HQ H204329
OT:RR:CTF:VS H204329 YAG
Port Director
U.S. Customs and Border Protection
JFK Airport, Building 77
Jamaica, NY 11430
Re: Internal advice request; transaction value; post-importation adjustments
Dear Port Director:
This is in response to the internal advice request, transmitted to our office on January 26, 2012, regarding the treatment of preliminary post-importation adjustments, made for tax purposes in accordance with [***] (“Company A’s”) bilateral Advance Pricing Agreement (“APA”). Furthermore, Company A filed a supplemental submission on July 17, 2012 and provided additional information to our office during our meeting on September 24, 2012. We regret the delay in responding.
Company A has asked that certain information submitted in connection with this internal advice be treated as confidential. Inasmuch as the request conforms to the requirements of 19 CFR §177.2(b)(7), the company’s request for confidentiality is approved. The information contained within brackets and all attachments to the internal advice request, forwarded to our office, will not be released to the public and will be withheld from published versions of this ruling.
FACTS:
Company A is a subsidiary of [***] (parent company) and is an importer, marketer, and distributor of various pharmaceutical products. Company A purchases the imported pharmaceutical products from its foreign related supplier. All imported products are classified in duty-free provisions of the Harmonized Tariff Schedule of the United States (“HTSUS”). With respect to the sale of the imported merchandise between Company A and its related foreign supplier, the parties entered into Supply Price Letter Agreements (“Agreement”), which set forth the prices Company A pays to its related supplier.
On August 11, 2009, Alston & Bird, LLP filed a prior disclosure, on behalf of Company A, disclosing preliminary tax transfer pricing adjustments that had been made to certain imported products the related foreign supplier sold to Company A. This prior disclosure covers approximately 370 entries of pharmaceutical products imported from 2005 through 2008, made at the Ports of Champlain, New York, and Newark.
Company A assigned these post-importation adjustments to certain imported products because it anticipated being a party to a pending APA with the Internal Revenue Service (“IRS”). In anticipation that the pending APA would be approved, Company A preliminary transferred funds to its related-party supplier to remain within the anticipated APA parameters. Company A states that there were various ways to make these adjustments, and for 2007 and 2008, Company A and its foreign related supplier decided to reduce Company A’s profitability (hereby, increasing the prices) through additional payments to the supplier. As stated in Alston & Bird’s supplemental submission, dated July 17, 2012, this plan was documented by revisions in the Agreements of the prices of these selected products and implemented through debit notes (all documents were provided for our consideration).
Since 2009, there have been some changes in the facts of this case. In 2011, the tax authorities in the United States and Germany agreed on the proposed APA renewal. The prior APA used the Comparable Profits Method (“CPM”), with Company A (the importer/buyer) being the tested party. The new bilateral APA (which covers the years in question in this internal advice request) uses the Residual Profit Split Method (“RPSM”) converted to a single profit level indicator. The profit level indicator is an operating margin. The final APA also covers fiscal years 2005-2014 and provides a specific net operating margin profitability range for 2005-2009 and for 2010-2014 (this APA is split into 2 parts). This APA covers all transactions between the parties, both tangible and intangible, as well as services (with the exception of intercompany loans and any non-operating and/or extraordinary transactions). Paragraph 5(b) of the APA states that “this APA addresses the arm’s-length nature of prices charged or received in the aggregate between Taxpayer and Foreign Participants with respect to the Covered Transactions.” With each of the functions of Company A being considered separately and with a net operating margin determined for each function, tax authorities also set a total net operating margin for all of the functions of Company A. The adjustments under the new APA do not have to be made on an annual basis, but the operating margin can be tested on a multi-year basis.
Ultimately, the tax authorities also accepted Company A’s preliminary adjustments for 2007 (which Company A declared to U.S. Customs and Border Protection (“CBP”) via a prior disclosure). With respect to 2008, the tax authorities found that the net operating margin (including the preliminary adjustments) was too low and that an additional adjustment of $[**] million from the foreign supplier to Company A was necessary. Thus, additional preliminary tax payments were found to be $[**] million too much from an overall net operating margin perspective. For 2009, Company A’s financial results were found to be too high and a reduction in Company A’s operating margin of $[**] million was necessary. These APA adjustments in the operating margin of Company A for 2008 and 2009 were made through a net $[**] million adjustment from the foreign related supplier to Company A. Company A allegedly booked this adjustment in 2011 as “Other Income.” However, in its additional submission, dated July 17, 2012, counsel for Company A stated that since Company A decided to effectuate the tax transfer by retroactively revising the Agreements as to certain products, these tax payments were recorded as “Costs of Goods Sold” (“COGS”) in Company A’s income statements for 2007 and 2008. Thus, the preliminary adjustments, subject to the internal advice request in 2009, are no longer preliminary. Company A participates in the Reconciliation program and occasionally reports royalty payment additions to the price actually or payable for the merchandise. Company A did not provide any evidence to establish that the prices between Company A and its related foreign supplier are not influenced by the relationship. In the company’s view, this is not at issue in this case.
Finally, in its prior disclosure and supplemental submission, dated July 17, 2012, Alston & Bird, LLP argued that Company A reported the proper transaction value at the time of importation using the prices negotiated between the parties applicable at the time, pursuant to the Agreements. Company A also argues that even though these post-importation tax-related adjustments were assigned to certain products, these payments were made solely for tax purposes and Company A believes that the previously declared customs values should remain. In line with this argument, there was no information submitted to satisfy the five-factor criteria, specified in Headquarters Ruling Letter (“HRL”) W548314, dated May 16, 2012. In fact, counsel for Company A believes that this ruling is neither controlling nor instructive in this case.
ISSUES:
Was it acceptable to take post-importation price adjustments (upward or downward) into account in determining transaction value?
Do the circumstances of the sale establish that the price actually paid or payable by Company A to its related supplier was not influenced by the relationship of the parties and was acceptable for purposes of transaction value?
LAW AND ANALYSIS:
Merchandise imported into the United States is appraised for customs purposes in accordance with Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. §1401a). The primary method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. See 19 U.S.C. §1401a(b)(1).
Was it acceptable to take post-importation price adjustments (upward or downward) into account in determining transaction value?
In this case, Company A ultimately set its prices pursuant to a bilateral APA, and the profit adjustments resulted in the revisions to the parties’ supply Agreements. Nonetheless, Company A’s counsel argues that even though the post-importation adjustments declared to CBP were assigned to certain products, these payments were made solely for tax purposes and did not affect the customs value of the merchandise. Although we realize that in certain circumstances, compensating (post-importation) adjustments might not relate to the imported goods, this is not the case here.
The ultimate selling price (operating profit) of Company A in the United States takes into account the costs of the product throughout each step, in sale from the manufacturer to the consumer. Thus, by working back from the arm’s length net margin (or profit) of Company A, the arm’s length COGS (or price actually paid or payable for customs purposes) can be deduced. Accordingly, we find that the customs value of the imported merchandise is affected every time the related parties reduce or increase their profitability pursuant to the APAs or transfer pricing studies, which cover the imported goods, resulting in payments, transfer of funds, or credit/debit transactions between the related parties. We also note that even though in this case, Company A’s complex APA covers tangible and intangible transactions between the parties, as well as services, the related parties made the adjustments to their profitability, which resulted in the transfer of funds between the parties, the adjustments booked to COGS, and the revised supply Agreements. Therefore, these adjustments must be reported to CBP since they directly relate to the imported goods; however, in order for Company A to claim post-importation adjustments to the value of the imported goods, Company A must satisfy our five-factor criteria, specified in HRL W548314, dated May 16, 2012, which is applicable to cases that involve compensating (post-importation) adjustments made to the profitability of related parties pursuant to APAs or transfer pricing studies.
On May 30, 2012, CBP published a notice concerning the treatment of post-import adjustments made pursuant to a formal transfer pricing policy. See Customs Bulletin, Vol. 46, No. 23, dated May 30, 2012 (and incorporating HRL W548314). In HRL W548314, CBP established a broader interpretation of what is permitted under transaction value to allow a transfer pricing policy/APA to be considered a “formula” in the transfer pricing context provided certain criteria are met. HRL W548314 specifically referred to the adjustments made pursuant to a company’s formal transfer pricing policy or APA. In order to claim the post-importation adjustments (upward and downward), all of the following factors must be met:
A written transfer pricing policy is in place prior to importation and the policy is prepared taking IRS code section 482 into account;
The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return;
The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted;
The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and,
No other conditions exist that may affect the acceptance of the transfer price by CBP.
Therefore, if the related parties meet the above referenced factors, CBP will accept the adjusted values, provided these adjusted values meet the circumstances of the sale (or test values) test, because the prices would be established pursuant to a “formula,” even though the prices were not fixed at the time of the importation.
In this case, Company A states that it used the transaction value method of appraisement. However, Company A failed to provide any information addressing the criteria in HRL W548314 with respect to post-importation adjustments. Instead, Company A’s counsel argues that HRL W548314 is not applicable to this case. Having already found that the post-importation adjustments in this case relate to the value of the imported merchandise, these adjustments must be reported to CBP. Nevertheless, if these post-importation adjustments result in the decrease to customs value of the imported merchandise (for example, the compensating adjustments made in 2008-2009), Company A cannot claim post-importation adjustments and obtain a refund of duties because no information was submitted to satisfy the criteria in HRL W548314 in order for the company’s APA/transfer pricing policy to be considered a “formula” for purposes of transaction value. However, if the post-importation adjustments result in an increase to the value of the merchandise (as was the case with Company A’s adjustments in 2007, declared to CBP via prior disclosure), these adjustments must also immediately be reported to CBP and any additional duties resulting therefrom must be tendered.
Do the circumstances of the sale establish that the price actually paid or payable by Company A to its related supplier was not influenced by the relationship of the parties and was acceptable for purposes of transaction value?
There are special rules that apply when the buyer and seller are related parties, as defined in 19 U.S.C. §1401a(g). Specifically, transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, an examination of the circumstances of the sale indicates that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain “test values.” 19 U.S.C. §1401a(b)(2)(B); 19 CFR §152.103(l).
In this case, Company A’s counsel argues that whether the prices were influenced by the relationship of the parties is not at issue. We disagree. We already determined that the post-importation adjustments to the profitability of the parties made for tax purposes relate to the value of the imported merchandise in this case. Pursuant to HRL W548314, once these adjustments are made, CBP will accept the adjusted value only if the adjusted values meet the circumstances of the sale or test values tests. Company A failed to submit any information with respect to this issue. Accordingly, we hold that Company A has failed to demonstrate that the adjusted prices have not been influenced by the relationship for purposes of the circumstances of the sale or test values tests. Thus, transaction value was not the proper method of appraisement for this related party transaction. In the past, CBP found that adjustments to the value could be made under the fallback method specified in 19 U.S.C. §1401a(f), but also only if one of the related party tests is met. See HRL 547654, dated November 8, 2001. In this instance the entries have been liquidated, and a prior disclosure has been filed. To the extent the value of the goods has increased, any duties owed should be tendered. As stated above, downward adjustments will not be recognized.
HOLDING:
In conformity with the foregoing, we find that the post-importation adjustments in question directly relate to the customs value declared to CBP; therefore, Company A correctly reported these adjustments to CBP via prior disclosure. Nevertheless, since Company A failed to submit the necessary information to meet the five-factor criteria, specified in W548314, we find that Company A cannot claim the downward adjustments (and obtain the necessary refunds, if applicable). In order for downward value adjustments to be recognized, the five-factor criteria and the circumstances of the sale or test values tests must be met, as specified in HRL W548314. As this was not done, transaction value was not the proper method of appraisement for this related party transaction; however, to the extent the value of the goods has increased, any duties owed should be tendered.
This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CPB personnel, and to the public on the CPB Home Page on the World Wide Web at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.
Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch