Customs Ruling HQ H157795 - Request for Internal Advice; Valuation between related parties when goods subject of a sale and when goods not the subject of a sale; Transfer pricing

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HQ H157795
Jun 29, 2015

Type : Valuation • HTSUS :
Related: 546979; 547654; H029658; H065015; H234029; H257520; W548314

OT:RR:CTF:VS H157795 CMR

U.S. Customs and Border Protection
Miami Service Port – Miami International Airport
6601 NW 25th Street
Room 272
Miami, FL 33122-3215
Attn: Assistant Port Director

RE: Request for Internal Advice; Valuation between related parties when goods subject of a sale and when goods not the subject of a sale; Transfer pricing

Dear Ms. Amato:

This is in response to your request for internal advice regarding the valuation of spare parts for aircraft imported by [the importer, Party A]. The spare parts are imported from [a related supplier, Party B] which is the foreign parent of [Party C], which is the U.S. parent of the importer. The question of the acceptability of transaction value between the related parties arose as a consequence of a Focused Assessment Pre-Assessment Survey conducted by the Office of Regulatory Audit reviewing importations from January 1, 2008 through June 30, 2009.

Counsel has requested confidential treatment be accorded to certain information submitted in connection with this Internal Advice request. In consideration of the request and sufficient justification presented pursuant to 19 CFR 177.2(b)(7), this office will not identify the parties having any connection to the transactions under review nor any of the financial information provided to CBP. Information for which confidentiality is being accorded will be denoted in brackets in the confidential internal advice response and will be redacted in any public version.

This office has considered the information in the file, responses from counsel to questions from this office, supplemental submissions from counsel, and the discussion at our offices with counsel and his client’s representatives on August 23, 2011 and January 22, 2013.

FACTS:

The importer, was described in one of the submitted transfer pricing studies as “a U.S. corporation that ‘distributes aircraft spare parts, markets and sells new and used aircraft, and provides technical and support services to existing and potential customers.’” See Counsel’s October 25, 2010 submission citing the Executive Summary of the September 15, 1997 Transfer Pricing Report. While discussed in further detail below, in summary, the importer provides marketing services and technical and support services on behalf of its foreign related supplier. It also imports spare parts for the related supplier’s aircraft; some of which it purchases and some of which are imported free of charge.

The importer is the exclusive distributor in the U.S. of its related supplier’s self-produced and proprietary parts for use in the supplier’s aircraft. The importer sells parts to customers who “are either ‘operators’ (companies that operate [the related supplier’s] aircraft), authorized repair stations (companies authorized to repair [the related supplier’s] aircraft) or brokers/distributors.” See Counsel’s submission of August 24, 2012. The importer provides certain after-market services, such as, a spare parts program, a pool program, and technical assistance, to the related supplier’s aircraft customers. The importer purchases parts from the related supplier, and sometimes from unrelated parties, to sell and to distribute to the related supplier’s aircraft customers or to provide to such customers pursuant to a “pool program.” The price the importer pays for parts it purchases from the related supplier is based on a list price which is established annually. Large volume customers, such as the importer receive a discount off the list price. See Counsel’s submission dated August 24, 2012.

Counsel explained the adjustment to the spare parts pricing between the related parties as follows:

At the end of the accounting period, a benchmark is performed, and [the importer’s] level of profitability is compared to the level of profitability of the benchmarked, comparable companies. If [the importer’s] level of profitability is not within the level of profitability of the comparable companies, the discount granted by [the related supplier] may have to be adjusted, causing an adjustment of the parts pricing. After this adjustment, [the importer’s] profit is comparable to like, limited risk distributors, including those selling aircraft spare parts in the U.S. The pricing structure, including the end of year adjustment, is based on a written agreement between [the importer] and [the related supplier].

The “pool program” operated by the importer allows purchasers of the related supplier’s aircraft to return defective parts to the importer and receive an operable part from the “pool” stock as a replacement at no charge. The importer purchases parts reserved for the pool program from the related supplier. Customers pay a fee to participate in the pool program. Counsel advises that the pool program is a strictly domestic program between the importer and its customers. Counsel has explained that

the “pool program” is a service whereby customers do not pay for parts, they pay to have parts available in inventory.

Counsel explained the pool program, by letter dated February 14, 2013, as:

. . . a domestic program operated by [the importer] in accordance with agreements made by [the importer] with its “pool” customers. It is separate and apart from [the importer’s’] “spare parts program,” which relates broadly to the warehousing and distribution of aircraft parts by [the importers]. The majority of the parts for the “spare parts program” are, in fact, purchased from [the related supplier]. Pursuant to these agreements, customers can return non-functioning aircraft parts to [the importer] and [the importer] will quickly provide replacements parts. [The importer] maintains a sufficient U.S. inventory of “pool” parts to service these customers. For this domestic service program, [the importer] typically receives a fixed fee from its customers based on aircraft flight hours or per availability. [The importer] receives this fee whether or not the customer requires a part during the contract period.

Only approximately [x]% of the parts included in the pool are purchased from [the related supplier] and imported by [the importer] into the U.S. The remaining [x]% are purchased from unrelated vendors, many of which are located in the U.S. The structure of the transaction on the small amount of goods purchased by [the importer] from [the related supplier] is identical to [its purchases from the related supplier for the “spare parts program.”] In other words, the pool parts purchased by [the importer] from [the related supplier] are purchased in the same manner as the parts not within the pool.

It is submitted that the “sale of services is a U.S. customer – importer transaction; i.e., a domestic sale.” See Counsel’s submission of August 24, 2012. However, “[t]he related supplier receives a portion of the profits relating to the pool program because it provides, among other things, access to the customer, supplier management relationships for non-[related supplier] parts and inventory management software.” See Counsel’s letter, dated February 14, 2013.

In addition to parts purchased for sale to customers and the parts purchased for the pool program, the importer receives parts for service bulletin and warranty agreement transactions. Parts imported for these purposes are not purchased by the importer, but are provided free of charge by the foreign manufacturer. The foreign manufacturer supplying these parts may be the related supplier or an unrelated supplier.

This office received a copy of a contract between the related parties, referred to as a “Commercial Representation Agreement,” dated January 1, 1996. The contract contemplated three principle functions to be carried out by the importer – sales promotion, technical assistance, and spare parts sales and support. The agreement established the responsibilities of the parties and two different methods of payment – one regarding spare parts and the other regarding the services rendered as the representative of the related supplier. Based on the contract, it appears that the importer acts as an agent of the related supplier with regard to the sale of aircraft and the provision of certain services, but at the same time buys spare parts for resale for the related supplier’s aircraft.

With regard to the sale of parts sold to the importer for the purpose of resale, i.e., related supplier-made parts, parts to which the related supplier held exclusive distribution rights, and parts which the related supplier held in stock, the price owed by the importer was the related supplier’s sales list price less a discount. With regard to sales promotion and technical assistance, the related supplier owed the importer a payment of the importer’s cost plus a commission. However, a portion of costs incurred by the importer for technical assistance activities was to be allocated to activities relating to the sale of spare parts. The discount to the spare parts’ sales price may be adjusted during the year or otherwise to ensure an arm’s length price between the parties. The contract expired on December 31, 2006. Per counsel, the parties have continued to operate under the terms of this original agreement. However, there is no formal document detailing the extension. While the contract addresses warranty, maintenance, repair and technical assistance activities provided by the importer for the related supplier, it makes no mention of the pool program and the rights and responsibilities of the parties with regard to that program. CBP did receive a copy of a memorandum by an independent tax advising company, dated December 14, 2009, in which the tax advising company described the breakdown of services performed by the related supplier and the importer in regards to the pool program. The memorandum indicates that:

The Related supplier:

set up the pool program provides access to the customer, i.e., customers are purchasers of aircraft from the related supplier arranges for the parts included in the pool to be supplied to the importer negotiates the prices of the parts included in the pool – “negotiates the prices of the parts directly with both the customers and vendors.” See page 2 of December 14, 2009 Memorandum performs the purchasing function related to the parts included in the pool based on [the importer’s] recommendations uses software it developed to provide the importer with the ability to make accurate just-in-time inventory holding decisions.

The importer:

services the pool program receives the payments for the pool program from customers pays the carrying cost with respect to the inventory manages the repair and exchange function signs the contracts for the pool program with the customer bears the accounts receivable risk packs and ships the parts

However, this breakdown did not provide any information with regard to the profit split, costs attributions or contractual agreement between the parties with regard to the pool program. The memorandum concluded by simply stating that “the portion of the transfer pricing adjustment identified with the operation of the pool programs is related to services provided by [the related supplier] is (sic) support of [the importer’s] operations in the United States and not related to the acquisition and importation of parts from [the related supplier].” See page 3 of December 14, 2009 Memorandum.

It is submitted by counsel that related supplier parts purchased for the pool program “fall under the [importer-related supplier] agreement for the sale of parts. The sale of services is a U.S. customer – [importer] transaction, i.e., a domestic sale. The scope of the 1996 agreement relates to the sales promotion and after sales support for aircraft, parts and accessories. Pool activities are within the scope of after sales support.” Counsel’s submission dated August 24, 2012. In a presentation describing the structure of the parts sales between the related parties, it was stated that “[i]n most cases, parts purchased by [the importer] from [the related supplier] are warehoused in the US for later sale by [the importer] to U.S. customers.” “The sale from [the related supplier] to [the importer] is made pursuant to a purchase order between the companies.” See Counsel’s submission dated February 14, 2013. When a U.S. customer requires a part, the customer places the order with the related supplier as it “operates a call center for most spare parts purchases, including those purchased by [the importer’s] customers in the U.S.” However, according to the importer, the sale takes place between the importer and the U.S. customer. The importer issues an invoice to the customer and the customer pays the importer. This has been the practice since 2001. The sale of parts between the related supplier and the importer is FCA which indicates “the seller delivers the goods, cleared for export, to the carrier nominated by the buyer at the named place.” See Incoterms 2000 (International Chamber of Commerce), at 33. Counsel states that title passes in accordance with the Incoterm at the same time as risk of loss. The importer maintains a stock of parts for sale to customers. With regard to the pool program, the presentation describes it as a domestic program between the importer and its U.S. customer. “There is no agreement between [the related supplier] and [the] U.S. customer.” CBP has been told that the “structure of [the] sale on pool parts purchased from [the related supplier] is identical to [the] structure for all other parts” and as previously noted “[the related supplier] receives a portion of the profits relating to the pool program. . . because it provides access to the customer, supplier management relationships (for non-related supplier parts) and inventory management software.” It is argued these profits are wholly unrelated to the imported goods purchased from the related supplier.

The related supplier has rare sales to unrelated U.S. customers when a part is not available in the U.S. and the customer needs the part immediately. However, the part “costs the customer more to buy from [the related supplier] because [the] customer must arrange freight/customs into [the] U.S.” See Slide Presentation submitted by Counsel. Examples of seven sales for identical merchandise from the related supplier to the importer and from the related supplier to unrelated U.S. buyers were submitted. The majority of these sales occurred during the audit period. The sales were submitted to show the differences in prices charged to the related party importer and to unrelated parties. In addition, counsel submitted information regarding the related supplier purchases of parts from unrelated suppliers which were then sold to the importer. Twenty-two items were identified. The sales prices to the importer reflected a mark-up so as to provide the related supplier with a profit on the sale.

The importer uses transaction value as the basis of appraisement for its entries of aircraft parts it purchases from the related supplier. For those parts not subject to a sale, i.e., parts imported from the related supplier and unrelated suppliers as a consequence of a service bulletin to customers or a warranty program, the importer asserts that transaction value of identical or similar merchandise is the proper basis of appraisement. For those parts which are purchased from the related supplier, the value listed on the Customs Form (CF) 7501 is based on an invoice prepared by the related supplier which includes estimated costs. Payment is made by wire transfers or through offsets on the books of the related parties as the importer provides services to the related supplier for which it is owed payment. The accounts are settled on a monthly basis and whichever company owes the other money sends payment to clear any outstanding invoices. After an annual transfer pricing study is conducted, the total amounts paid by the importer to the related supplier are adjusted to bring U.S. profit margins within the inter-quartile range established by [the importer’s] transfer pricing study. As the entered values are estimated values which are subject to change after the annual transfer pricing study is conducted, the importer uses reconciliation to report the adjusted final values on their entries of goods imported from the related supplier to Customs and Border Protection (CBP).

CBP received a copy of a consolidated and segmented income statement for the related supplier for 2007, 2008 and 2009. Income from the sale of spare parts was reflected in the amounts attributed to “Aviation Services” which includes the sale of spare parts, as well as training and other amounts unrelated to the sale of parts. A chart of the importer’s trial balance gross revenue and net income was also submitted for comparison purposes. CBP also reviewed a power point presentation presented by counsel.

In support of the use of transaction value between the related parties, the importer has submitted three transfer pricing studies as evidence that the transfer price between the parties meets the arm’s length requirement of 19 U.S.C. § 1401a. These studies cover calendar years 1996, 2007 and 2008. The 1997 study, which reviewed calendar year 1996, considered:

The intercompany sales of aircraft parts manufactured by the related supplier and sold to the importer for distribution in the U.S.; The provision of marketing services by the importer on behalf of the related supplier; and, The provision of technical and support services provided by the importer on behalf of the related supplier.

With regard to the intercompany sales, the study used the resale price method and used seven comparable companies. Of the seven, only three companies were in the business of distributing aircraft parts. The study concluded that the intercompany transactions between the related supplier and the importer for the sale of spare parts were arm’s length for parts purchased in 1996. The transfer pricing studies covering calendar years 2007 and 2008 were conducted by a different accounting firm from that used for the 1997 study. The 2007 study explained the sales of spare parts similarly to how the company explained it to CBP. The study states:

[The importer] purchases the parts from [the related supplier] and thus takes legal ownership of the aircraft parts and performs the transportation, distribution logistics, and warehousing functions, and assumes the related risks, which include inventory risk, market risk and risks involving the logistics of distribution and transportation. Inventory is maintained off premises as well as on [the importer’s] premises.

While [the importer] holds the inventory and accounts receivables risk in the transaction, [the related supplier] maintains the customer relationships and negotiates the prices of the parts directly with the customer. Customers contact [the related supplier] directly as a result of the fact that [the related supplier] is the initial customer contact and [the related supplier] sells the planes. Further [the related supplier] provides related services such as filling customer orders, inventory planning, and advising customers on the nature of parts they may require. . . .

The later studies used the comparable profits method in analyzing the spare parts distributor functions of the importer and the cost-plus method for analyzing the marketing functions performed by the U.S. parent of the importer on behalf of the related supplier and the technical and support functions performed by the importer on behalf of the related supplier. In the calendar year 2007 study, two of the five comparable companies were aircraft parts distributors and the calendar year 2008 study included only one aircraft parts distributor in the four comparable companies used in the study. Basically, all of the studies conclude that with regard to the sale of spare parts, the related parties’ pricing reflects arm’s length transactions, or as two of the studies stated: “[The importer’s] return for the intercompany policy for the provision of distribution services is appropriate from a transfer pricing perspective.” The calendar year 2008 study indicated that the importer’s “return for the intercompany policy for the

provision of distribution services is above the interquartile range of results expected from a transfer pricing perspective.”

In a September 15, 2011, submission, CBP was provided with information regarding sales of identical or similar merchandise by the related supplier to unrelated parties for the same price. The related supplier establishes a list price annually of the parts it manufactures. It then grants discounts to related and unrelated buyers, such as operators of the related supplier’s aircraft, “authorized” repair stations and customers who purchase in large volumes. Large volume purchasers receive a larger discount, similar to the discount extended to the importer. As evidence of this practice, four examples were presented.

The first example illustrated that operators purchasing a cable assembly received a discount and the importer received a larger discount for the same part. The second example showed a foreign exclusive distributor of certain parts received essentially the same discount as the importer when purchasing a rod assembly. The third example showed again the same foreign exclusive distributor receiving the same discount as the importer when purchasing a part referred to as canvas. The fourth example showed that same foreign distributor paying the same amount for a seal as the importer and therefore, receiving the same discount.

This office also received two examples of warranty agreements between the related supplier and customers. One agreement indicates that defective parts shall be returned to the importer at the customer’s expense. The other agreement indicates the defective parts shall be returned to the related supplier or its representatives at the customer’s expense.

Your port does not believe that sufficient information has been submitted to establish that the related party relationship did not influence the price. In addition, you do not believe that sufficient information has been provided relating to “identical” transactions used as the basis for appraisement of service bulletin and warranty parts, whether imported from unrelated suppliers or the related party supplier. Therefore your office does not believe appraisement under transaction value is proper. You advocate appraisement under the deductive value method as transaction values of identical or similar merchandise are not available.

ISSUES:

I. Whether transaction value, 19 U.S.C. § 1401a(b), is the proper method of appraisement for the parts imported by the importer as a result of a purchase from the related supplier?

II. Whether transaction value of identical or similar merchandise, 19 U.S.C. § 1401a(c), is the proper method of appraisement for the parts imported by the importer which are not purchased by the importer, but supplied free of charge by

the related supplier or an unrelated supplier due to service bulletins or warranty programs?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised 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 preferred method of appraisement is transaction value, which is defined as the "price actually paid or payable for merchandise when sold for exportation to the United States," plus five statutorily enumerated additions. 19 U.S.C. § 1401a(b)(1). In order for transaction value to be applicable for appraisement purposes, there must be a bona fide sale of merchandise for export to the United States.

The transactions at issue involve related parties as defined in section 402(g) of the Tariff Act of 1930, as amended by the TAA, codified at 19 U.S.C. 1401a. Under 19 U.S.C. § 1401a(b)(2)(A)(iv), transaction value is used for appraisement of imported merchandise “only if” the buyer and seller are unrelated, or if the buyer and seller are related, transaction value is acceptable under 19 U.S.C. § 1401a(b)(2)(B) which states:

The transaction value between a related buyer and seller is acceptable for the purposes of this subsection if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between such buyer and seller did not influence the price actually paid or payable; or if the transaction value of the imported merchandise closely approximates—

(i) the transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States; or

(ii) the deductive value or computed value for identical merchandise or similar merchandise;

but only if each value referred to in clause (i) or (ii) that is used for comparison relates to merchandise that was exported to the United States at or about the same time as the imported merchandise.

In this case, the related parties have a mixed relationship, i.e., one in which the importer provides services for, or on behalf of, the related supplier, i.e., acts as an agent, and one in which the importer buys aircraft parts from the related supplier for sale to unrelated customers. As a consequence of the parties’ mixed relationship, the importer owes money to the related supplier for the purchase of parts, receives payment (reimbursement of certain costs plus a commission) with regard to services provided on behalf of the related supplier, and owes the related supplier a portion of the monies received from the pooling program operated by the importer. Our focus in this internal advice is on the appraisement of the imported parts.

Stock and Pool Merchandise

Invoices and proof of payment have been submitted for sample transactions of parts imported by the importer for subsequent sale to U.S. customers. CBP has accepted that a bona fide sale of merchandise for export to the United States occurs between the importer and the related supplier with regard to stock merchandise purchased by the importer for sale to U.S. customers and merchandise purchased from the related supplier for the importer’s pool program. CBP has been told that the importer purchases approximately [x]% of the merchandise in the pool program from the related supplier and [x]% from unrelated vendors. CBP must determine the acceptability of the price paid by the importer to the related supplier under transaction value due to the relationship of the parties.

The Statement of Administrative Action (SAA) for the TAA discusses the use of transaction value by related parties. It addresses methods for determining whether transaction value between related parties would be acceptable – the circumstances of the sale and test values. With regard to the circumstances of the sale, the SAA stated:

. . . the Customs Service will examine relevant aspects of the transaction, including the way in which the buyer seller organize their commercial relations and the way in which the price in question was arrived at, . . . If it is shown that the buyer and seller, although related, buy and sell to each other as if they were not related, this will demonstrate that the price has not been influenced by the relationship and the transaction value will be accepted.

The SAA goes on to offer examples of how the parties may show their transaction is not influenced by the relationship. The examples are that the price is settled in a manner consistent with the normal pricing practices of the industry in question, or with the way the seller settles prices with unrelated buyers; or, the price is sufficient to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit over a representative period of time in sales of merchandise of the same class or kind. See “Statement of Administrative Action,” H.R. Doc. No. 153, 96 Cong., 1st Sess., Pt II, at 449 (1979). These examples are repeated in the CBP Regulations at 19 CFR § 152.103(l). However, as recently stated by CBP in Headquarters Ruling Letter (HQ) H029658, dated December 8, 2009, “[t]hese are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well.”

In an effort to show that the parties’ prices should be accepted by CBP as representing arm’s length transactions, counsel has submitted three transfer pricing studies. Each study supports the argument that the prices paid by the importer to the related supplier for spare parts are arm’s length prices. One indicates the importer’s return on its distribution services is higher than expected from a transfer pricing perspective. However, the existence of supportive transfer pricing studies is not enough. Such studies do not eliminate the need for CBP to examine the circumstances of the sale between the related parties to determine if the price is acceptable. See HQ

H065015, dated April 14, 2011, citing HQ 546979, dated August 30, 2000. As stated further in HQ H065015:

. . . 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 [HQ] 546979, dated August 30, 2000. Whether products covered by the study are comparable to the imported products at issue is another important consideration. See [HQ] 547672, dated May 21, 2002. The methodology selected for use in a transfer pricing study is also relevant. [HQ] 548482, dated July 23, 2004.

In this case, no information has been provided to CBP to indicate that any of the transfer pricing studies have been submitted to the Internal Revenue Service, much less approved by them. The limited number of comparable companies in the studies engaged in distributing the same class or kind of merchandise limits the persuasive weight CBP gives to the studies. The aircraft parts distributors included in the transfer pricing studies were not direct competitors of the importer due to the differences in the parts the importer and the companies distribute. The remaining companies in the studies did not trade in the same class or kind of merchandise as the importer. While transfer pricing studies provide useful information in considering whether related parties’ transactions reflect arm’s length prices, generally transfer pricing studies alone will not suffice as a basis for accepting related parties transfer prices. We find the submitted transfer pricing studies in this case to be of limited value.

Counsel focuses his argument on the comparison of the profits of the related parties in “aviation services.” Aviation services includes the sale of spare parts (with which we are concerned), but also includes maintenance and repair, training and other product support services. It was submitted that approximately three-quarters of “aviation services” relates solely to the sale of spare parts and therefore, a comparison of the profits between the related parties for these services is appropriate. However, focusing on the differences in the profit between the related supplier and the importer which is attributable to aviation services is not helpful because it includes services with which we are not concerned. Information regarding the differences between the related parties in operating profit margin in sales of spare parts for the year 2008 was provided. It does show that the related supplier had an operating profit margin that was approximately 12 times more than that of the importer. Counsel submits that as the related supplier received the majority of the profit in the sale of parts, the importer paid duties on a higher value.

Sample transactions with an unrelated foreign distributor were provided in the September 15, 2011 submission. Additionally, it was explained that companies that operate the related supplier’s aircraft and “authorized” repair stations are provided a [x]% discount off the list price and sometimes a larger discount. Large volume purchasers, including related subsidiaries and unrelated exclusive distributors, receive discounts of [x]% or [x]% off the list price. The first example provided is not particularly helpful as the unrelated parties involved are not distributors, but operators. It merely shows the application of the operator discount to their purchases and only one of the unrelated parties is located in the U.S. The remaining three examples do show an unrelated supplier receiving the same discount, or basically paying the same amount, as the related party in purchases of the same parts during the time-frame examined by Regulatory Audit. While CBP will consider this information in examining the totality of the circumstances, these examples cannot be used as test values pursuant to 19 U.S.C. 1401a(b)(2)(B) because the sales were not to unrelated buyers in the United States for merchandise exported to the United States, but sales to a foreign distributor for sales outside the U.S.

With regard to sales to unrelated parties in the United States, information was presented regarding sales over a two-month period – March and April 2009. Invoices were submitted to show that the related supplier charges the importer less than it charges an unrelated U.S. customer. It is to be expected that a distributor would be charged less than an ultimate customer. The explanation that is offered to explain the differences is that the importer receives a [x]% discount off the list price while U.S. customers buying directly from the related supplier, a rare occurrence, pay the list price plus must transport the goods to the U.S., i.e., handle the freight, duties and fees.

We examined the seven examples of sales of merchandise from the related supplier to unrelated U.S. customers to sales of the same merchandise to the importer. One purpose of submitting the examples was to illustrate that the importer’s sales price to U.S. customers is similar to the direct sales price from the related supplier to unrelated U.S. customers. This concept was reflected in examples 4 through 7 where the importer’s resale price was identical to the related supplier’s sales price to the unrelated customers. In examples 1 through 3, the importer actually had a lower resale price in two instances. However, it was also stated that the examples show that the related supplier treats the importer as an ordinary, unrelated distributor. Yet, when we looked at who the unrelated customers were, we found the customers included an FAA designated Repair Station (including certification for repair of one of the related supplier’s aircraft), an aftermarket support company providing spare parts (primarily, if not exclusively, for helicopters) and a company related to the aftermarket company providing maintenance, repair and overhaul services for planes and helicopters, including spare parts. These two related companies are distributors of spare parts and perform similar services as those performed by the importer, yet they paid more for the same part. In addition, if we assume the U.S. customers all paid the list price and received no discounts, then the importer received discounts ranging from [x]% to [x]%. If we assume that the importer received a discount of between [x]% to [x]%, then the designated repair station (not clear if it was considered an “authorized” repair station) either paid more than the list price or received a [x]% discount.

The transactions between the related supplier and the importer and those between the related supplier and unrelated customers present differences in commercial level and quantity. No explanation was offered regarding the proper adjustments to make to account for such differences. The sales from the related supplier of parts purchased from unrelated suppliers wherein the examples showed the related supplier makes a profit are of little value as, like all sales from the related supplier to the importer, the sales are subject to post-entry adjustments. As the importer’s prices are impacted by post-entry adjustments addressed by Reconciliation entries, the comparisons are less useful. Counsel states that while “the price ultimately paid by [the importer] may change, that change historically would lead to [the importer] actually paying more for the good than [the] unrelated [distributor] (which is what occurred in 2008).” See Counsel’s submission dated August 24, 2012. The purpose of test values is to show that the relationship does not influence the price for the goods. As such, it is expected that prices to related and unrelated would be comparable. In counsel’s February 14, 2013 submission, it is stated that “due to the 2008 end of year adjustment, the price ultimately paid for these parts by [the importer] to [the related supplier] was more than that paid by the unrelated party to [the related supplier].” In addition, we note that the 2008 entries by the importer are subject to a Reconciliation protest, Protest No. 5201-10-100154, claiming monies were paid to the related supplier which do not relate to the value of the imported goods.

Counsel also argues that the related parties’ profit is “commensurate with the activities performed and risks taken by each party. It is stated that the “appraised value of merchandise imported by [the importer] is higher than it would be if less profit was kept in [related supplier’s country] and duties are paid on this higher amount . . . . the transactions reflect that [the importer] is not attempting to lower its duty liability by shifting profits to the U.S.” Our task is to determine if the valuation method is arm’s length, i.e., that the importer is valuing the imported merchandise properly (not overvaluing or undervaluing).

With regard to the pool program, it is claimed that only approximately [x]% of the parts included in the pool are purchased by the importer from the related supplier and “the sale is identical to all other sales between the companies.” See Counsel’s Submission dated September 15, 2011. CBP has been told that the “[c]ontract terms are negotiated by the importer with each customer and the importer usually receives a fixed fee based on aircraft flight hour or per availability in exchange for pool services.” Id. Counsel admits that the related supplier is directly involved in the purchasing function of goods destined for the pool, but states that “[w]hether or not domestic, [the related supplier] orders the part in [the importer’s] name and the seller directly invoices [the importer (the importer’s U.S. parent)].” See Counsel’s email of April 29, 2013. Counsel submits that the pool program has little relevance to the question of whether the sales of parts between the related parties is impacted by the relationship as it is a wholly domestic program. The sale of services offered by the pool program is between the importer and the U.S. customer. However, a related Reconciliation protest refers to monies sent to the related supplier under the pool program as mistakenly being apportioned to the value of imported merchandise. The related supplier plays a role in the functioning of the pool program, thus, clearly there is an element of the pool program that involves the related supplier so that it is not a wholly domestic program.

Warranty and Service Bulletin Merchandise

As for parts imported free of charge, i.e. not subject to a sale, because they are to fulfill a warranty or are imported due to a service bulletin to replace defective parts, it is claimed that the values declared are identical to the values that would be declared if the goods were sold by the related supplier to the importer. Counsel submits that appraisement based on the transaction value of identical or similar merchandise under 19 U.S.C. 1401a(c) or 1401a(f), is appropriate. Further, with regard to such parts imported from the related supplier, it is stated that at least [x]% of the parts received by the importer from the related supplier are shipped pursuant to a sale. Therefore, only [x]% of the parts received from the related supplier are not subject to a sale.

As to the parts not subject to a sale, there seems to be concerns regarding such parts whether imported from the related supplier or unrelated suppliers. With regard to the parts supplied by unrelated suppliers, this office received an example of a Service Bulletin Transaction showing parts received from unrelated parties After our review, we are satisfied that for this transaction, the value of identical or similar merchandise may be used if the statutory requirements of 19 U.S.C. § 1401a(c) are met, i.e., that the value be based on sales of identical or similar merchandise that were exported to the U.S. at or about the same time as the imported merchandise. To use this method, the transaction value of the identical or similar merchandise must be a previously accepted value; that is, it must be demonstrated that the transaction value is fully acceptable under section 402(b) of the TAA at the time of appraisement of the merchandise under consideration in order to be applied as the transaction value of identical or similar goods under section 402(c). See T.D. 91-15, 25 Cust. Bull. 31 (1991); and HQ H234029 dated April 22, 2013. As explained in T.D. 91-15, the previously accepted value is determined on the basis of information provided by the importer or already available to CBP.” See HQ H257520, dated January 16, 2015. Appraisement based upon the value of identical or similar merchandise would only be applicable if the importer is able to obtain the necessary information from their suppliers, which is not likely if the supplier is unrelated, or has purchased the identical or similar merchandise at or about the same time.

As to warranty and service bulletin parts supplied by the related party supplier, it is our understanding that the prices declared are based on “either prior sales or, if not, a formula by which the price for such goods would be sold.” See Counsel’s email dated January 22, 2013. As stated above, appraisement based upon the value of identical or similar merchandise requires sales of identical or similar merchandise that were exported to the U.S. at or about the same time as the imported merchandise and the value must be a previously accepted value. If the importer is able to show sales by the related supplier of identical or similar merchandise for export to the U.S. at or about the same time as the imported merchandise and those values were previously accepted by CBP, such values may be used under 19 U.S.C. § 1401a(c). If there are no previously accepted values, appraisement under 19 U.S.C. § 1401a(c) is not possible. As for the use of prices that would be charged if the parts were sold, this is not an acceptable approach to valuing the merchandise unless it is considered under the fallback method of appraisement, 19 U.S.C. §1401a(f). However, as the methods of valuation must be applied in order, the deductive value and computed value methods must be considered before resorting to the fallback method.

As the warranty and service bulletin parts (whether supplied by an unrelated party or the related party supplier) are not sold after importation, deductive value may not be an appropriate method. However, if the importer has imported identical or similar merchandise that was then sold after importation, the deductive value of such identical or similar merchandise may be used under the deductive method to value the warranty and service bulletin parts. See 19 U.S.C. § 1401a(d)(1) defining “merchandise concerned.” Computed value may be used for appraisement purposes if the related party supplier, the related supplier, provides the information required under 19 U.S.C. 1401a(e) for parts it manufactures; however, unrelated suppliers are not necessarily inclined to reveal the information necessary to calculate computed value to their customers. If the information is not provided, or if such information is not available because the related party supplier does not manufacture the part, then appraisement will fall to the fallback method of 19 U.S.C. § 1401a(f). If the importer is receiving replacement parts for parts previously purchased, or for which a purchase price that would be charged by the supplier can be shown, i.e., the supplier has a catalogue price list, the port may consider such prices in valuing the merchandise under the fallback method.

Transfer Pricing Adjustments – HQ W548314

While we find that transaction value is not applicable, for the sake of completeness we address counsel’s reference to a CBP Notice dated May 30, 2012, wherein CBP announced a change in practice regarding the denial of post-entry decreases in value based on transfer pricing adjustments in sales between related parties. In HQ W548314, dated May 16, 2012, CBP revoked HQ 547654, dated November 9, 2001, regarding the valuation of bulk chemicals. In HQ W548314, CBP held that the methodology for determining the transfer price in that case constituted an objective formula for purposes of applying transaction value and claiming post-importation adjustments. The decision further stated:

. . . the post-importation analysis has two requirements: (1) there is a “formula” within the meaning of 19 CFR §152.103(a)(1) that is analyzed using the factors, so that properly documented adjustments may be claimed if they occur; and (2) the parties satisfy the requirements under 19 U.S.C. §1401a to show that the relationship did not influence the price.

With regard to the factors used to determine whether an objective formula is in place prior to importation for purposes of determining the price within the meaning of 19 CFR §152.103(a)(1), CBP listed the factors in HQ W548314 as:

A written “Intercompany Transfer Pricing Determination Policy” is in place prior to importation and the policy is prepared taking IRS code 482 into account; The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return; The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted; The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and, No other conditions exist that may affect the acceptance of the transfer price by CBP.

Counsel submits that the importer meets the factors set forth in HQ W548314 and, as such, the post-entry adjustments may be taken into account in determining transaction value. Counsel states that the 1996 “Commercial Representation Agreement” describes the formula for compensation between the related parties for various activities, including the sale of spare parts. We disagree.

The 1996 Agreement is not an Intercompany Transfer Pricing Determination Policy, it is a representation agreement with the sale of spare parts by the representative, i.e. the importer, broken out from the rest of the Agreement involving services provided by the importer and its compensation for such services. With regard to the sales of spare parts, the price owed by the importer was the related supplier’s list price less a discount. “The Parties shall review and, if necessary, in accordance with arm’s length pricing principals applicable under U.S. tax laws, adjust the discount . . ., whether during the year or otherwise, or set off amounts one PARTY may owe to another PARTY.” See “Commercial Representation Agreement.” This is not a formula. There is no specificity regarding how adjustments will be made with regard to the prices for sales of spare parts from the related supplier to the importer. In fact, it appears that a mixing of the amounts owed to the importer for services may be used to offset amounts owed to the related supplier for parts. The transfer pricing studies which were submitted also do not offer any specificity regarding how adjustments will be made. The transfer pricing studies merely provide the opinion of the independent accounting companies who performed the transfer pricing studies utilizing information provided by the related parties and pertaining to the companies they decided were comparables, to determine whether the prices for the sales of spare parts between the related parties reflected an arm’s length price and would be appropriate from a tax perspective.

No information has been provided to this office regarding the accounting details from the company’s books and/or financial statements to support the claimed adjustments. Further, we believe that other conditions exist that may affect the acceptance of the transfer price by CBP. Specifically, CBP has not been provided with any agreement between the parties that addresses the “pool program.” Yet, the importer is using the pool program and monies owed by the importer under that program to the related supplier (which the importer submits were mistakenly attributed to the sales of goods and added to the values of imported goods from the related supplier in a Reconciliation Entry) as the basis for a claim in a related Reconciliation Protest before this office. The 1996 Agreement came into being before the pool program was created and therefore, does not address the program. Counsel, in the August 24, 2012 submission, attempts to bring the pool program within the scope of the 1996 Agreement by claiming that the pool activities are within the scope of after sales support, which is covered by the agreement under the commercial representative services, but there is nothing in the Agreement addressing the related supplier providing services to the importer and receiving any consideration for such services. The Agreement only address the purchase of spare parts by the importer from the related supplier and the payment by the related supplier to the importer for commercial representative services. Yet, we have payments to the related supplier from the importer for services and no information presented to CBP to explain such payments, other than a memorandum from an independent accounting company summarizing the responsibilities of the related parties under the pool program. The memorandum is not sufficient evidence of the rights and responsibilities of the related parties under the pool program or their agreed upon compensation. Further, if, as claimed, the pool program is a completely domestic program between the importer and the U.S. customer, then it is unclear how the pool program could possibly fall within the scope of an Agreement compensating the importer for acting as a commercial representative of the related supplier.

Simply put, the transfer pricing studies presented by the parties are inadequate, the 1996 expired Commercial Representation Agreement is inadequate as it does not address the apparent current arrangement between the parties in its entirety, and, the submitted comparison invoices are insufficient for CBP to conclude that the related parties meet the circumstances of the sale for transaction value to apply.

Treatment

Finally, in the February 14, 2013 submission, counsel asserts that CBP has accorded a “treatment” to the importer’s valuation of merchandise purchased from the related supplier. Counsel claims that CBP has reviewed and accepted his client’s valuation of such goods imported from its related supplier.

With regard to claims for treatment and the evidentiary requirements to substantiate such a claim, the CBP Regulations provide, in relevant part, at 19 CFR § 177.12(c)(1):

(i) There must be evidence to establish that:

There was an actual determination by a Customs officer regarding the facts and issues involved in the claimed treatment;

The Customs officer making the actual determination was responsible for the subject matter on which the determination was made; and

(C) Over a 2-year period immediately preceding the claim of treatment, Customs consistently applied that determination on a national basis as reflected in liquidations of entries or reconciliations or other Customs actions with respect to all or substantially all of that person's Customs transactions involving materially identical facts and issues[.]

Determinations of whether a treatment occurred will be made by CBP on a case-by-case basis and will involve consideration of all relevant factors, including whether the past transactions were reviewed by CBP personnel. See 19 CFR § 177.12(c)(1)(ii). With regard to the evidence required for establishing a treatment, 19 CFR § 177.12(c)(1)(iv) provides:

The evidentiary burden as regards the existence of the previous treatment is on the person claiming that treatment. The evidence of previous treatment by Customs must include a list of all materially identical transactions by entry number (or other Customs assigned number), the quantity and value of merchandise covered by each transaction (where applicable), the ports of entry, the dates of final action by Customs, and, if known, the name and location of the Customs officer who made the determination on which the claimed treatment is based. In addition, in cases in which an entry is liquidated without any Customs review (for example, the entry is liquidated automatically as entered), the person claiming a previous treatment must be prepared to submit to Customs written or other appropriate evidence of the earlier actual determination of a Customs officer that the person relied on in preparing the entry and that is consistent with the liquidation of the entry.

In this case, counsel relies upon the submission of a prior disclosure supplemental submission, dated May 11, 2007, in which it is claimed the importer described the failure to report end of year adjustments made on entries filed between August 2001 and February 2007; described the structure of its transactions with its related party supplier and its failure to account for end of year adjustments made during the disclosure period. Counsel submits that the prior disclosure was accepted by CBP in December 2009 and, based upon that acceptance, “there was an actual determination by responsible CBP officials regarding the identical facts and issued involved in CBP’s present review.” See Counsel’s submission of February 14, 2013.

The issue before this office is whether transaction value is the proper method of appraisement for the parts imported by the importer as a result of a purchase from the related supplier. This question arose as the request of a Focused Assessment Pre-Assessment Survey conducted by the Office of Regulatory Audit which began on April 13, 2009 and included an examination of the valuation method used by the importer for appraisement of merchandise purchased from the related supplier. We contacted the Office of Fines, Penalties and Forfeitures at the Port of Miami and were informed that there is more than one prior disclosure and that all are currently in suspense awaiting this office’s decision in this internal advice. Counsel has failed to establish any of the elements necessary to establish that a treatment exists as to the valuation of the merchandise imported by his client.

We note with regard to the Reconciliation Protest, the importer seeks reliquidation of the Reconciliation entry based only on the assertion that monies sent to the related supplier did not relate to the value of the merchandise, but related to monies owed to the related supplier under the pool program for which no information, i.e., written agreement which reflects the agreement between the parties, has been submitted. No evidence to substantiate the claim appears to have been submitted.

Without further information to persuade CBP that the related parties’ prices for parts meet the arm’s length test to qualify for use of transaction value, we agree with you and the Office of Regulatory Audit that transaction value is not the proper method of appraisement for these transactions. As there appear to be no transactions of identical or similar merchandise to use as a basis for appraisement of the merchandise, we agree that deductive value should be used for appraisement purposes. Pursuant to 19 CFR § 152.101(c), the importer may opt to use computed value, before resorting to deductive value, in regard to parts for which it is able to obtain the necessary information from the manufacturer.

HOLDING:

We agree with the Port of Miami and the Office of Regulatory Audit that transaction value is not the proper method of appraisement for the parts imported by the importer as a result of a purchase from the related supplier. Parts purchased from the importer’s related supplier should be appraised based upon the deductive value method, unless the importer requests appraisement under the computed value method and is able to provide the information required for application of that method of appraisement. With regard to the Reconciliation Protest, the port should take appropriate action based upon this decision.

As to the appraisement of parts imported by the importer for which there is no purchase, i.e. imported pursuant to warranty or service bulletins, if the importer is able to show sales by its related party supplier or an unrelated supplier of identical or similar merchandise for export to the U.S. at or about the same time as the imported merchandise and those values were previously accepted by CBP, such values may be used under 19 U.S.C. § 1401a(c). If there are no previously accepted values, appraisement under 19 U.S.C. § 1401a(c) is not possible. Deductive value may be used if the importer has imported identical or similar merchandise that was then sold after importation. See 19 U.S.C. 1401a(d)(1). Computed value may be used for appraisement purposes if the information required under 19 U.S.C. 1401a(e) is provided. If appraisement is not possible based on the 19 U.S.C. § 1401a(b) through (e), then appraisement should be based on the fallback method of 19 U.S.C. § 1401a(f). Sixty days from the date of this letter, Regulations and Rulings of the Office of International Trade will take steps to make this decision available to Customs and Border Protection ("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