OT:RR:CTF:VS H313988 JMV
Bethany Hovis
[XXXXXXXXXXXXXX]
1451 McMahon Drive
Neenah, WI 54956
RE: Additions to Transaction Value; Costs included in Computed Value
Dear Ms. Hovis:
This is in reply to your letter dated September 15, 2020, on behalf of [XXXXXXXX] (U.S. Entity) and [XXXXXXXXXXX] (“the Foreign Entity”), (collectively “the Company”), in which you requested a ruling, pursuant to 19 C.F.R. Part 177, regarding whether certain costs should be included in the customs value of imported health and hygiene products.
You have asked that certain information submitted in connection with this request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 C.F.R. § 177.2(b)(7), the request for confidentiality is approved. The information contained within brackets in this ruling or in the attachments to this ruling request, forwarded to our office, will not be released to the public and will be withheld from published versions of this ruling.
FACTS:
The entities involved with the transactions at issue are part of a larger global hygiene and health company called [XXXXXXXXXX] (“Parent Company”). The products at issue are orthopedic, wound care, and vascular products. The products at issue are manufactured by [XXXXXXXXXXXXXXX] (“Foreign Manufacturer”) in Mexico. Both the U.S. Entity and the Foreign Entity provide the materials to the Foreign Manufacturer on consignment and the Foreign Manufacturer processes the material into the completed goods. The Foreign Manufacturer will also provide quality control and warehousing services for the Company. The Foreign Manufacturer will bill U.S. Entity and Foreign Entity directly for processing and services. The completed goods are then imported by the Foreign Entity, which acts as a foreign importer, or the U.S. Entity. As there is no acceptable sale between the Foreign Manufacturer and the U.S. Entity or Foreign Entity, the Company would like to use the computed value method to determine the customs value when entering the goods into the United States. You asked whether certain costs should be included when the Company is determining the computed value.
The following costs are under consideration:
Material costs, including, but not limited to yarn, chemicals, gauze, fabric;
Direct labor costs, including the salary and benefits of the Foreign Manufacturer’s employees;
Indirect labor costs at the Foreign Manufacturer;
Fixed overhead costs, including depreciation, maintenance and repair, human resources, intercompany recharges, information technology, travel expenses, insurance and fees and risk and safety costs at the Foreign Manufacturing facility;
Variable overhead costs include energy, machinery maintenance, consumable materials, molds, dyes for artwork on the packaging of the manufactured products, tooling, and warehouse costs at the Foreign Manufacturing facility;
Costs for services related to global quality assurance, regulatory affairs, logistics, warehousing and sourcing of wound care products;
A fee charged by the Foreign Manufacturer agreed to under a contract manufacturing agreement between the foreign manufacturer and the importing parties;
Global research and development costs, which include costs incurred by the Company for support services for the global research and development personnel salary and benefits, depreciation on machinery and equipment and travel & training for this function (the Company would base this value on the percentage of global research and development costs equal to the percentage of U.S. sales to worldwide sales);
Global marketing / advertising and promotion costs, which includes support services for global marketing personnel salary, social costs, travel, and training for this area of the business. Global advertising and promotional communications are specific to the compression function (the Company would base this value on the percentage of global marketing / advertising and promotion costs equal to the percentage of U.S. sales to worldwide sales);
Global brand, innovation, and sustainability (“GBIS”) costs, which include intellectual property costs related to the company brand, support services for personnel salary and social costs, travel, training, and intellectual property (the Company would base this value on the percentage of GBIS costs equal to the percentage of U.S. sales to worldwide sales);
Royalty paid to the individual [XXXXXXX] for vascular products which is 2.5% of all the Company’s 3rd party net sales of [XXXXXXX] vascular products; and
Sales commission costs for domestic sales of orthopedic products in the United States. The U.S. Entity pays this commission to [XXXXXXXXXXX] (“U.S. Sales Agent”). Sales commissions are based on a percentage of sales as defined in the contract terms. This sales commission is only at issue for orthopedic products.
According to the Company, the costs that are designated “global” costs are incurred by various entities within the larger parent company. These costs are not billed to any of the entities involved in that transactions at issue but the Company would like to know whether they must be included when determining an appropriate customs value.
The importing parties also import goods purchased from other foreign related parties and declare the related party sales price under the transaction value method. You ask whether the following costs should be added as assists or other additions under transaction value:
Global research and development,
Global marketing, advertising, and promotion;
Global brand, innovation, and sustainability costs; and
Sales commissions for domestic sales of orthopedic products after importation to the United States.
The company provided the following documents for review:
Manufacturing agreements,
Transfer pricing policy,
Membership Interest Purchase Agreement (“MIPA”) and other financial documents, regarding the purchase of an outside company,
Company organizational chart,
Sales agent agreement,
Sales orders,
Commercial invoices, and
Shipping manifests.
ISSUE:
Whether the aforementioned costs should be added to the customs value as an assist when the transaction value method is used.
Whether the aforementioned costs should be added to the customs value as a cost when the computed value method is used.
LAW AND ANALYSIS:
Transaction Value
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). When transaction value cannot be applied, then the appraised value is determined based on the other valuation methods in the order specified in 19 U.S.C. § 1401a(a).
The enumerated statutory additions to the price actually paid or payable are listed in 19 CFR § 152.103(b)(1) and include:
(i) The packing costs incurred by the buyer with respect to the imported merchandise;
(ii) Any selling commission incurred by the buyer with respect to the imported merchandise;
(iii) The value, apportioned as appropriate, of any assist;
(iv) Any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States; and
(v) The proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller.
No other additions other than those specifically enumerated may be added to the price actually paid or payable. 19 CFR § 152.103(b)(2).
The Company states that in imports of goods from other related entities, transaction value is the appropriate method of customs valuation. However, the Company is unsure whether the following costs should be added to the price actually paid or payable as required by in 19 CFR § 152.103(b):
1. Global research and development,
2. Global marketing, advertising, and promotion;,
3. Global brand, innovation, and sustainability costs;, and
4. Sales commissions.
Selling commissions are defined in 19 CFR § 152.102(b) as “any commission paid to the seller’s agent, who is related to or controlled by, or works for or on behalf of, the manufacturer or the seller.” Here, the U.S. Entity pays a commission to U.S. Sales Agent for domestic sales that take place after importation when the imported goods are resold to U.S. customers. Therefore, since the selling agent works on behalf of the buyer in the import transaction, the selling commissions on domestic sales should not be added to the price actually paid or payable.
The costs related to global R&D; global marketing, advertising, and promotion; and global brand, innovation, and sustainability costs are not included in the required statutory additions. However, this is not to say that these costs should not be considered when determining a transaction value in the context of related party sales.
Special rules apply when the buyer and seller are related parties, as defined in 19 U.S.C. § 1401a(g), which is the case in the transactions at issue here. Specifically, transaction value between a related buyer and seller is acceptable only if the transaction satisfies 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. Headquarters’ Ruling Letter (“HQ”) 543568, dated May 30, 1986. The purpose of these rules is to ensure that the relationship between the parties does not affect the price.
Under the “circumstances of the sale” test, CBP looks for evidence showing that the parties’ relationship did not affect the price paid or payable. All relevant aspects of the transaction are analyzed including the way the buyer and seller organize their commercial relations and the way in which the price was determined. The regulations, as set out in 19 C.F.R. § 152.103(l), provide three illustrative examples that demonstrate that a relationship did not influence the price: (i) the price was settled in a manner consistent with the normal pricing practices of the industry in question; (ii) the price was settled in a manner consistent with the way the seller settles prices for sales to buyers who are not related to it; or (iii) the price is adequate to ensure 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.
While these are examples to illustrate situations where the relationship has not influenced the price, other factors may also be considered. See 19 C.F.R. § 152.103(I); see also HQ H037375, dated December 11, 2009; HQ H029658, dated December 8, 2009; HQ H032883, dated March 31, 2010; and HQ H219515, dated October 11, 2012. For example, in HQ H219515, CBP found that even though none of the information provided strictly fell under the three illustrative examples, the sales price was not considered to be influenced by the relationship of the parties under the circumstances of the sale test, “based on the totality of the information considered and our review and examination of all relevant aspects of the transaction, including the way in which the Importer and the related manufacturers organize their commercial relations and the way in which the price in question was arrived at.”
The Company provided this office with its transfer pricing policy which states, “The pricing of the transfer of goods between enterprises belonging to an international Group
can be made in different ways. The method chosen is the Cost Plus Method” (“CPM”). The transfer pricing policy also states that the purpose of sharing the aforementioned costs “in an arm’s length way and establishing an overall arm’s length transfer pricing policy is that each participant in the cost sharing arrangements bears their fair share of expense and all legal entities enjoy profits commensurate with their business functions, risks and assets.”
While CBP has accepted transfer prices based on the CPM in the past (see HQ H292850, dated December 13, 2018; and HQ H219515), it is not CBP’s role to determine which costs should be included in the transfer pricing policy of a company. Further, CBP Regulations do not define what profit we are to consider under the CPM – gross profit or operating profit. While CBP may consider gross profit in certain circumstances, 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, such as marketing, have been paid. See HQ H037375. Therefore, when the CPM is used, it is CBP’s preference to include costs related to research and development, marketing, advertising, promotion, innovation, and sustainability costs, but it is not a requirement. Further, the Company should ensure that its transfer prices are calculated according to its transfer pricing policy, which currently includes these costs.
Computed Value
While transaction value may be used by related parties when the transaction is an “arm’s length” transaction and can be demonstrated as such, the importer has determined that, in some instances, transaction value cannot be used as there is no bona fide sale for exportation. Further, the Company is not aware of any identical or similar merchandise being sold to unrelated parties in the United States from the country of export. Therefore, to the extent that such information is not available, the subject goods cannot be appraised using transaction value of identical merchandise or similar merchandise.
The next method available by which to appraise the merchandise is the deductive value method at 19 U.S.C. § 1401a(d). 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. 19 U.S.C. §1401a(d)(2)(A)(i)-(ii). However, at the time of entry, an importer may elect to reverse the order of appraisement under deductive and computed value. See 19 U.S.C. §1401a(a)(2) and 19 CFR §152.101(c). If the importer makes the request, but the value of the imported merchandise cannot be determined using the computed value method, the merchandise will be appraised using the deductive value method if it is possible to do so. If the deductive value cannot be determined, the appraised value will be determined as provided for in 19 CFR §152.107. Here, the company is electing to use the computed value method in instances where transaction value is not an option.
The appraisement under the computed value method is set forth in section 402(e) of the TAA. Section 402(e) of the TAA (19 U.S.C. 1401a(e); TAA) provides:
The computed value of imported merchandise is the sum of:
the cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise;
an amount for profit and general expenses equal to that usually reflected in sales of merchandise of the same class or kind as the imported merchandise that are made by the producers in the country of exportation for export to the United States;
any assist, if its value is not included under subparagraph (A) or (B); and
the packing costs.
The amount for general expenses and profit is considered as a whole. Section 152.106(c), Customs and Border Patrol (CBP) Regulations (19 C.F.R. 152.106(c)) provides as follows:
Profit and general expenses. The amount for profit and general expenses will be taken as a whole. If the producer’s profit figure is low and general expenses high, those figures taken together nevertheless may be consistent with those usually reflected in sales of merchandise of the same class or kind.
Interpretative note 2 to the regulations states:
If the producer’s own figures for profit and general expenses are not consistent with those usually reflected in sales of merchandise of the same class or kind as the merchandise being valued which are made in the country of exportation for export to the United States, the amount for profit and general expenses will be based upon reliable and quantifiable information other than that supplied by or on behalf of the producer of the merchandise.
19 U.S.C. § 1401a(e). The Statement of Administrative Action (“SAA”), adopted by Congress with the passage of the TAA, provides that with respect to computed value:
The cost or value of the materials and the fabrication and other processing of any kind employed in the production of the imported merchandise will be determined on the basis of information supplied by, or on behalf of, the producer and will be based upon the commercial accounts of the producer, if such accounts are consistent with the generally accepted accounting principles applied in the country where the goods are produced. The “amount for profit and general expenses” will be determined on the basis of information supplied by, or on behalf of, the producer and will be based upon the commercial accounts of the producer, provided that such accounts are consistent with the generally accepted accounting principles applied in the country where the goods are produced and unless the figures provided are inconsistent with those usually reflected in sales, of merchandise of the same class or kind as the imported merchandise, that are made by producers in the country of exportation for export to the United States.
Senate Report 96-249 to Public Law 96-39 adds that “determination of an acceptable computed value generally would require the producer to supply all the necessary cost information . . .[t]he bill also would provide for the use of the producer's own general expenses and profit unless such amount is inconsistent etc. . .” Thus, the legislative history of the TAA stresses reliance on the producer’s books to obtain figures from which a computed value can be calculated.
We find that the following costs should be included when determining the computed value as they are costs recorded on the books of the producer, the foreign manufacturer:
Direct labor costs for orthopedic and vascular products, including the salary and benefits of the Foreign Manufacturer’s employees;
Indirect labor costs at the Foreign Manufacturer;
Fixed overhead costs, including depreciation, maintenance and repair, human resources, intercompany recharges, information technology, travel expenses, insurance and fees and risk and safety costs at the Foreign Manufacturing facility;
Variable overhead costs include energy, machinery maintenance, consumable materials, molds, dyes for artwork on the packaging of the manufactured products, tooling, and warehouse costs at the Foreign Manufacturing facility; and
Costs for services related to global quality assurance, regulatory affairs, logistics, warehousing, and sourcing of wound care products.
Under the computed value method, assists must also be included. 19 C.F.R. § 152.102(a)(1) states:
“Assist” means any of the following if supplied directly or indirectly, and free of charge or at reduced cost, by the buyer of imported merchandise for use in connection with the production or the sale for export to the United States of the merchandise:
(i) Materials, components, parts, and similar items incorporated in the imported merchandise.
. . .
Therefore, the cost of the material the importing entities provided to the foreign manufacturer must be included in the computed value as an assist.
Computed value must also include an amount for profit. Since the fee paid to the Foreign Manufacturer is what the producer earns over costs of production, it should be added to the computed value as profit, assuming it is equivalent to the profit usually reflected in sales of merchandise of the same class or kind by Mexican producers.
Where the producer’s amount for general expenses and profit is recorded on the producer’s books in a manner consistent with generally accepted accounting principles, there is no authority to add to that figure certain amounts recorded on the importer’s books. Therefore, an amount for general expenses and profit recorded on the importer’s books is not included in the computed value of imported merchandise. See HQ 545577 dated January 4, 1995; and HQ 545088 dated February 14, 1995. Because global costs related to brand innovation and sustainability, marketing, and advertising and promotion are not included on the books of the producer, they should not be included in the computed value.
The final question is whether the payment of 2.5% of all third-party net sales of [XXXXXXXXXXXXXX] (“Medical Products Company”) branded vascular products paid to the individual [XXXXXXXXXX] (“Seller’) is a dutiable royalty. The Company provided to CBP its manufacturing agreements and its Membership Interest Purchase Agreement (“MIPA”). Pursuant to the MIPA, the U.S. Entity purchased Medical Products Company from Seller and in exchange, the U.S. Entity paid Seller a lump sum plus an “earn out” payment on a yearly basis, which represents 2.5% of yearly sales of the relevant products. While this sale included patents for various products, including the products at issue, the Seller also transferred all the “Company Proprietary Rights” to the U.S. Entity.
The MIPA refers to a 2.5% payment on yearly sales as an earnout payment. An earnout payment is an arrangement where the buyer “agrees to pay the seller additional consideration after [an] acquisition is completed based on whether the business achieves defined performance targets.” 1 M & A Practice Guide § 9.10 (2021). This sort of payment arrangement is common when the parties cannot agree on the value of a business, or the business is anticipated to grow or improve significantly after closing. Id. Earnout payments are particularly common in sales of startups and firms with new products or technologies. Id. A royalty, however, is “the compensation paid by the licensee to the licensor for the use of the licensor’s patented invention.” Ballentine’s Law Dictionary (3d ed. 2010).
While the name of the payment in the MIPA may not be dispositive, we find that this payment is not a royalty since it is part of the payment for the purchase of the entire company, which includes property other than patents. Additionally, the U.S. Entity now owns all relevant patents and may still import the relevant goods regardless of whether the payments continue to be paid. According to the sales contract, in the event of non-payment, the Seller is entitled to the payments plus interest, but the U.S. Entity would still own the patents. Therefore, these earnout payments are not made in exchange for the right to use any patents. Further, all payments to the Seller will stop 15 years after U.S. Entity’s purchase of Medical Products. Therefore, these payments are for the sale of the Medical Products Company as whole and are not dutiable royalties.
HOLDING:
When the transaction value is used, the sales commissions should not be added to the customs value. However, it is not CBP’s position to determine if the other global costs should be included in the transfer price.
When the computed value is used, the computed value should include: direct and indirect labor costs; fixed and variable overhead costs; costs of materials; service costs related to global quality assurance, regulatory affairs, logistics, warehousing, and sourcing of wound care products; and the fee paid to the Foreign Manufacturer.
A copy of this ruling letter should be attached to the entry documents filed at the time the goods are entered. If the documents have been filed without a copy of this ruling, it should be brought to the attention of the CBP officer handling the transaction.
Sincerely,
Monika R. Brenner, Chief
Valuation and Special Programs Branch