RR:IT:VA 548233 CRS

Mr. Damon V. Pike
Director, Customs and International Trade Services
Deloitte & Touche LLP
191 Peachtree Street N.E.
Atlanta, Georgia 30303-1924

RE: Acceptability of transfer price; transaction value; Advance Pricing Agreement

Dear Mr. Pike:

This is in reply to your letter, dated November 21, 2002, in which you requested a ruling on behalf of your client, [***************************], on the applicability of transaction value. We regret the delay in responding.

You have asked that certain information submitted in connection with your ruling request be treated as confidential. Inasmuch as your request conforms to the requirements of 19 C.F.R. § 177.2(b)(7), your request for confidentiality is approved. The information contained within brackets will not be released to the public and will be redacted from published versions of this ruling. In accordance with 19 C.F.R. § 177.6, we have retained the copy of your client’s submission to this office of information originally provided to the Internal Revenue Service in support of your client’s request for renewal of a bilateral Advance Pricing Agreement. This information was reviewed pursuant to a waiver provided by your client. Since the information contained therein constitutes confidential commercial and financial information, it will be so designated in our files and not be released to the public. See also 19 C.F.R. §§103.5(b)(1), 103.12(d).


[Your client] (“the importer”) is a wholesale distributor of photo-processing systems and related parts, and a subsidiary of [*****************], a Japanese manufacturer of photo-processing systems. The importer purchases merchandise manufactured in Japan by [*********************] (“the manufacturer”) and imports it into the United States exclusively through the port of Long Beach.

In December 2001 the importer submitted a request to the Internal Revenue Service to renew its bilateral Advance Pricing Agreement (APA). An APA constitutes a prospective agreement between a taxpayer and the IRS (and in the case of bilateral APAs, foreign tax authorities) regarding the correct transfer pricing methodologies under tax law to be applied to transactions between related parties. The foreign competent authority in this instance is the National Tax Administration (NTA), Japan.

Section 482 of the Internal Revenue Code (26 U.S.C. § 482) requires that the arm’s length result of a controlled transaction be determined under the method that, given the facts and circumstances, provides the most reliable measure of an arm’s length result. The application of the best method establishes an arm’s length range of prices or financial returns with which to test controlled transactions. In its APA request, the importer identified the comparable profits method (CPM) as being the best method for evaluating its related party or controlled transactions. The CPM examines whether the amount charged in a controlled transaction is an arm’s length price by comparing the profitability of the tested party to that of comparable companies. The information provided in this regard is intended to demonstrate that the importer earns a profit on its sales of the imported merchandise that is consistent with normal industry practices. It is contended that the CPM therefore satisfies the arm’s length test and, moreover, approximates a deductive value analysis under section 402(d) of the TAA.

However, because Japan does not recognize the CPM, the importer identified the modified resale price method (modified RPM), which examines whether an adequate profit is realized on sales of imported merchandise by computing an operating profit for the relevant transactions. To this end, the RPM takes the tested party’s gross profit, in this case, the manufacturer’s gross profit, and computes an operating margin by subtracting from this figure the sales, general and administrative expenses (SG&A) of comparable companies. In this instance, the method thus seeks to determine whether both the importer and manufacturer, as buyer and seller, respectively, recover their costs plus an adequate profit.

After discussions, the IRS and NTA reached mutual agreement regarding a bilateral APA governing the transfer price to be paid by the importer to the manufacturer relative to the importer’s distribution of the manufacturer’s products. The term of the importer’s APA is for five tax years ending January 31, 2003, through January 31, 2007. The transfer pricing methodology used is the modified RPM. If, for any APA year, the importer’s actual RPM falls within the adjusted RPM interquartile range, no adjustment is required and the transfer price is assumed to comply with the arm’s length standard. If the results for an APA year fall outside the applicable range, a secondary test is applied. Under this test, the importer’s simple average actual RPM for the three years ending with the fiscal year being tested are compared to the adjusted RPM interquartile range. If the result falls within the range then no adjustment is required. However, if the result of the secondary test falls outside the range, then a compensating adjustment is required. In accordance with paragraph 11 of the APA, if neither the primary or secondary test is met, the importer is required to make an adjustment to its taxable income in order to bring its actual gross income margin for the year to the nearest point in the applicable adjusted RPM interquartile range. The terms of the mutual agreement between the IRS and the NTA were incorporated into the APA between the IRS and the importer.


The issue presented is whether transaction value is the appropriate method of appraisement in respect of sales between the importer and the manufacturer.


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. 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 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). While the fact that the buyer and seller are related is not in itself grounds for regarding transaction value as unacceptable, where Customs has doubts about the acceptability of the price and is unable to accept transaction value without further inquiry, the parties will be given the opportunity to supply such further detailed information as may be necessary to support the use of transaction value pursuant to the methods outlined above.

The term "test value" refers 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 (HRL) 543568 dated May 30, 1986. See also 19 C.F.R. § 152.103(l). In this instance, however, there are no previously accepted test values. Consequently, the circumstances of sale approach must be used in order to determine the acceptability of transaction value.

Given the detailed information contained in your client’s bilateral APA submission, you contend that a review of the relationship is unwarranted and that Customs and Border Protection (hereinafter, “CBP” or “Customs”) does not need to validate transaction value by examining the circumstances of sale. In support of this you cite to the Statement of Administrative Action, which constitutes part of the legislative history of the TAA:

The fact that the buyer and seller are related is not in itself grounds for regarding the transaction value as unacceptable and there will be related party transactions in which validation of the transaction value, using either of the two methods outlined above, will not be necessary. For example, the Customs Service may have previously examined the relationship or may already have sufficient detailed information concerning the buyer and seller to be satisfied that the relationship did not influence the price actually paid or payable. In such case, where the Customs Service has no doubts about the acceptability of the price, the price will be accepted without requesting further information from the importer.

Statement of Administrative Action, H.R. Doc. No. 153, 96 Cong., 1st Sess., pt 2, reprinted in, Department of the Treasury, Customs Valuation under the Trade Agreements Act of 1979 (October 1981), at 53-54. See also 19 C.F.R. § 152.103(l)(1). In this instance, you note that the importer sought – and ultimately received approval for - a bilateral APA, and that it had every incentive to provide the IRS and the NTA with accurate and complete information relative to its related party purchases.

However, while the importer has supplied considerable information in the context of its APA submission, it is CBP’s position that it does not constitute “sufficient detailed information” as would preclude application of the related party tests set forth in the TAA. While the goal of the TAA and section 482 of the Internal Revenue Code is the same, i.e., to ensure that related party transactions are at arm’s length, the method of making that determination is different under each law. While section 482 of the Internal Revenue Code reviews the acceptability of transfer pricing from the company perspective, the TAA focuses on prices in discrete import transactions. Nevertheless, the importer’s APA submission and the APA itself, in particular, the fact that it is a bilateral APA, constitute valuable information in applying the circumstances of sale test, which is the only test applicable in this instance.

Under this approach, if the circumstances of sale indicate that while related, the parties buy and sell from one another as if they were unrelated, transaction value will be considered to be acceptable. 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. 19 C.F.R. § 152.103(l)(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 buyer's overall profit realized over a representative period of time. 19 C.F.R. § 152.103(l)(1)(iii).

You assert that the importer meets the circumstances of the sale test. In analyzing whether the price is determined in a manner that is consistent with normal industry price practice, or the way in which the seller deals with unrelated buyers, you note that the overriding question is whether the transactions at issue approximate an arm’s length price. Further, you claim that the key determinant in arm’s length analysis is whether an adequate profit is realized on those transactions, and that the APA request analyzes this issue to determine the level of profit that should be earned by the buyer and the seller. Here, the importer’s profitability was compared to that of comparable companies and the IRS approved the range of profitability after evaluating the information submitted by the Importer. On this basis you conclude that the information demonstrates that the importer earns a profit on sales of imported merchandise that is consistent with normal industry practices, thus satisfying the arm’s length test.

As noted previously, Customs approach to related party transactions differs from the IRS approach. Specifically, the modified RPM reviews profitability on an aggregate basis, not a product by product basis. However, you contend that to disaggregate the results of the modified RPM in order to analyze each product division individually would require potentially arbitrary allocations that would reduce the reliability of the modified RPM approach. Furthermore, it would not be possible to find different sets of comparison companies for the Importer’s individual product divisions. See Headquarters Ruling Letter (HRL) 546979 dated August 30, 2000.

While Customs generally analyzes related party transactions at a detailed product by product level, we note that pursuant to paragraph 6 of the APA, all of the products produced by the manufacturer on or behalf of the importer are covered by the APA. While this is not a requirement under the APA program, the importer has chosen to have all of its purchases of merchandise produced by the manufacturer covered by the APA. See also HRL 546979 at 6. Consequently, we will not require the importer to provide Customs with a further breakdown of product line profitability for comparability purposes. However, CBP expects that in any future verification, the Importer will be able to show that the profit earned by product line falls within the agreed upon range specified in the APA.

Further, we conclude that more detailed information is unnecessary since the importer operates under a bilateral APA, in which both countries have reviewed the submission and negotiated a fair result for both taxing authorities. Based on our review of the information submitted, including the information submitted to the IRS and covered by the waiver referenced above, we conclude that we have examined the relevant aspects of the transaction, including the way in which the importer and the manufacturer organize their commercial relations, as well as the way in which the price in question was arrived at between the parties. Based on this review we hold that the Importer has demonstrated that the price has not been influenced by the relationship for purposes of the circumstances of the sale test.

In the event that the importer should make compensating adjustments, whether upward or downward, pursuant to paragraph 6 of the APA, the adjustments must immediately be reported to Customs. Any additional duties resulting therefrom must be tendered.


In conformity with the foregoing, transaction value is the appropriate method of appraisement in respect of sales between the importer and the manufacturer.


Virginia L. Brown
Chief, Value Branch