• HQ H088815
• Sep 28, 2011

• Type : Classification • HTSUS :
•  Related:   952033; 733579; 029658; 546979; 547672; 548482; 542261; 546998; H004649; H037375; H032883; H065015   

CLA-2 OT:RR:CTF:VS H088815 KSG

Field Director
Regulatory Audit
U.S. Customs and Border Protection
555 Battery Street
San Francisco CA 94111

Re: Request for Internal Advice; GSP; cookware; Nissho; related parties; sets

Dear Field Director:

This is in reference to your memorandum dated December 18, 2009, requesting Internal Advice regarding the issue of whether certain steel and clad metal cookware imported by Company B is eligible for preferential treatment under the Generalized System of Preferences ("GSP") and whether the imported cookware may be appraised based on the sale between the foreign manufacturer and the related middleman. We have considered a submission from counsel dated August 6, 2010, which also deals with the issue of the eligibility and calculation of the 35% value-content for sets of imported cookware that include Chinese-made glass lids. At the request of counsel, a meeting was held on this matter at Headquarters. Additional submissions dated February 26, 2010, and February 18, 2011, are included in the file and were considered in this case. We have partially granted the Company's request for confidentiality in this case.

FACTS:

The case involves imported pots, pans and lids. Company B is the importer of record and is a wholly owned subsidiary of Company P. The pots are manufactured by Factory C and purchased by Company M or Company N. Further, the raw materials are purchased from related parties (and sometimes unrelated parties) such as xxx.

CBP sampled 60 unliquidated GSP entries dated December 28, 2007, through September 25, 2008. The Office of Regulatory Audit concluded that 42 of the 60 entries did not meet the 35% value-content requirement for the GSP.

Production of Pots and Pans

The first step in the production of the pots and pans occurs in Country C or in China, where steel coil is cut into circular shapes or stainless steel blanks that are stamped to form the shell of the pan. To cut the blank, a mold is placed on an automatic blanking machine and the machine is programmed to cut the steel to the required diameter. Sample blanks are cut to shape, and checked and inspected for quality control. If the samples are satisfactory, mass production is commenced.

The remainder of the processing of the pots and pans takes place in a facility in Country C. The circular blank is sent to the deep drawing machine where it is stamped by the mechanical action of a punch to create the shell of the pot. Quality control is then performed. After stamping of the shell, the edge is edge blanked, which means that the edges of the shell are made smooth.

In some cases, friction bonding is used to bond the steel shell with an aluminum heat-conducting disc. The aluminum disc improves the conductivity and durability of the finished pots and pans. Not all the pots and pans are friction bonded. Friction bonding is done by spot welding the steel shell, aluminum disc and an additional stainless steel disc together. The piece is then fed into an auto forging machine which heats the plates in order to join them. At the screw press, the piece is marked with lettering (capacity code and date code). The pieces are then cooled and again undergo quality control. Next, the piece undergoes interior and exterior polishing, bottom base finishing and cleaning. Custom made machine molds, polishing fabric and polishing wax are used. The bottom base finishing is performed by a separate machine. Edge beading is also performed by a separate machine.

Some products undergo annealing, which involves heating the metal to strengthen it and improve its cold working properties. A custom made machine performs bulging while the metal is heated up.

Finally the piece undergoes both interior and exterior polishing and the handle is assembled onto the pot and pans, which are then packed.

Counsel also submitted a chart that shows a breakdown of the value added at each stage of production by percentage. Blanking accounts for 6% of the total labor costs of production, stamping accounts for 7% percent of the total labor costs of production, and the remainder of the processing that occurs after stamping accounts for the majority (88%) of the labor costs of production. We were not provided with any information regarding what percentage the total labor costs of production of the imported pots and pans are, compared to the total costs for the materials used to produce the pots and pans.

The August 6, 2010, submission relates to 10-piece cookware sets that include four glass lids that are produced in China with 6 pots and pans produced in Country C.

First sale Issue

The Group's website states that it is xxx and that it manufactures xxx. As described above, this case involves a related importer, middleman, manufacturer, and parent corporation. Some of the suppliers of raw materials are also related parties. Company B states that it performs the following functions: acts as the purchaser and importer of record, places orders for merchandise with its offshore related suppliers Company M and Company N, purchases finished merchandise from related companies Company M and other affiliates, and settles payment to Company M and Company N.

Company M engages in the design, sales and marketing of xxx cookware and other related products. It contends that it receives and processes orders placed by Company B for merchandise destined for the U.S., places orders for merchandise with Factory C, purchases merchandise from related companies, sells merchandise to Company B, settles payment to Factory C for merchandise sold to Company B and receives payment from Company B for merchandise. It states that it also is responsible for settling product defect claims relating to products sold in the U.S.

Factory C is based in Country C where it manufactures and operates xxx. Factory C receives orders for merchandise from Company M, purchases raw materials. sells merchandise to Company M, and receives payment from Company M for merchandise. Factory C manufactures and sells exclusively to related companies for further distribution to domestic and overseas markets.

The Office of Regulatory Audit in San Francisco, California, completed a Focused Assessment ("FA") Referral Audit Report dated August 31, 2009 ("the Audit Report"), of Company B. Company B requested duty refunds by claiming the "first sale" between the middleman and factory as the basis of appraisement. The Audit Report concluded that Company B was not entitled to claim "first sale" for entries valued at $xxx, because these entries involved first sale transactions between a related manufacturer and middleman that did not satisfy the arms length requirement. The remaining $xxx involved first sales transactions where the manufacturer was not a related party. Further, the Audit Report examined a statistical sample of unliquidated entries for the period of December 28, 2007 to September 25, 2008, and determined that of 60 entries examined, 42 entries did not satisfy the 35% value-content requirement for GSP. Of the 60 entries, only two entries were filed in December 2007. The remaining entries were filed in 2008. The Audit Report concluded that the 35% value-content requirement was not met for 42 entries because foreign-origin materials did not undergo a double substantial transformation and therefore, could not be counted toward the 35% value and because CBP determined that first sale should not be used as the basis of appraisement, which affected the value used for the denominator in the formula for the 35% value-content calculation.

The Audit Report found that 3 of the 60 entries involved a first sale between Company M and an unrelated manufacturer, xxx. These entries were found to satisfy the first sale requirement. According to the Audit Report, the unrelated manufacturer manufactured tea kettles, which Factory C does not produce. Of the 60 entries, 58 entries were from calendar year 2008.

The Audit Report reviewed a transfer pricing study conducted by PriceWaterhouseCoopers ("PWC") dated September 23, 2008, that dealt with the use of first sale methodology, for the period ending December 31, 2007 ("PWC Study"), and concluded that the PWC Study, which examined seven (7) Country C xxx cookware companies, was not sufficient to establish that the prices were settled in a manner consistent with the normal pricing practices of the industry in question. Further, the Audit Report concluded the PWC Study was insufficient to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit, in sales of merchandise of the same class or kind.

The CBP FA also reviewed company documents including: the Master Manufacturing Agreement; the Master Distribution Agreement; several e-mails; consolidated financial statements for Company B for 2005, 2006, and 2007; updated unaudited financial documents for Factory C and Company M for 2008 and 2009; and a table marked Exhibit C titled "Updated Benchmarking Analysis." We note that Company B did not submit any financial documents for Company P, which is the parent corporation of the xxx.

Company B submitted two documents which are identified as the basis of the intercompany transactions: a Master Manufacturing Agreement between Factory C and Company M, dated February 14, 2003; and a Master Distribution Agreement between Company M and Company B dated May 16 2003.

The Master Manufacturing Agreement provides for a minimum order obligation from Company M to Factory C and that Factory C agrees to manufacture goods ordered by Company M via purchase orders. Company M agrees to own or procure the technology at its own cost. The terms of sale are FOB Country C port - title and risk of loss to the product shall pass to Company M upon delivery. The Master Agreement states that "the per unit price of each type of the Products shall be such amount as is reasonably prescribed by the company (Company M) in the relevant purchase order or such other amount as the Company (Company M) and the supplier (Factory C) may from time to time agree."

The Master Distribution Agreement provides that Company B is the distributor and must pay for the goods within 21 days of invoice. Company M owns the imported goods until the total amount owed is paid in full. Risk passes to Company B from the first to occur of the passing of property to the distributor or the physical delivery of the products to the distributor. The company (Company M) must charge the distributor (Company B) the prices which have been negotiated and agreed upon by the parties prior to the placement of orders for the products.

Company B also submitted the PWC Study which was conducted to determine the arm's length nature of the related party transactions between Factory C and other related companies in the Group. As stated in the PWC study, the Transaction Net Margin Method ("TNMM") was chosen as the most appropriate method for testing the operating results of Factory C. The TNMM compares the operating profit earned by one of the parties engaged in the controlled transactions to the operating profits earned by uncontrolled parties engaged in similar business activities. The PWC Study searched for companies in Country C engaged in the manufacture of cookware products during 2002-2006 and identified seven (7) companies. The Return on Total Cost ("RTC") was selected as an appropriate profit level indicator. The PWC Study concluded that the TNMM analysis showed that the operating results of Factory C fell within the range of the adjusted operating results of the seven selected independent Country C companies. The five year weighted-average ROC of Factory C is 4.99% while the five-year weighted average ROC adjusted to the tested party of comparable independent companies ranged from 2.71% to 7.08%, with a median of 3.92%. Therefore, the report concluded that "Factory C's operating results fell within the range of the operating results adjusted to Factory C's basis of independent companies performing similar functions, similar risks, and employing similar assets."

The PWC Study stated that aluminum was used and accounted for more than half of all cookware sold in that time frame and the main alternative was stainless steel. The PWC Study stated that during 2007, there was a significant increase in the price of stainless steel and aluminum and that Factory C was affected by raw material price increases. Further, the PWC Study stated that there was a vast fluctuation in foreign currency as Country C's strengthened significantly against the U.S. dollar. The sales of Factory C in 2007 were xxx and the operating profit margin was -3.05%.

The PWC Study stated that it is not binding on the Country C tax authorities or any other tax authorities. There is no assurance that the tax authorities agreed with the PWC Study. PWC stated that all of the factual information and financial data on which the report is based was provided by Factory C and PWC did not independently audit or verify the accuracy of any of the information provided by Factory C.

The PWC Study also noted that "it is crucial to point out that in the context of the 60 item sample drawn by Customs, an evaluation may also need to be made of fiscal year 2008 (ending December 31, 2008) since the vast majority of the sample items selected fall within fiscal year 2008."

In selecting comparables for its analysis, PWC reviewed publicly-available databases and focused on companies operating in Country C under the following Standard Industrial Classification ("SIC") keywords or codes: cookware, containers, fabricated metal products, kitchenware, metal drums, tableware, utensils, water tanks, home and office products, packing, 28993 (manufacturer of cutlery), 28999 (manufacturer of metal products), 27310 (casing of iron and steel), 28920 (treatment and coating of metals), and 28120 (manufacture of tanks, reservoirs and containers of metal). The search identified 411 companies. Of those companies, 282 companies were discarded since they manufactured products in industries in significantly different environments or products of significantly different stages of production. Twenty seven companies were discarded as engaged in businesses other than manufacturing. Eleven companies with sales of less than xxx were eliminated. Three companies were discarded because information was not available or they had ceased business operations. This screening resulted in a list of 87 companies, for which PWC requested financial statements from the government. After detailed screening, seven companies remained as comparable companies.

None of the seven companies used in the PWC Study were direct competitors of Factory C in the domestic market or the global market. The PWC Study stated that xxx are the main competitors in the Country C market. The seven companies used in the PWC Study were xxx. According to the PWC Study, these companies produced stainless steel kitchenware products as well as stainless steel tanks and drums.

Exhibit C, labeled as an "updated benchmarking analysis" is a one-page table. The table lists seven companies, and three columns: a column for 2008, 2007, and 2006. The seven companies listed are: xxx. We note that only one company listed in Exhibit C was used in the PWC Study. There are figures for "full cost markup" ("FCM") and "operating profit margin" ("OPM") for each company for each of the three years. The 3-year average FCM lists a low of -11.08%, a high of 7.4% and a median of -2.71%. The 3- year average OPM lists a low of -11.63%, a high of 6.8% and a median of -2.81%. Factory C lists a FCM of -0.38% and an OPM of -0.43%.

CBP requested more information regarding the seven companies listed in the table that had not been included in the PWC Study. In a March 30, 2009, submission, Company B provided information that it described as summary profiles and financial statements for the seven companies used in the table marked Exhibit C. The financial statement descriptions, which consist of several terse bullets, covers the period 2002-2006. The company profile for xxx (which cites to four sources) states that the company is a manufacturer of enamel cookware and enamel and stainless steel teakettles. The company profile for the unrelated manufacturer xxx (which cites to three sources) states that it is a manufacturer, exporter and importer of stainless steel kitchenware and cutlery. The company profile for xxx (which cites to one source) states that it manufactures kitchenware. The company profile for xxx (which cites to two sources) states that it is a manufacturer, importer and exporter of kitchenware products/cutlery. The company profile for xxx (which cites to one source) states that it is a manufacturer of enamel cookware. The company profile for xxx (which cites to three sources) states that it produces stainless kitchenware products, which includes pots, pans, hotel and restaurant kitchenware, utensils, and houseware. The financial statements do not indicate that they were audited and provide profit and loss statements and balance sheets for the period 2002-2006.

Company B also submitted two e-mails which it states are evidence of transfer price negotiations between the parties. The first e-mail states "would you pls. advise the selling price for the following items. Thanks." A list of goods from a particular product family were then listed.

The second e-mail states as follows:

7/26/07

Pls note that the unit price is the selling price for customer. Pls add the xxx price into this file.

Besides, Would you pls provide your price list to us? We can revise the price on the vendor part data Firstly that the new price will be uploaded automatically for any new order via EDI

7/27/07

After reviewing with Joe, I have added xxx suggested selling price, % increase and sales increase in bold blue. The price increases from xxx% to xxx% and result in xxx USO sales increase. Please review. If OK, I shall amend xxx part sales data ourself and sales orders shipped after 2007/08/02. thanks

8/7/07 Pls note that the P/O's has been revised by customer gradually BUT I found our margin for few items to be sold for xxx is negative, in xxx% or only xxx% (pls see the sh Pls see the worksheet2 (2) in yellow color and review for us. Thanks

A list with codes and prices and percent increases is attached to the e­mail.

Company B also submitted a four page document prepared by PWC titled "Economic Analysis of Pricing Practices of Factory C in 2006 and 2007" dated February 15, 2011, which analyzed the sluggish adjustment of product prices by Factory C and tied to losses incurred in 2006 and 2007. It provides economic theory, both macroeconomic and microeconomic, which could explain the rationale for acceptance of short-term losses by a company.

ISSUES:

Whether pots and pans manufactured in Country C from Chinese-origin circular blanks undergo a double substantial transformation.

Whether 10-piece sets of cookware that include Chinese-origin glass lids are eligible for preferential tariff treatment under the GSP.

Whether the imported pots and pans produced by Factory C, which is related to Company M, the middleman, may be appraised based on the transaction between the foreign manufacturer and related middleman.

LAW AND ANALYSIS:

Substantial Transformation

Title V of the Trade Act of 1974, as amended (19 U.S.C.A. 2461-65), authorizes the President to establish a Generalized System of Preferences ("GSP") to provide duty-free treatment for eligible articles from beneficiary developing countries ("BDCs"). Articles produced in a BDC may qualify for duty­free treatment under the GSP if the good are imported directly into the customs territory of the U.S. from the BDC and the sum or value of materials produced in the BDC plus the direct costs of the processing operations performed in the BDC is equivalent to at least 35 percent of the appraised value of the article at the time of entry into the U.S. See 19 U.S.C. 2463(a)(2) and (3).

Country C has been designated as a BDC for purposes of the GSP and may be afforded preferential treatment under the HTSUS. See GN 4(a), HTSUS.

A good is considered to be a "product of” a BDC if it is wholly the growth, product or manufacture of the BOC, or if made of materials imported into the BDC, those materials are substantially transformed in the BOC into a new and different article of commerce. See 19 CFR 10.176(a). A substantial transformation occurs "when an article emerges from a manufacturing process with a name, character, or use which differs from those of the original material subjected to the process." Texas Instruments Inc. v. United States, 681 F.2d 778 (1982).

To be eligible for duty-free treatment under the GSP, merchandise must also satisfy the 35% value-content requirement. If an article consists of materials that are imported into a BDC, as in the instant case, the cost or value of these materials may be counted toward the 35% value-content requirement only if they undergo a double substantial transformation in the BDC. The purpose of the double substantial transformation rule is to ensure that a significant portion of the value of the good result from processing performed in the BDC and/or materials that originate in the BDC.

In Uniroyal, Inc. v. United States, 542 F. Supp. 1026 (CIT 1982), the Court of International Trade held that no substantial transformation occurred because the attachment of a footwear upper from Indonesia to it outsole in the United States was a minor manufacturing or combining process which left the identity of the upper intact. The court found that the upper was readily recognizable as a distinct item apart from the outsole to which it was attached, it did not lose its identity in the manufacture of the finished shoe in the United States, and the upper did not undergo a physical change or a change in use. The court concluded that the upper was the essence of the completed shoe and was not substantially transformed.

The Court of International Trade considered whether Japanese-origin steel sheet that was annealed and galvanized in a second country underwent a substantial transformation in Ferrostaal Metals Corporation v. United States, 664 F. Supp. 535 (CIT 1987). Galvanizing involved coating the steel with zinc so as to improve its resistance to rust. Annealing restored the ductibility of the steel which was lost in the cold rolling process performed in Japan by controlled heating at a high temperature in a furnace and cooling of the steel sheet. Annealing makes the steel less strong but more ductile or formable. Further, the steel sheet had to be heated to a specific temperature to meet the standards for a particular grade of steel sheet (e.g. ASTM A446 Grade A sheet had to be heated to 1350 Fahrenheit). Galvanizing involves dipping the steel sheet into molten zinc, which is a process known as alloying. Galvanizing constitutes a chemical change in the product and as a result of the galvanic protection, the steel lasts up to ten times as long as ungalvanized steel. The court discussed all these factors and found that strength and ductibility constituted important characteristics of the steel and dedicated the steel to use consistent with the improved characteristics. Lastly, the court stated that cold-rolled steel sheet was not interchangeable with annealed and galvanized steel sheet; building codes would require the use of galvanized steel sheet and also, certain automobile parts. The court held that that annealing and galvanizing of steel sheet was a substantial transformation.

In National Hand Tool Corporation v. United States, 16 CIT 308 (1992), the court held that mechanic's hand tool, which were either cold-formed or hot­forged in Taiwan into their final shape before processing in the U.S. were not substantially transformed in the U.S. The processing in the U.S. included heat treatment, formation of the grips, cleaning by sand-blasting, tumbling and/or chemical vibration, electroplating with nickel and chrome to resists rust and corrosion, and assembly for some of the sockets. The court stated that the heat treatment, electroplating and assembly in the U.S. did not change the character of the articles since each component was either hot-forged or cold-formed into its final shape in Taiwan. Further, there was a pre-determined use of the goods after the forging in Taiwan.

In Headquarters Ruling letter ("HRL") 733579, dated August 20, 1990, CBP held that pots and pans processed in the U.S. did not undergo a substantial transformation in the U.S. The processing in Venezuela, which was held to be a substantial transformation, involved cutting aluminum coil into a disc and then stamping the disc to form the shell of a pot. The processing in the U.S. included the following: the shells were de-burred; polished; painted; coated with a non­stick surface; and the handle was attached to form a finished pot. CBP held that the stamped unfinished shell was the very essence of the finished product and did not become a new article with a new name, character and use based on finishing operations such as polishing and deburring (removal of rough edges) and coating and the attachment of a handle.

In HRL 952033, dated November 4, 1992, CBP considered whether pots and pans produced from Hong Kong-origin aluminum circles processed in Thailand and then further processed in the U.S. were substantially transformed in the U.S. The processing in Thailand included: stamping aluminum circles, scroll trimming, drawing, edge trimming, punching of holes for handle assembly, machine etching, interior sandblasting and polishing. The U.S. processing included: hard anodizing; sealing; washing; applying a non-stick surface; sealing; assembly of the handles; cleaning and packing the finished pots and pans. CBP held that the pots and pans were substantially transformed in Thailand but not in the U.S. The processing of raw aluminum circles into unfinished aluminum shells in Thailand created a new article with a new name, character and use. Customs found that although the unfinished aluminum pots and pans underwent the hard anodizing process and the application of a non-stick surface in the U.S., no substantial transformation took place. CBP classified the products imported from Thailand as unfinished aluminum pots and pans. CBP stated that the imported goods had the essential character of finished aluminum pans.

Based on the information submitted, the pots and pans involved in this case would satisfy the "product of' requirement and would be considered products of Country C because regardless of whether the circular blanks are produced in Country C or in China, the pots and pans undergo a substantial transformation in Country C. This occurs when the circular blank is stamped to create the shell of the pot pr pan, which creates the basic shape and characteristics of a pot or pan. This is consistent with the court's finding in Uniroyal, in which the upper was held to constitute the essence of the shoe and adding a sole did not substantially transform the upper. In National Hand Tool, the court held that rough forgings of tools were the essence of the tools. The finishing of the rough forgings into hand tools was not considered a substantial transformation.

The issue presented is whether the pots and pans undergo a double substantial transformation so that all the materials may be counted toward satisfaction of the 35% value-content requirement under the two scenarios. Under the first scenario, pots and pans would be produced in Country C from foreign steel coil. We find that steel coil formed into a circular flat disk and then stamped to form the shape of a pot undergoes a double substantial transformation in Country C. This is consistent with HQ 733579 and HQ 952033 which find that the process of producing a circular blank from steel coil is a substantial transformation. Steel coil is a raw material that has a wide variety of industrial uses while the circular blanks are cut to shape and dedicated to a particular use. The circular blanks are a new product with a new name, character and use that differs from the steel coil. Secondly, stamping the blank to form a shell that has the basic shape of a pot or pan and further finishing the piece into a finished pot or pan would create a new article with a new name, character and use and would be considered a substantial transformation. The stamped out shell is the very essence of the finished pot, similar to the analysis in Uniroyal, and National Hand Tool.

In scenario two, pots and pans are produced in Country C from Chinese­origin circular blanks. In Country C, the circular blanks are stamped out to form the shell and the shell undergoes further finishing to create a finished pot or pan. We find that stamping out the shell constitutes a substantial transformation. As discussed in National Hand Tool and HRL 952033, the rough shell of the pot has the finished shape of a pot and the essential character of a pot. It is classified as an unfinished pot. However, the additional processing performed on the shell in Country C does not constitute a second substantial transformation.

Counsel argues that CBP should consider the cost of the labor value added by each level of production in Country C in making the substantial transformation determination. There is no showing that labor costs are significant for the production of these products. More importantly, this factor does not examine whether a new article is created as a result of each level of production. In HRL H004649, dated March 20, 2007, CBP held that a ceramic mug blank made in China was not substantially transformed when sent to Thailand or Taiwan for sublimation coating. CBP noted that value alone is not dispositive in the determination of substantial transformation and found that whilethe coating was more costly than the mug, it did not result in the creation of a new article with a new name, use and character.

Counsel contends that the shells are used to produce steamer inserts, mixing bowls and frying pans, and therefore, the shells are intermediate products. Counsel illustrated production of steamer inserts and stated that a shell was used to produce the steamer insert, with the major difference being that holes were punched into the base of the shell to produce a steamer insert. Counsel did not demonstrate how mixing bowls are produced. We assume for the purposes of this decision that pots and pans are produced in a similar manner. Although an unfinished or incomplete article could possibly be made into another article, this does not change the conclusion that it has been dedicated to a particular use and that it imparts the essential character of the good. The rationale for examining this factor is that a raw material, which could potentially have many different uses, has been converted into a material which has a much narrower range of uses and that the character of the good has been determined. CBP is not convinced that just because there is a fugitive use for the shell to be made into a product that is not a pot or pan (but rather a steamer insert or bowl) that the shell would be considered an intermediate product. . Counsel argues that annealing or friction-bonding of pots would constitute a substantial transformation. Counsel acknowledges that not all pots and pans undergo either process. Friction-bonding is performed on stainless steel pots to improve the heat conducting capacity of the shell because stainless steel is a poor conductor of heat while aluminum is a better conductor of heat. This case is distinguishable from Ferrostaal because in that case, all the goods underwent both annealing and galvanizing and in fact, had to undergo such processing to be suitable for the intended use. The court found that galvanized and non­galvanized steel were not interchangeable for use (ex. building codes. some automobile parts). In this case, some of the pots are annealed or friction-bonded and some are not. While processing may improve the quality of an article so that it is superior, it does not necessarily result in a substantial transformation. This is similar to the processing in National Hand Tool that was performed on the rough forgings which protected the tools from rusting and corrosion but did not create a new article. We find that annealing or friction bonding of some of the pots and pans in this case is a process which improves the quality of the good but does not create a new article with a new name, character and use resulting in a substantial transformation.

Lastly, counsel cited to the purpose behind the GSP program as a basis to find a double substantial transformation for the Chinese-origin blanks that are processed in Country C. The purpose behind the 35% value-content requirement, as stated above, is to encourage the use of materials and skilled from the BDC. We find our conclusion in this case to be consistent with the purpose behind the GSP program, which is to support the creation of infrastructure, jobs, new industries and development in Country C.

Set issue

In Uniden America Corporation v. United States, 120 F. Supp. 2d 1091 (CIT 2000), the court examined a General Rule of Interpretation ("GRI") 1 set involving an imported cordless telephone set with an a/c adapter. The cordless telephone and base unit were produced in the Philippines, a beneficiary developing country ("BDC country"). The a/c adapter was produced in China. The assembly of the cordless telephone and base unit in the Philippines involved the assembly of 275 parts. The court considered the use of the a/c adapter, (which is to supply power) differed from the purpose of the cordless telephone. A new character emerged because the a/c adapter neither characterized nor defined the phone in question. The court examined the issue of whether the a/c adapter imparted the essential character of the cordless telephone and found that it did not impart the essential character of the set. The adapter was of minor value as compared to the other components in the set. The court held that the cordless telephone set satisfied the "product of" requirement under the GSP because the imported good was a GRI 1 set which was classified in accordance with the portion of the set that imparted the essential character of the set, the cordless telephone which was produced in a BDC country. The court specifically did not rule on whether the same result would occur if it involved a GRI 3(b) set.

Counsel argues that pursuant to Uniden, the imported cookware set would be considered a product of Country C because the pots and pans impart the essential character of the set and not the lids and further, that the 35% calculation would be calculated based on the value of the Country C originating pots and pans.

Treasury Decision ("T.D.") 91-7 (dated January 8, 1991), held that for GRI 3(b) sets which claimed preferential tariff treatment under the GSP after August 20, 1990, all the components of the set have to satisfy the "product of” requirement. Therefore, in considering a hairdressing set consisting of a comb, brush and scissors made in Jamaica, and hair clippers made in Taiwan, CBP held that neither the set nor any part of the set would be entitled to duty-free treatment under the Caribbean Basin Initiative. The same would be true under the GSP with regard to all articles entered after August 20, 1990.

We disagree with counsel's interpretation of Uniden. The Court in Uniden made the point that it was dealing with a GRI 1 set, and the non-BDC good was an ale adapter for a cordless telephone set, a minor component of the telephone set that did not impart the essential character of the telephone. This case involves a GRI 3(b) set. Unlike Uniden, the lids do not differ from the purpose of the pots and pans, which is to cook food. Further, the non-BDC pieces account for four of the ten pieces of the set and represent more than a minor value of the set, which differs from Uniden, where the ale adapter represented a very small percentage of the value of the imported telephone sets.

The set in this case is 10 pieces of cookware consisting of six pots and pans made in Country C and four glass lids made in China that are merely packaged together. Pursuant to 19 CFR 10.176(a)(2), no article is eligible for preferential tariff treatment under the GSP that only undergoes a packaging operation. The cooking lids would not satisfy the "product of" requirement for the purpose of the GSP. We find that the 10-piece set would not be considered a "product of" Country C pursuant to Uniden and T.D. 91-7, and would not be eligible for preferential tariff treatment under the GSP.

In the alternative, counsel contends that CBP should permit the segregation of the lids from the Country C-origin pots and pans and allow entry of the pots and pans under GSP pursuant to 19 CFR 141.52. Nineteen CFR 141.52 provides that if a port director is satisfied that there will be no prejudice to: Import admissibility enforcement efforts; the revenue; and the efficient conduct of Customs business, separate entries may be made for different portions of all merchandise arriving on one vessel or vehicle and consigned to one consignee under any of the following circumstances: ... (f) the consignment consists of different classes of merchandise which are to be processed by different Customs commodity specialist teams .... (i) A special application is submitted to the Commissioner of Customs with the recommendation of the port director concerned and is approved by the Commissioner.

In the circumstances of this case, there would be prejudice to the revenue and therefore, we find that 19 CFR 141.52 is inapplicable. Based on the above analysis, we find that the cookware sets which contain Chinese-origin glass lids would not satisfy the "product of” requirement and would not be eligible for preferential tariff treatment under the GSP.

Ill. First Sale Issue

The preferred method of appraising merchandise imported into the United States is the transaction value method as set forth in section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 ('TAA"), codified at 19 U.S.C. 1401 a. Transaction value of imported merchandise is the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus amounts for five enumerated statutory additions. 19 U.S.C. 1401 a(b). In order for imported merchandise to be appraised under the transaction value method, it must be the subject of a bona fide sale between a buyer and seller, and it must be a sale for exportation to the United States. Although it is assumed for the purposes of this ruling that transaction value is the appropriate basis of appraisement, CBP may consider whether this is an appropriate basis of appraisement given the vertical integration of the related companies involved.

In Nissho lwai American Corp. v. United States, 982 F.2d 505 (Fed. Cir. 1992) and Synergy Sport International, Ltd. v. United States, 17 CIT 18 (1993), the Court of Appeals for the Federal Circuit and the Court of International Trade, respectively, reviewed the standard for determining transaction value when there is more than one sale which may be considered as being a sale for exportation to the United States. Both cases involved a foreign manufacturer, a middleman, and a United States purchaser. In each case, the court held that the price paid by the middleman/importer to the manufacturer was the proper basis for transaction value. Each court further stated that in order for a transaction to be viable under the valuation statute, it must be a sale conducted at arm's length, free from any non-market influences, and involving merchandise clearly destined for export to the United States at the time of the first sale.

In accordance with the Nissho lwai and Synergy decisions, we presume that transaction value is based on the price paid by the importer. In further keeping with the courts' holdings, we note that an importer may request appraisement based on the price paid by the middleman to the foreign manufacturer in situations where the middleman is not the importer. However, it will be the importer's responsibility to show that the "first sale" price is acceptable under the standard set forth in Nissho lwai and Synergy. That is, the importer must present sufficient evidence that the alleged sale was a bona fide "arm's length sale," and that it was "a sale for export to the United States," within the meaning of 19 U.S.C. 1401a.

In T.D. 96-87, 30 Cust. Bull. 52/1 (January 2, 1997), CBP set forth the documentation and information needed to support a ruling request that transaction value should be based on a sale involving a middleman and the manufacturer or other seller rather than on the sale in which the importer was a party. CBP advised that the importer must provide a description of the roles of the parties involved and must supply relevant documentation addressing each transaction that was involved in the exportation of the merchandise to the United States. The documents may include, but are not limited to purchase orders, invoices, proof of payment, contracts, and any additional documents (e.g. correspondence) that establishes how the parties deal with one another. The objective is to provide CBP with "a complete paper trail of the imported merchandise showing the structure of the entire transaction." If such information is unavailable the ruling should so provide. T.D. 96-87 further provides that the importer must also inform CBP of any statutory additions and their amounts. If unable to do so, the sale between the middleman and the manufacturer cannot form the basis of transaction value.

According to Nissho lwai, in order for a transaction to be viable for transaction value purposes, it must be a sale negotiated at arm's length, free from any non-market influences. There is a presumption that a transaction will meet this standard if the buyer and seller are unrelated. If the parties are related, then "it is necessary to provide Customs with information which demonstrates that transaction value may be based on the related party sale as provided in 19 U.S.C. 1401a(b)(2)(B). (i.e., that the circumstances of sale indicate that the relationship did not influence the price or that the transaction value closely approximates certain test values.)" See T.D. 96-87, supra.

In this case, the first sale is between related parties. While the fact that the buyer and seller are related is not in itself grounds for rejecting the use of the first sale, where CBP has doubts about the acceptability of the price and is unable to accept the first sale 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 first sale pursuant to the methods outlined above.

"Test values" refer to values previously determined pursuant to actual appraisements of imported merchandise. 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.

When the importer claims that transaction value is acceptable because the transfer price was settled in a manner consistent with the normal pricing practices of the industry in question, the importer must have objective evidence of such practices and present evidence that the transfer price was settled in accordance with these industry pricing practices.

The issue involved in this case is whether Company B has demonstrated to CBP that although the sale is between related parties, Factory C and Company M, the relationship did not affect the price and the parties dealt with each other at arm's length.

Normal pricing practices of the industry

In its February 26, 2010, submissions, Company B argues that it demonstrated that the transfer prices between Factory C and Company M were settled in a manner consistent with the normal pricing practices of the industry in question.

Section 482 of the Internal Revenue Code (26 U.S.C. 482) requires that for tax purposes, 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 established am arm's length range of prices or financial returns with which to test controlled transactions.

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. See 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. See 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. If it can be shown that the price in question was settled in a manner consistent with the normal pricing practice of the industry in question, this will demonstrate that the price has not been influenced by the relationship.

The importer must have objective evidence of how prices are set in the relevant industry in order to establish the "normal pricing practices of the industry" in question, and present evidence that the transfer price was settled in accordance with these industry pricing practices. See HRL 542261, dated March 11, 1981. In HRL H037375, dated December 11, 2009, CBP noted that the companies used in the transfer pricing study were direct competitors of the company being examined and all companies sold merchandise of the same class or kind. CBP held in that case that the transfer pricing study supported a finding that the company's price was settled in a manner that was consistent with the normal pricing practices of the industry.

Company B states that it relied on its transfer pricing study that covered the period ending December 31, 2007. However, in its discussion of the PWC Study, counsel referenced the seven companies listed in the one-page table (described in the facts as Exhibit C), not the companies used in the PWC Study. Company B also argued that using full cost markup was a valid profit level indicator. This was also information included in the table but not the PWC Study. Company B argues that the PWC Study was contemporaneous with the entries reviewed even though it did not include fiscal year 2008 information and further, that it updated the PWC Study with 2008 data for Factory C. Company B contends that the PWC Study and table demonstrate a severe decline in profits in the industry for 2006-2008 with a small improvement in profit margins for the period 2008.

Company B argues that despite the contract language contained in the master manufacturing agreement between Company M and Factory C, the two companies deal with each other at arms' length. The language in the master manufacturing agreement states that: "The per unit price of each type of the Products shall be such amount as is reasonably prescribed by the company (Company M) in the relevant purchase order or such other amount as the Company (Company M) and the supplier (Factory C) may from time to time agree." Company B contends that prices were competitively set based on market influences and cited to the e-mails it provided which it contends showed that prices were changed to accommodate the pricing that Company B was able to sell to U.S. retailers for the imported goods. Company B states that rather than a scenario where Company M dictated the price to Factory C, a "process is in place where the U.S. buyer, via Company M approached the manufacturer with specs and a price in mind to assess under which conditions the price is feasible." Company B also states that Company M can source identical products from manufacturers other than Factory C.

In this case, the existence of language in the master manufacturing agreement regarding how prices are set serves as further evidence to show that the first sale transaction was not at arm's length. Although Company B states that the middleman purchases from unrelated parties, there is only evidence that it purchased tea kettles from an unrelated party, a product which Factory C does not produce. Factory C does not sell to unrelated companies and the e-mails submitted do not show vigorous negotiation regarding pricing between the parties. Changing a price so that a second company can make a profit shows how the relationship between the parties affects the price, rather than showing independence. Based on the information reviewed, Factory C sells all the goods it produces to Company M. The language in the master manufacturing agreement and the e-mails submitted do not demonstrate to the satisfaction of CBP that the transaction between the parties is at arm's length.

CBP has reviewed the 2007 PWC Study and gives it little weight. It does not cover the relevant time period (2008). PWC concedes this point in the PWC Study. None of the seven companies examined in the PWC Study are direct competitors of Factory C in Country C or the global market. Several of the companies included in the PWC Study sell goods not of same class or kind, such as steel drums and tanks, as well as cookware. The PWC Study also does not separate out the profit margins to calculate profit margins based on sales of cookware. The PWC Study differs from the study reviewed in HRL H037375, which studied companies that were in direct competition and all the companies produced goods of the same class or kind, thereby supporting a finding that the company's price was settled in a manner that was consistent with the normal pricing practices of the industry.

Further, the PWC Study was not reviewed by the IRS leaving CBP unaware as to whether the assumptions on which the study is based and conclusions reached would be acceptable to the IRS. Finally, Company B chose to rely on Exhibit C, the "update," in its submission to CBP.

Exhibit C, (the one page table), utilized only one company included in the PWC Study covering 2002-2007 and six companies that were not included in the PWC Study, with little background information on the six new companies and no explanation of how the seven companies referenced in Exhibit C were chosen. None of the seven companies are identified as direct competitors of Factory C in the global market and only one company is listed as a direct competitor in the Country C market. As described in its own submission, the Group is a xxx. We also note that a different methodology was used in the table than that used in the earlier PWC Study. A one-page table with no transfer pricing study to support its conclusions and analysis is of little weight to CBP and does not demonstrate that Factory C's price was settled in a manner that was consistent with the normal pricing practices of the cookware industry.

Company B discusses an economic recession which began at the end of 2007 and in 2008-2009 in the U.S., and the shrinking U.S. economy. General economic data and information regarding the price of aluminum in 2007, the strength of the Country C currency in 2007, and information about the weak U.S. economy in 2007-2008 is relevant to the general global market conditions in 2007 but would not be the type of narrowly-drawn analysis that CBP would rely on alone to demonstrate the normal pricing practices of a relevant industry, the cookware industry in this case, to the satisfaction of CBP.

All costs plus profit

The "all costs plus a 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 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 customs purposes.

Company B did not submit financial information on the profits of the parent corporation and argues that the all costs plus a profit method does not mandate that the profits of the parent company be compared to satisfy the term "the firm's overall profit." In its December 22, 2008 submission, PWC argues that Factory C's overall profit should be compared to "the profit realized over a period of time in sales of merchandise of the same class or kind to the middleman, Company M." PWC argues that it would not be appropriate to compare the profit of Factory C to the profit of the middleman, Company M, because Company M does not own or control Factory C and has different functions and activities and operates in a different manner. We concur with PWC that comparison to the middleman would not be appropriate for the reasons stated above.

In HRL H065015, dated April 15, 2011, the company asserted that CBP should not look at the profit of the parent company, but rather the seller's 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. CBP stated that this comparison "did not shed any light on whether the sale is at arm's length." This case is on point with the arguments made in this case and similarly, we find that the comparison proposed by Company B between the overall profits of Factory C and the profits of Factory C in sales of merchandise of the same class or kind to the middleman does not shed any light on whether the sale is at arm's length. The proposed comparison would show whether the particular cookware line is profitable as compared to the profitability of Factory C, which would be of interest to the company and perhaps investors, but does not show that the sale between Factory C and Company M is an arm's length transaction. Accordingly, we find that the importer has not demonstrated based on the "all costs plus a profit" method that the first sale was at arm's length.

T.D. 96-87 states that the presumption is that CBP will use the price paid by the importer as basis of transaction value. Company B has failed to rebut this presumption. Company B has failed to meet its burden of showing that the related party price has not been influenced by relationship.

Therefore, we find that Company B has not shown that the prices in the related first sale was adequate to ensure its recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind.

The importer has not established that the prices paid by the middleman in the related party transaction were at arm's length. The prices were not shown to be consistent with the industry in question; nor was the evidence sufficient to show that the prices contained all costs plus a profit equivalent to the firm's overall profit as a whole for the same class or kind of merchandise. Without this information, we find that the importer has not shown that the transaction between the related parties was at arm's length.

In summary, Company B has failed to show that the first sale between the related manufacturer and middleman is agreed upon through arms length negotiation. Accordingly, the goods may not be appraised on the basis of the "first sale," the price paid by the related middleman to the manufacturer because the protestant has failed to demonstrate that the price actually paid or payable was not affected by the relationship between the parties.

HOLDING:

Pots and pans produced in Country C from Chinese-origin blanks would not undergo a double substantial transformation in Country C and therefore, the cost of the Chinese-origin blanks may not be counted toward the 35% value­content requirement. The 10-piece pots and pans set that includes 4 Chinese-origin glass lids would not be considered a "product of' Country C pursuant to T.D. 91-7 and would not be eligible for preferential tariff treatment under the GSP.

Company B has failed to show that the relationship between the related manufacturer and middleman did not influence the price and that the transaction was at arm's length. Accordingly, the importer has not met its burden of overcoming the presumption that Customs will use the price paid by the importer as the basis of appraisement.

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 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,

Monika R. Brenner, Chief
Valuation & Special Programs Branch