withheld from published versions of this ruling.
FACTS:
The Company [***] develops and markets instrument-based systems, consumables, software, and services for the life science industry and research community. The Company’s customers use these products and services to analyze nucleic acids (DNA and RNA), small molecules, and proteins to make scientific discoveries, develop new pharmaceuticals, and conduct standardized testing.
The Company was incorporated in 1998 under the laws of the State of Delaware. It was comprised of two business segments: (1) the [***]; and (2) the [***]. Effective July 1, 2008, the Company separated the [***] group business from the Company, and the [***] became the Company’s only business. The Company changed its name to [***] on July 1, 2008. On November 24, 2008, [***] merged with another corporation, [***], to form a new company, [***]. This new company, [***], currently operates two divisions: [***] and [***]. The Company [***], who is also the Importer, is a parent company that purchases the imported merchandise from its affiliates in Singapore and the United Kingdom, [***] [***], for resale to unrelated customers in the United States.
On March 31, 2009, the Office of the Regulatory Audit in San Francisco, California, completed a Focused Assessment (“FA”) Follow-Up Audit of the Company. The Office of the Regulatory Audit determined that the Company does not declare its accurate and complete values to the U.S. Customs and Border Protection (“CBP”). The Company flags its entries for reconciliation at the time of importation and adjusts these entries after the importation on the basis of transfer pricing studies, prepared for the Internal Revenue Service (“IRS”), to determine the final value of the imported merchandise. During the FA Follow-Up Audit, the Company first used these studies to justify that its final values established through reconciliation were appropriate transaction values. After the Office of the Regulatory Audit found this procedure to be noncompliant with the regulations for transaction value, the Company attempted to demonstrate, by use of the same studies, the same final price under the computed value method of appraisement. The Office of the Regulatory Office rejected the Company’s arguments, and this internal advice request followed.
This decision is being issued subsequent to our review of the following documents: (1) Distribution and Service Agreement between the Company’s affiliate in Singapore [***] and the Company [***], effective July 1, 2001; (2) Distribution Agreement between the Company [***] and the Company’s affiliate in the United Kingdom [***], effective July 1, 2000; (3) The Company’s [***] Finance Manual; (4) the Company’s Routine Return Analysis of Asian Manufacturing Comparables, dated December 8, 2004 (prepared by PricewaterhouseCoopers LLP); (5) the Company’s FY 2006 Asian Manufacturing Comparable Analysis, dated March 15, 2007 (prepared by Baker & McKenzie Consulting, LLC); (6) Analysis of [***] Manufacturing Comparables in the United Kingdom, dated January 20, 2005 (prepared by PricewaterhouseCoopers LLP); (7) the Company affiliate’s in the United Kingdom FY2006 [***] Comparable Analysis, dated March 14, 2007 (prepared by Baker & McKenzie Consulting, LLC); (8) the Company’s Intercompany Pricing Study for fiscal year 2005, dated March 14, 2006 (prepared by PricewaterhouseCoopers LLP); (9) the Company’s FY 2006 [***] Distribution Comparables Analysis, dated March 14, 2007 (prepared by Baker & McKenzie Consulting, LLC); (10) the Company’s [***] Customs Disclosure for FY 2006 ([***] and [***]); and, (11) Cost Build-Up (Singapore and the United Kingdom Manufacturing Locations). Moreover, on September 16, 2009, in response to our request for additional information, the Company [***] set forth additional arguments concerning the proper method of appraisement of the imported merchandise.
The Company, [***], purchases finished products from its affiliate in Singapore, [***], pursuant to the terms of a Distribution and Service Agreement, effective July 1, 2001. The products purchased pursuant to this agreement and imported into the United States consist of instruments related to the Company’s [***] Core Polymerase Chain Reaction, Sequence Detection, Nucleic Acid Synthesis, Microfluidics Control Delivery, and Gene Expression Array systems. The Company [***] purchases finished products from its affiliate in the United Kingdom [***] pursuant to the terms of a Distribution Agreement, effective July 1, 2000. The products purchased pursuant to this agreement and imported into the United States consist of reagents and consumables that are used with the Company’s [***] life science instruments.
Pursuant to these Distribution Agreements, the Company [***] acts as the U.S. distributor of the instruments manufactured by its affiliate in Singapore [***] and the reagents and chemicals manufactured by its affiliate in the United Kingdom [***]. The Company [***] purchases its merchandise only from its related manufacturers, [***] and [***]. The Company does not buy its merchandise from unrelated suppliers, and [***] and [***] do not sell to the unrelated distributors in the United States.
The intercompany prices between the Company [***] and its affiliates in Singapore and the United Kingdom, [***] and [***], are based on an average list price less a distributor’s discount. In order to establish the intercompany transfer prices, each legal entity creates a forecasted Profit & Loss statement at the beginning of the year. These projected P&L statements include projected sales revenue, anticipated cost of sales, anticipated operating expenses, etc. Based on these projections, the transfer price is established in SAP by taking each product’s standard cost and multiplying it by the uplift factor needed to arrive at the average unit price (“AUP”) (i.e. the average sales price to third party customers) minus [***]%. The uplift factor is the percentage that is multiplied against the standard cost to arrive at the intercompany transfer price. The amount of the uplift is meant to cover costs other than standard costs (e.g., production variances) as well as profit. The list price represents the price at which the Company believes it can sell the articles to third parties. The average unit price is the average of the list prices for the same article (since the list price can vary by jurisdiction). The list price is reviewed on an annual basis. The discounts are designed to help ensure that the Company/U.S. Importer [***] covers its distribution costs and earns an appropriate arm’s length profit when the articles are resold to third parties. The Company states that this method, in turn, helps ensure that its manufacturing affiliates, [***] and [***], each cover their respective costs and earn an appropriate, arm’s length profit on their respective sales to the Company [***].
No information concerning negotiations of the above referenced prices was presented. Distribution Agreements also refer to sales commissions. The Company stated that sales commissions are only due when its affiliate in Singapore [***] makes direct sales into the Company’s [***] territory. The Company argues that these commissions would be paid by the seller, not the importer; therefore, they would not be relevant for U.S. Customs purposes. No further explanation was provided. Thus, it is not clear what these sales commissions represent, to whom they are paid, and if they are included in the profit calculations for both companies. Additionally, as mentioned in the FA Follow-Up Audit, there might be an issue of the inclusion of the royalty payments in the value of the imported merchandise, however, no further explanatory information was provided concerning this issue.
The Company’s [***] margins are reviewed on a quarterly basis (beginning with the end of the second quarter) in order to determine whether transfer pricing adjustments might be required. An adjustment would be required if the financial results for the legal entity indicate that it will earn a profit that is inconsistent with the arm’s length range (i.e., too much profit, or too little profit). If adjustments are required, they are generally booked in expense and asset/revenue accounts. Pursuant to the Company, adjustments are generally made through journal entries booked to “Costs of Sales” and “Intercompany Receivable/Payable” accounts. Therefore, the Company is adjusting the transfer price of the articles sold between legal entities and is participating in CBP’s reconciliation program, effective November 4, 2005.
The Company submitted multiple transfer pricing studies covering the manufacturing activities of its affiliates in Singapore and the United Kingdom, [***] and [***], and distribution activities of the Company [***], who is also the Importer. All transfer pricing studies and updates are conducted in compliance with Section 482 of the Internal Revenue Code. Section 482 of the Internal Revenue Code (26 U.S.C. §482) requires that the arm’s length result of a controlled transaction be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result. The application of the best method establishes an arm’s length range of prices or financial returns with which to test controlled transactions. However, according to the Company’s [***] submission, there is no Advance Pricing Agreement with the IRS.
The Company’s [***] initial transfer pricing study was prepared by an outside consulting firm, PricewaterhouseCoopers LLP, in 2006. PricewaterhouseCoopers LLP was engaged to assist the Company in determining the arm’s length character of [***] transactions with related parties, limited to the distribution of finished products imported from the Company’s affiliates in the United Kingdom and Singapore during fiscal year 2005.
As stated in the Company’s [***] transfer pricing study prepared by PricewaterhouseCoopers LLP, the Comparable Profits Method (“CPM”) was selected as the best method to evaluate the intercompany tangible transactions between the Company and its foreign affiliates. The CPM examines whether the amount charged in a controlled transaction is an arm’s length price by comparing the profitability of the tested party to that of comparable companies. The Berry ratio, or the ratio of gross profit to operating expenses, was selected as the most reliable profit level indicator (“PLI”) to test the reasonableness of the intercompany pricing between the Company [***] and its foreign affiliates. The tested party under the CPM transfer pricing analysis is the entity that performs the least complex functions and faces the least amount of risk. The Company (Importer) [***] was selected as a tested party in this analysis.
In selecting comparables for its analysis, PricewaterhouseCoopers, LLP reviewed publicly-available databases and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 504 (Wholesale: Professional and Commercial Equipment and Supplies), 506 (Wholesale: Electrical Goods), 508 (Wholesale: Machinery, Equipment, and Supplies), 509 (Wholesale: Miscellaneous Durable Goods), 512 (Wholesale: Drugs, Drug Proprietaries, and Druggists’ Sundries), and 516 (Wholesale: Chemicals and Allied Products). The search identified 411 potentially comparable companies. In order to limit the search, PricewaterhouseCoopers, LLP excluded companies that (1) had data available for less than 2 years; (2) indicated an R&D to sales ratio of greater than or equal to 3 percent (this indicated significant investment in R&D and possible intangibles associated with that investment); and, (3) indicated an advertising to sales ratio of greater than or equal to 3 percent (this indicated significant investment in advertising and possible non-routine marketing intangibles associated with that investment). The business descriptions of the remaining companies were reviewed with a focus on functional comparability with the Company’s [***] distribution activities. This search and selection yielded ten (10) comparable companies, which distribute chemically-derived pharmaceuticals, biopharmaceuticals, brand name and generic pharmaceutical products, over-the-counter health and beauty products (personal care products), nutritional supplements, disposable medical, dental, veterinary supplies, health and beauty aids, surgical supplies, companion-pet veterinarian and rehabilitation supplies. None of the comparable companies belong to the life science and research industries. There is no indication in the transfer pricing study of any adjustments to the financial data for the comparable parties. Therefore, over the 2002 to 2004 period, the financial results of the accepted comparable distributors indicated an interquartile range of three-year weighted average Berry Ratios that extends from [***]% to [***]%, with a median of [***]%. Additionally, the interquartile range of Return on Sales achieved by the evaluated comparable distributors extended from [***]% to [***]%, with a median of [***]%. 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 Company (Importer) [***]. With respect to the tested transactions, the Company [***] achieved a three-year weighted average Berry Ratio of [***]% on its purchases from the manufacturers in Singapore and the United Kingdom, [***] and [***], a result that fell within the interquartile range identified by the evaluated comparable distributors. However, the Company [***] achieved a Return on Sales ratio of [***]% on the same transactions, a result that fell above the established range.
The second analysis, conducted by Baker & McKenzie Consulting, LLC was to assist the Company in the development of a set of independent U.S. distributors whose activities are comparable to those of the U.S. affiliates of the Company. The CPM was affirmed as the best method to conduct this analysis. The Berry ratio, or the ratio of gross profit to operating expenses, was selected as the most reliable PLI to test the reasonableness of the intercompany pricing between the Company [***] and its foreign affiliates. The Company/Importer [***] was selected as a tested party in this analysis. A global search was conducted to identify a set of comparable companies that engaged in distribution activities similar to those of the Company’s [***] distribution activities. In selecting comparables for its analysis Baker & McKenzie Consulting, LLC reviewed the publicly available Thomson Financial Worldscope database and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 504 (Professional and Commercial Equipment), 508 (Hardware and Plumbing and Heating Equipment and Supplies), and 5099 (Durable Goods, Not Elsewhere Classified). The search identified 293 potentially comparable companies. In order to limit the search to unrelated companies with the distribution activities similar to the Company, the companies were eliminated based on the following criteria: (1) companies that did not present sales data during the years 2004 or 2005; (2) the company was engaged in significant manufacturing; (3) the company was engaged in provision of services; (4) the company was engaged in the distribution of non-comparable products (however, large scale distributors of industrial products were deemed sufficiently comparable); (5) companies had significant intangible assets; and, (6) companies were engaged in unrelated activities (investment, research and development, mining, etc). This search and selection yielded fifteen (15) comparable companies, which distributed the following merchandise: personal protection and safety equipment, heating, ventilation, and air-conditioning equipment, commercial and industrial dry cleaning, laundry and steam boilers equipment, repair and operating products, and automated office equipment. None of the comparable companies discussed in this transfer pricing study are the
direct competitors of the Company Group [***] or even remotely relate to the life science and research industry. This transfer pricing study concluded that the results of the analysis presented reasonably can be used by the Company Group [***] in the application of the CPM to the distribution activities of its U.S. affiliates. The range of Berry Ratios established by the comparables was [***]% to [***]%, with a median [***]%. The cost plus mark-up for the Company/Importer [***] was not provided.
Furthermore, the Company provided two transfer pricing studies, which summarized the results of PricewaterhouseCoopers LLP’s review of Asian manufacturers, comparable to [***], the Company’s affiliate in Singapore. The CPM was selected as the best method to evaluate the manufacturing activities of the affiliate in Singapore [***], and the full cost mark-up ratio was chosen as PLI. The Company’s affiliate in Singapore, [***], was chosen as a tested party. A search of publicly available Global Vantage and Worldscope databases for the comparable companies was performed. The search focused on companies classified in the following primary Standard Industrial (“SIC”) Codes: 281 (Industrial Inorganic Chemicals); 2835 (In Vitro and In Vivo Diagnostic Substances); 2836 (Biological Products, Except Diagnostic Substances); 286 (Industrial Organic Chemicals); 289 (Miscellaneous Chemical Products); 3821 (Laboratory Apparatus and Analytical, Optical, Measuring and Controlling Instruments); and, 3823 (Industrial Instruments for Measurement, Display, and Control Process Variables and Related Products). One hundred and thirty (130) companies were identified. After the screening to remove the duplicate companies, related parties, companies with less than 2 years of available financial information, companies that engaged in the manufacture of products not directly related to measuring and analyzing instruments/control systems, unrelated activities, research and design, and in extensive provision of services, the search resulted in the final set of six (6) companies, comparable to the activities undertaken by the affiliate in Singapore, [***]. All of the companies are located in Japan and are in the business of manufacturing market temperature control systems, analyzing equipment, semiconductor products, fine ceramic-based censors, and electronic devices for industrial measuring. None of the comparable companies actually produce Core Polymerase Chain Reaction, Sequence Detection, Nucleic Acid Synthesis, Microfluidics Control Delivery, and Gene Expression Array systems. Using an interquartile analysis based on the full cost mark-up ratios for Asian comparable manufacturers, the range of the operating margin results for the comparable companies extended from [***] % to [***] %, with a median of [***]%. In FY 2004, a full cost mark-up of [***]% was used for purposes of calculating the Singapore affiliate’s [***] manufacturing profit. Therefore, this return lies within the interquartile range established by the Singapore affiliate’s [***] transfer pricing study.
In 2006, Baker & McKenzie Consulting, LLC updated the 2004 transfer pricing study of the affiliate in Singapore [***] in order to develop a set of independent Asian manufacturing companies whose manufacturing activities were comparable to the Company’s affiliate in Singapore [***] manufacturing activities. The CPM was affirmed as the best method to conduct this analysis. The Return on Total Costs (“ROTC”), or operating profits divided by sales, was selected as the most reliable PLI to test the reasonableness of the intercompany pricing. The Company’s affiliate in Singapore [***] was selected as the tested party in this analysis. A global search was conducted to identify a set of comparable companies that engaged in manufacturing activities similar to those of the manufacturing affiliate in Singapore, [***]. In selecting comparables for its analysis Baker & McKenzie Consulting, LLC reviewed the publicly available Thomson Financial Worldscope database and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 382 (Laboratory Apparatus and Analytical, Optical, Measuring, and Controlling Devices) and 384 (Surgical, Medical, and Dental Instruments and Supplies). One thousand four hundred and forty (1440) comparable companies were identified within the above-referenced SIC codes. These companies were further examined through a series of screening criteria in order to eliminate those companies not comparable to the manufacturing affiliate in Singapore, [***]. For example, only companies operating in Asia were selected for further analysis. Additionally, the companies that did not possess the financial data for at least 2 years and all companies with a weighted average R&D/Sales ratio greater than 5 percent were also eliminated from further analysis. Finally, a review of business descriptions (such as companies engaged primarily in distribution activities, in manufacturing of non-comparable products (industrial products, HVAC systems, contact lenses, surgical disposables, etc.), and engaged in unrelated activities) left eleven (11) companies that were considered to be comparable to [***] manufacturing activities. The ROTC range established by the comparable study was [***]% to [***]%, with a median of [***]%. No calculations for the Company’s affiliate in Singapore [***] were provided.
Additionally, the Company provided two transfer pricing studies, which summarize the results of PricewaterhouseCoopers LLP’s review of the U.K. manufacturers, comparable to [***], the Company’s affiliate. For the transfer pricing study for FY 2004, the CPM was selected as the best method for the manufacturing activities of the Company’s affiliate in the United Kingdom, [***], and the full cost mark-up ratio was chosen as PLI. The Company’s affiliate in the United Kingdom, [***], was chosen as a tested party. A search of publicly available Amadeus, Global Vantage, and Worldscope databases for the comparable companies was performed. The search focused on companies classified in the following primary Standard Industrial (“SIC”) Codes: 281 (Industrial Inorganic Chemicals); 2835 (In Vitro and In Vivo Diagnostic Substances); 2836 (Biological Products, Except Diagnostic Substances); 286 (Industrial Organic Chemicals); 289 (Miscellaneous Chemical Products); 3821 (Laboratory Apparatus and Analytical, Optical, Measuring and Controlling Instruments); and, 3823 (Industrial Instruments for Measurement, Display, and Control Process Variables and Related Products). A total of six hundred and eight (608) companies were identified in the search of the above referenced SIC codes. After the screening to remove the related parties, companies with less than 2 years of available financial information, companies that engaged in the manufacture of products not directly related to specialty chemicals, and unrelated activities, the search resulted in the final set of eleven (11) companies, comparable to the activities undertaken by the Company’s affiliate in the United Kingdom, [***]. All of the companies are located in the United Kingdom and are in business of manufacturing chemical colors, fluorocarbon products and finishes, pigments, agricultural and animal health products, and pet accessories, and specialty chemicals. Four (4) out of eleven (11) comparable companies perform distributing as well as the manufacturing functions. Using an interquartile analysis based on the full cost mark-up ratios for the U.K. comparable manufacturers, the interquartile range of the operating margin results for the comparable companies extended from [***]% to [***]%. In FY 2004, the Company’s affiliate in the United Kingdom, [***], earned a full cost mark-up ratio of [***]% on its routine manufacturing activity. Therefore, this return lies within the interquartile range established by the U.K. affiliate’s [***] transfer pricing study. The U.K. affiliate’s [***]% full cost mark-up ratio also falls within the full range of returns earned by comparable companies, [***]% to [***]%.
Finally, in 2006, Baker & McKenzie Consulting, LLC’s London office updated the 2004 transfer pricing study of the affiliate in the United Kingdom [***] in order to develop a set of independent manufacturing companies from the United Kingdom whose manufacturing activities were comparable to the U.K. manufacturing activities. The CPM was affirmed as the best method to conduct this analysis. The mark-up on total costs ratio (or operating profit divided by the sum of cost of goods sold and selling, general, and administrative expenses), was selected as the most reliable PLI to test the reasonableness of the intercompany pricing. The Company’s affiliate in the United Kingdom [***] was selected as a tested party in this analysis. A global search was conducted to identify a set of comparable companies that engaged in manufacturing activities similar to those of the affiliate’s [***] manufacturing activities. In selecting comparables for its analysis Baker & McKenzie Consulting, LLC reviewed publicly available databases and focused on companies under the following Standard Industrial Classification (“SIC”) codes: 24 (Manufacture of Chemicals and Chemical Products) and 3320 (Manufacture of Instruments and Appliances for Measuring, Checking, Testing, Navigating and Other Purposes, Except Industrial Process Control Equipment). Five hundred (500) potentially comparable companies were identified within the above-referenced SIC codes. These companies were further examined through a series of screening criteria in order to eliminate those companies not comparable to the affiliate in the United Kingdom [***]. For example, companies engaged in the manufacturing of fine chemicals or laboratory consumables were accepted and companies involved in distribution, engineering, and installation were rejected. Additionally, the manufacturers of certain products, such as petrochemicals, adhesives, varnishes, coatings, etc. were rejected because the manufacturing processes for these chemicals differ significantly from the Company. However, manufacturers of agrochemicals, veterinary chemicals, detergents, biological chemicals, flavor compounds, and chemicals for water treatment
were accepted as their products were not dissimilar to production of the Company’s affiliate in the United Kingdom, [***]. In the end, the search identified eleven (11) comparable U.K. manufacturing companies. The mark-up on total costs range established by comparable study is [***]% to [***]%, with a median of [***]%. The mark-up on total costs range for the Company’s affiliate in the United Kingdom [***] for the same time period was not provided.
Moreover, in an effort to confirm that its intercompany prices were sufficient to ensure that each manufacturer (seller) covered its costs, plus made an appropriate profit, the Company provided two (2) tables, which summarize the total profits earned by the Company’s affiliates in Singapore and the United Kingdom, [***] and [***], of [***]% and [***]% respectively. Finally, each table calculates the manufacturer’s profitability on the products exported to the United States at the product-line level.
ISSUE:
What is the proper method of appraisement for the transactions between the Company/Importer and its related party suppliers (affiliates)?
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). 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). While the fact that the buyer and seller are related is not in itself grounds for regarding transaction value as unacceptable, where CBP has doubts about the acceptability of the price and is unable to accept transaction value without further inquiry, the parties will be given the opportunity to supply such further detailed information as may be necessary to support the use of transaction value pursuant to the methods outlined above.
“Test values” refer to values previously determined pursuant to actual appraisements of imported merchandise. Thus, for example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of merchandise under section 402(d) of the TAA. Headquarters Ruling Letter (“HRL”) 543568, dated May 30, 1986. In this instance, no information regarding test values has been submitted or is available; consequently, the circumstances of the sale must be examined in order to determine the acceptability of transaction value.
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. See also HRL 029658, dated December 8, 2009; H037375, dated December 11, 2009; and, HRL H032883, dated March 31, 2010. In this respect, CBP 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, CBP 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.
The Company argues that the combination of detailed, narrowly-tailored transfer pricing studies demonstrating that both the foreign manufacturers and the Company/U.S. Importer each earn an arm’s length return on their respective activities, and detailed financial data demonstrating that each foreign manufacturer covers its costs and makes an appropriate profit on the products exported to the United States, together indicate that the prices have not been influenced by the relationship between the parties.
We note that the existence of a transfer pricing study does not, by itself, obviate the need for CBP to examine the circumstances of the sale in order to determine whether a related party price is acceptable. HRL 546979, dated August 30, 2000. However, information provided to CBP in a transfer pricing study may be relevant in examining the application of the circumstances of the sale, but the weight to be given this information will vary depending on the level of detail provided by the study. A significant factor, by way of example, is whether the transfer pricing study has been reviewed and approved by the IRS. See HRL 546979, dated August 30, 2000. Whether products covered by the study are comparable to the imported products at issue is another important consideration. See HRL 547672, dated May 21, 2002. The methodology selected for use in a transfer pricing study is also relevant. HRL 548482, dated July 23, 2004. Thus, even though the Company’s [***] transfer pricing studies by themselves are not sufficient to show that a related party transaction value is acceptable for Customs purposes, the underlying facts and the conclusions reached in such transfer pricing studies may contain relevant information in analyzing circumstances of the sales.
We note that none of the transfer pricing studies submitted to CBP by the Company have been reviewed by the IRS leaving CBP unaware as to whether the assumptions on which the study is based and the conclusions derived would be acceptable to the IRS. See HRL 548482, dated July 23, 2004; see also H032883, dated March 31, 2010. Further, all of the transfer pricing studies utilize the CPM methodology to evaluate distribution and manufacturing activities of the buyer and the seller. Although CBP has, in the past, given some weight to an importer’s transfer pricing methodology when it has been based on the CPM, special circumstances were present. See HRL 546979, dated August 30, 2000. It is important to note the following special circumstances or other factors that were present in HRL 546979: 1) the transfer pricing methodology had been approved by the IRS through the Advance Pricing Agreement program; 2) Customs participated in the APA pre-filing conference between the importer and the IRS, and had access to the information provided to the IRS throughout the APA process; 3) the importer provided Customs with a waiver that enabled access to the documents that were submitted to the IRS in the APA process; 4) all of the importer's imported products were covered by the APA; and 5) the transfer pricing agreement was a bilateral agreement for which the transactions had been examined and accepted by the taxing authorities of both the United States and Japan. A similar outcome was achieved in HRL H029658, dated December 8, 2009 in which CBP determined, based on these unique circumstances and the overall structure of the transaction, that the circumstances of the sale were satisfactory. None of the factors relied upon in HRL 546979 and HRL H029658 are present in this case.
Additionally, all of the transfer pricing studies focus on functional comparability of the products, and although some of the studies strive to achieve the product comparability by eliminating, for example, the companies that engaged in the manufacture of products not related to specialty chemicals (as is the case with the manufacturer in the United Kingdom), such efforts fall short of achieving the necessary product comparability for Customs purposes. Thus, we note that the comparable companies, chosen in the Company’s transfer pricing studies to evaluate the manufacturers (sellers) as well as the distributor (importer), [***], sell the merchandise ranging from pharmaceuticals, surgical supplies, air conditioning and agricultural products to petrochemicals. While the comparison in the transfer pricing study between an importer’s profitability (or especially, sellers’ profitability) and that of other companies may provide some evidence that the relationship of the parties did not influence the price, we find this information to be less valuable since the comparable companies chosen for the analysis of the Company and its foreign affiliates in this case are not engaged in the sale of the same class or kind of merchandise. See H032883, dated March 31, 2010. Therefore, taking into consideration the above referenced facts, under the circumstances of this particular case, we are reluctant to solely rely on the analysis of the transfer pricing studies provided by the companies. Furthermore, due to the lack of the information concerning the sales commissions, referenced in the Distribution Agreements and royalty payments (applicable to the affiliate in the United Kingdom, [***]), we are unable to determine what effect, if any, these payments had on the price paid by the Company [***] to its affiliates in Singapore and the United Kingdom, [***] and [***].
Additionally, the intercompany prices between the Company [***] and its related suppliers, [***] and [***], are based on an average list price less a distributor’s discount. Even though we have no evidence of the negotiation of the transfer price, this methodology of creating a forecasted Profit & Loss statement at the beginning of the year and taking each product’s standard cost and multiplying it by the uplift factor needed to arrive at the average unit price (“AUP”) (i.e. the average sales price to third party customers) minus [***]% is not in itself prohibitive. This list price represents the price at which the Company believes it can sell the articles to third parties, and the discounts are designed to help ensure that the Company [***] covers its distribution costs and earns an appropriate arm’s length profit when the articles are resold to third parties. However, since based on the above referenced reasons, we cannot accept the Company’s [***] transfer pricing study without further evidence supporting the fact that the relationship did not influence the price, we cannot determine whether the methodology of arriving at the transfer price is at arm’s length.
Moreover, the Company argues that the two (2) tables it provided show that the relationship between the parties did not influence the price and the Company satisfied the “all cost plus a profit” test. As stated in the FACTS portion of this ruling, these tables summarize the total profits earned by the Company’s related suppliers, [***] and [***], of [***]% and [***]% respectively. Finally, each table calculates the manufacturer’s profitability on the products exported to the United States at the product-line level. The “all cost plus profit” method examines whether the related party price compensates the seller for all its 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. A very important consideration in the all costs plus a profit example is the “firm’s” overall profit. In applying the all cost plus 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 customs purposes. In this case, both sellers are subsidiaries of the parent company; however, the Company uses the manufacturers/sellers’ profit, not the parent company’s profit, to satisfy the circumstances of the sale test. While we acknowledge that in certain circumstances it is possible to compare transactional profit to the seller’s overall aggregated result based on certain economic considerations (as in HRL H032883, dated March 31, 2010), it is not the case here. In this case, the Company asserts that the manufacturers’/sellers’ profitability on the product-line level should be compared to the manufacturer’s total profit in the sale of the merchandise of the same class or kind into the United States. This type of comparison of the total profit of the seller in sales of the merchandise to the United States to the product line profit of the seller in the sales of the same merchandise to the same country, does not shed any light on whether the sale is at arm’s length. Accordingly, having examined the relevant aspects of the transaction, including the way in which the Company [***] and its subsidiaries in Singapore and the United Kingdom organize their commercial relations, as well as the way in which the price in question is arrived at between the parties, we hold that the Company [***] has not demonstrated that the transfer price has not been influenced by the relationship. Therefore, we find that transaction value is not the proper method of appraisement in this instance.
When transaction value is eliminated as the appropriate method of appraisement, imported merchandise must then be appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. §1401a(a). The alternative bases of appraisement, in order of precedence, are: the transaction value of identical or similar merchandise (19 U.S.C. §1401a(c)); deductive value (19 U.S.C. §1401a(d)); computed value (19 U.S.C. §1401a(e)); and, the “fallback” method (19 U.S.C. §1401a(f)).
The transaction value of identical or similar merchandise is based on sales, at the same commercial level and in substantially the same quantity, of merchandise exported to the United States at or about the same time as the merchandise being appraise. During the FA Follow-Up Audit of the Company [***], conducted by the Regulatory Audit office for the Port of San Francisco, the Company indicated that their competitors produced merchandise identical or similar to the merchandise produced by the Company’s affiliates in Singapore and the United Kingdom, [***] and [***]. Therefore, the imported merchandise may be appraised on the basis of the transaction value of identical or similar merchandise. However, since we have not been provided any information concerning the transaction value of identical or similar merchandise, we are not able to value the imported merchandise under this method of appraisement. Nevertheless, if information with respect to the transaction value of identical or similar merchandise is available, the imported merchandise must be appraised under this method of appraisement.
Under the deductive value method, imported merchandise is appraised on the basis of the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. 19 U.S.C. §1401a(d)(2)(A)(i)-(ii). This price is subject to certain enumerated deductions. 19 U.S.C. §1401a(d)(3). Pursuant to 19 U.S.C. 1401a(a)(2), if the value cannot be determined on the basis of the transaction value of identical or similar merchandise, the merchandise shall be appraised on the basis of the computed value, rather than the deductive value, if the importer makes a request to that effect to the customs officer concerned. See also 19 CFR § 152.102(c). In this case, the U.S. Importer argues that the merchandise should be appraised under the computed value method of appraisement; therefore, no information is presented as to the applicability of the deductive value method. Hence, we are not able to value the imported merchandise under the deductive value method of appraisement.
The next appraisement method is computed value. 19 U.S.C. §1401a(e) defines computed value as the following:
The computed value of imported merchandise is the sum of:
(A) the cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise;
(B) an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by the producers in the country of exportation for export to the United States;
(C) any assist, if its value is not included under subparagraph (A) or (B); and,
(D) the packing costs.
(2) For purposes of paragraph (1):
(A) the cost or value of materials under paragraph (1)(A) shall not include the amount of any internal tax imposed by the country of exportation that is directly applicable to the materials or their disposition if the tax is remitted or refunded upon the exportation of the merchandise in the production of which the materials were used; and,
(B) the amount for profit and general expenses under paragraph (1)(B) shall be based upon the producer’s profits and expenses, unless the producer’s profits and expenses are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by producers in the country of exportation for export to the United States, in which case the amount under paragraph (1)(B) shall be based on the usual profit and general expenses of such producers in such sales, as determined from sufficient information.
19 U.S.C. §1401a(e)(h)(5) defines “sufficient information” as the following: the term sufficient information . . . (iii) added under subsection (e)(2) as profit or general expense; . . . means information that establishes the accuracy of such amount, difference, or adjustment. Furthermore, 19 U.S.C. §1401a(g)(2) states that “for purposes of this section, merchandise (including, but not limited to, identical and similar merchandise) shall be treated as being of the same class or kind as other merchandise if it is within a group or range of merchandise produced by a particular industry or industry sector.
The Company argues that the intercompany transfer prices are acceptable customs values under the computed value methodology because these prices represent the producers’ costs plus an uplift factor to ensure that each producer earns an appropriate amount of profit. Pursuant to the Distribution Agreements between the Company [***] and its related suppliers, [***] and [***], the intercompany transfer prices are set at the beginning of each year on the basis of forecasted Profit & Loss statements of each legal entity. These projected P&L statements include projected sales revenue, anticipated cost of sales, anticipated operating expenses, etc. Based on these projections, the transfer price is established in SAP by taking each product’s standard cost and multiplying it by the uplift factor needed to arrive at the average unit price (“AUP”) (i.e. the average sales price to third party customers) minus [***]%. The uplift factor is the percentage that is multiplied against the standard cost to arrive at the intercompany transfer price. The amount of the uplift is meant to cover costs other than standard costs (e.g., production variances) as well as profit. We have no argument with the above referenced formulation; however, we note that the Company is using the same transfer pricing studies to justify the use of the transaction value method of appraisement and to replace the profit incurred by the related manufacturers (as stated in 19 U.S.C. §1401a(e)) with the profit found within a range of profits established by the transfer pricing studies of comparable companies to argue for the validity of the post-importation adjustments. Please note that 19 U.S.C. §1401a(e)(2)(B) clearly states that the amount for profit and general expenses under paragraph (1)(B) shall be based upon the producer’s profits and expenses, unless the producer’s profits and expenses are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise.
In Peerless Clothing International, Inc. v. United States, the Court held that the statutory requirement that computed value be consistent with other producers in the country of export is not absolute. See Peerless Clothing International, Inc. v. United States, 602 F.Supp.2d 1309 (CIT, Jan. 13, 2009). When an exporting manufacturer makes a diligent effort to find a comparable manufacturer in the country of export but cannot do so, it can use profits of manufacturers in other comparable countries or actual profits it makes in the computed value determination. See Peerless, 602 F.Supp.2d at 45. However, the producer’s profits and expenses must be inconsistent with those usually reflected in sales of merchandise of the same class or kind.
The transfer pricing studies submitted to support the computed value method of appraisement for the merchandise imported from Singapore do not establish the fact that the manufacturer in Singapore lacked comparable competitors. The transfer pricing studies simply limited the geographical search for comparable companies to China, Hong Kong, India, Japan, South Korea, Malaysia, Singapore, Taiwan, or Thailand, with the final set of comparable companies coming from Japan. With respect to the merchandise imported from the United Kingdom, although all of the comparable manufacturers were located in the United Kingdom, the profit range was not calculated on the basis of the merchandise within a group or range of merchandise produced by a particular industry or industry sector such as the life science and research industry. As previously mentioned, none of the studies included any of the Company’s direct competitors in the final selection of comparable companies. Further, the comparable companies chosen for the analysis of the manufacturing activities in Singapore are in the business of manufacturing market temperature control systems, analyzing equipment, and electronic devices for industrial measuring. The comparable companies
selected for the analysis of the manufacturer in the U.K., engage in manufacturing of chemical colors, animal health products, and pet accessories among other things. Pursuant to the 2006 transfer pricing study of the manufacturer in the U.S., the comparable companies engaged in the manufacture of agrochemicals, veterinary chemicals, detergents, biological chemicals, flavor compounds, and chemicals for water treatments were accepted because their products were not dissimilar to production of the Company’s affiliate in the United Kingdom, [***]. The facts presented in the transfer pricing studies do not lead us to conclude that the comparable companies utilized in these studies reflect a group or range of merchandise produced by the life science and research community industry. Therefore, in this case, the Company failed to establish the fact that the producers’ profit and expenses were inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise. Thus, the Company did not demonstrate that the value adjustments were warranted because the Company’s profit was inconsistent with profits usually reflected in sales of merchandise of the same class or kind as the imported merchandise. However, we find that the Company may appraise its merchandise under the computed value method of appraisement on the basis of the producers’ amount for profit and general expenses. If, in the future, the Company can demonstrate that its profits and general expenses are inconsistent with the sales of merchandise of the same class or kind in line with this ruling, then the Company is urged to submit another internal advice request to this office for reconsideration.
HOLDING:
In conformity with the foregoing, transaction value is not the appropriate method of appraisement for sales between the Company [***], (the Importer), and the manufacturers in Singapore and the United Kingdom. Nevertheless, the Company may use the computed value method of appraisement on the basis of the producers’ amount for profit and general expenses, provided that it substantiates its costs and the amount for profit and general expenses.
This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CPB personnel, and to the public on the CPB 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.
Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch