OT:RR:CTF:VS H246651 GaK

Ms. Margaret M. Gatti
Morgan, Lewis & Bocklus LLP.
1111 Pennsylvania Avenue, NW
Washington, DC 20004

RE: Fallback Method; Consignment; Related Parties

Dear Ms. Gatti:

This is in response to your prospective ruling request, dated September 10, 2013, on behalf of your client, [******] whether the use of the “fallback” value method of appraisement is appropriate for goods imported on a consignment basis from related parties.

Per your letter dated September 10, 2013, we have reviewed your request for confidentiality pursuant to 19 C.F.R. § 177.2(b)(7) with respect to the information submitted. As that information constitutes privileged or confidential matters, it has been bracketed and will be deleted from any published versions.

FACTS:

You state that your client currently purchases and imports merchandise from its foreign related companies, [******] Group, using transaction value. Your client acts as a distribution center by storing the goods until they are sold to its customers in North America, Central America and South America or by demand from other distribution centers in Europe and Asia. A change in its business model is contemplated, under which another related party, located in Switzerland, retains title and ships the merchandise to your client on a consignment basis, until the merchandise is sold to the Group’s customers. You state that the price of the merchandise is established by the Group, which they consider “Management Services,” and that your client does not have access to any financial information regarding the merchandise.

The Group proposes to perform annual forecasts and examine average external pricing changes, targeted sales volumes changes, administrative costs, sourcing availability, risks, destination, profit and other cost changes. The Group will assign target margins for each sales brand/operation to reach an arm’s length Earnings Before Interest and Taxes margin for each product type and prices will be adjusted resulting in a market Gross Price List that takes into account overall discounts at an aggregate level thereby establishing a transfer price to the sales operation in each country in compliance with all local laws. The price will be established on a product by product basis and generally will be effective for one year.

You state that the Group’s proposed pricing methodology complies with the US Internal Revenue Service’s arm’s length transaction requirements and also follows the Organization for Economic Cooperation and Development Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration to maintain arm’s length principles for the valuation for tax purposes of cross-border transactions between related parties.

ISSUE:

Whether the use of the “fallback” value method of appraisement is appropriate for goods imported on a consignment basis from related parties.

LAW AND ANALYSIS:

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. See 19 U.S.C. § 1401a(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. Since there is no sale in this case, transaction value cannot be used as a method of appraisement.

The transaction value of identical or similar merchandise is based on sales, at the same commercial level and in substantially the same quantity of merchandise exported to the United States at or about the same time as that good being appraised. See 19 C.F.R. § 1401a(c). Whether the merchandise can be appraised on the basis of the transaction value of identical or similar merchandise will depend on whether there are other entries of the same or commercially interchangeable merchandise from the same country proximate in time to the merchandise being entered. Since, your client states that no sales are made to non-related parties, this method of appraisement cannot be used.

Under the deductive value method, merchandise is appraised on the basis of the price at which it is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. See 19 U.S.C. § 1401a(d)(2)(A)(i)-(ii). Since your client states that the goods will be stored indefinitely until future orders are received and many sales may occur well after the 90th day after importation, the merchandise cannot be appraised under the deductive value method. The next method of appraisement is the computed value method. Under this method, merchandise is appraised on the basis of the materials and processing costs incurred in the production of imported merchandise, plus an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind, and the value of any assists and packing costs. See 19 U.S.C. § 1401a(e)(1). As a distributor, it is claimed that your client does not have access or visibility to the necessary financial information to appraise the goods under the computed value method. The Group establishes the price without any input from its subsidiaries and is not willing to share its financial information with your client. Accordingly there is insufficient information available to appraise the merchandise pursuant to the computed value method.

When merchandise cannot be appraised under the methods set forth in 19 U.S.C. § 1401a(b)-(e), its value is determined in accordance with the “fallback” method set forth in section 402(f) of the TAA. The fallback method provides that merchandise should be appraised on the basis of a value derived from one of the prior methods reasonably adjusted to the extent necessary to arrive at a value. See 19 U.S.C. § 1401a(f) and 19 C.F.R. § 152.107. You request that we approve the proposed modified transaction value as the “fallback” method of appraisement to your clients’ transactions.

Special rules apply when the buyer and seller are related parties, as defined in 19 U.S.C. § 1401a(g). Specifically, transaction value between a related buyer and seller is acceptable only if the transaction satisfied one of two tests: (1) circumstances of sale or (2) test values. See 19 U.S.C. § 1401a(b)(2)(B). “Test values” refer to values previously determined pursuant to actual appraisements of imported merchandise. Thus, for example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of merchandise under section 402(d) of the TAA. HRL 543568, dated May 30, 1986. In this instance, there is no information available concerning previously accepted test values. Consequently, the circumstances of the sale approach must be used in order to determine the acceptability of transaction value. The purpose of these rules is to ensure that the relationship between the parties does not affect the price.

In this case, however, your client is importing the merchandise on a consignment basis and there is no sale. The proposed modified transaction value method should nonetheless demonstrate that the parties’ relationship does not affect the price. The Customs Regulations specified in 19 C.F.R. § 152 set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, Customs will examine the manner in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 C.F.R. § 152.103(I)(1)(i)-(ii). In addition, Customs will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. 19 C.F.R. § 152.103(I)(1)(iii). Nonetheless, these are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well. See 19 CFR § 152.103(I); see also HRL H037375, dated December 11, 2009; HRL H029658, dated December 8, 2009; and, HRL H032883, dated March 31, 2010.

We note that the existence of a transfer pricing study does not, by itself, obviate the need for CBP to examine the circumstances of sale in order to determine whether a related party price is acceptable. See HRL H037375, dated December 11, 2009; HRL 546979, dated August 30, 2000. However, information provided to CBP in a transfer pricing study may be relevant in examining the circumstances of the sale, but the weight to be given this information will vary depending on the details set forth in the study. See HRL H037375; HRL 548482, dated July 23, 2004. A significant factor, by way of example, is whether the transfer pricing study has been reviewed and approved by the IRS. See HRL H037375; 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 H037375; 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.

Further, CBP Regulations do not define what profit we are to consider - gross profit or operating profit. However, CBP is of the view that the operating profit margin is a more accurate measure of a company's real profitability because it reveals what the company actually earns on its sales once all associated expenses have been paid. Nevertheless, in certain circumstances, gross profit can be considered. See HRL H037375.

We do not have sufficient information/documentation to establish that the proposed modified transaction value would meet the circumstances of the sale test. While the proposed modified transaction value is described, no financial information was provided to determine whether the relationship between the parties will affect the price. No transfer pricing study was presented and no documentation was presented relating to the comparison of the prices set in the relevant industry and the price between your client and the Group.

Accordingly, while a modified transaction value may be used, your client should be prepared to substantiate its values by maintaining and providing accounting records from its books and/or financial statements if requested by CBP. Further, if requested by CBP, your client should be prepared to specify how the transfer price and adjustments are determined with respect to all imported products, which may require presentation of financial records from the Group.

HOLDING:

As set forth above, we determine that the merchandise may need to be appraised under the fallback method. However, our finding is based on the assumption that the transfer pricing structure yields a price that meets one of the related party tests. Furthermore, we are not ruling on the acceptability of the proposed pricing methodology.

Please note that 19 C.F.R. § 177.9(b)(1) provides that “[e]ach ruling letter is issued on the assumption that all of the information furnished in connection with the ruling request and incorporated in the ruling letter, either directly, by reference, or by implication, is accurate and complete in every material respect. The application of a ruling letter by a Customs Service field office to the transaction to which it is purported to relate is subject to the verification of the facts incorporated in the ruling letter, a comparison of the transaction described therein to the actual transaction, and the satisfaction of any conditions on which the ruling was based.”

Please do not hesitate to contact us at (202) 325-7941 if you have any questions or concerns.

Sincerely,

Monika R. Brenner, Chief
Valuation and Special Programs Branch