VAL OT:RR:CTF:VS H169975 HkP
Office of Regulatory Audit
Office of International Trade
U.S. Customs and Border Protection
555 Battery Street, Suite 313
San Francisco, CA 94111
RE: Internal Advice; Transaction Value; Related Parties; Design Activities; Research and Development; Tooling Expenses
Dear Field Director:
This is in response to your memorandum, dated June 1, 2011, forwarding a Request for Internal Advice submitted on behalf of Super Micro Computer, Inc. (SMC), dated January 31, 2011. The Request for Internal Advice concerns the nature of the relationship between SMC and its Taiwanese supplier, Ablecom Technology Inc. (Ablecom), as well as the dutiability of certain payments made by SMC to Ablecom. These issues were first raised in a Focused Assessment Pre-Assessment Survey Audit Report issued by the Regulatory Audit San Francisco Field Office on December 17, 2010, covering audit period July 1, 2008, through June 30, 2009.
SMC is an importer and reseller of computer server systems and components. One of SMC’s key suppliers is Ablecom. SMC outsources some of its design activities and a significant part of its manufacturing operations to Ablecom and reimburses Ablecom for certain research and development (R&D) and tooling expenses. Ablecom coordinates the manufacturing of chassis for SMC and also provides warehouse services to SMC in Taiwan for components and subassemblies manufactured by multiple suppliers.
SMC’s Annual Report 10-K, dated August 31, 2009, detailed the following information about the relationship between SMC and Ablecom.
Charles Liang is the President and CEO of SMC. He is also Chairman of the Board for SMC. Chiu-Chu (Sara) Liang, Charles Liang’s wife, is Vice President of Operations and Treasurer for SMC. She is also a member of the Board. Charles and Sara Liang together owned 30.7 percent of Ablecom voting stock in 2008. In 2009 they reduced this amount to 10.5 percent. In 2009, the couple, Mr. Liang’s sister, sister-in-law, nephew, and brother (Bill Liang – see below) collectively owned 41.75 percent of Ablecom stock.
Steve Liang is CEO of Ablecom and a Board member. He is the brother of Charles Liang, President, CEO, and Chairman of the Board of SMC. As of January 31, 2001, Steve Liang owned 2.5 percent of SMC common stock. His ownership interest in SMC in 2008 and 2009 is unknown.
Bill Liang, brother of Steve and Charles Liang, is a member of the Board of Ablecom and owns 17 percent of company stock. His financial or management interest in SMC is unknown.
Yih-Shyan (Wally) Liaw is the VP of International Sales and Secretary for SMC as well as a member of the Board. In 2009, he and his wife owned 5.2 percent of Ablecom stock. They currently do not own any stock in Ablecom.
The relationship between SMC and Ablecom is governed by a Product Manufacturing Agreement; a Product Development, Production and Service Agreement; and a Product Development Agreement.
Under the terms of the Product Manufacturing Agreement (PMA), Ablecom agrees to procure materials, components, equipment and other supplies and to manufacture, assemble, test and deliver products pursuant to specifications, standards and quality requirements provided by SMC. SMC has the option to provide components required for the manufacture, assembly, testing, and delivery of the products. Art. 2.2. In order to fulfill its obligations under the PMA, Ablecom is granted a limited license by SMC to use the relevant SMC patents, trade secrets and other intellectual property to the extent required to manufacture the products. Art. 2.3. The prices to be paid by SMC to Ablecom are to be individually negotiated based on quotations provided by Ablecom on a quarterly basis. Art. 3.2. Prices agreed upon between the parties may not be increased by Ablecom without the prior written approval of SMC. In addition, Ablecom must make best efforts to reduce costs on a continuing basis to make prices more competitive than market prices and must pass cost reductions on to SMC in the form of price reductions. Price increases are not binding on SMC unless the increase is caused by an increase of more than five percent in manufacturing costs in any given quarter, Ablecom notifies SMC of the increase, and the parties negotiate the price increase. Art. 4.1. In addition, whenever there is a change in the market price, the parties must negotiate a mutually acceptable price reduction or increase. All price increases must be preapproved by SMC in writing and applied prospectively. Art. 4.3.
The Product Development, Production and Service Agreement (PDPSA) is an attachment to the PMA. Under the terms of the Agreement, SMC pays Ablecom a “Development Fee”, which covers the cost of research and development supplies as well as the cost of overhead and services. Art. 2.5. These costs are included in the Ablecom selling price to SMC. Addendum B. Any and all technology concerning tooling, including related intellectual property rights developed by Ablecom, are the sole and exclusive property of SMC. Art. 3.1. A per unit tooling charge is to be amortized by Ablecom and paid for by SMC over a minimum quantity of units. Addendum C, IV. However, in the event that SMC does not meet a minimum sales volume requirement and elects not to pay a one-time payment penalty, SMC will make the tooling available to Ablecom on a joint ownership basis and SMC will use commercially reasonable efforts to assist Ablecom in obtaining joint ownership of the tooling. Addendum C, III, B.
The Product Development Agreement (PDA) regulates the assistance provided by Ablecom to SMC in developing and producing chassis and related products. Under the terms of the PDA, SMC pays Ablecom a non-recurring engineering (NRE) fee, which represents the one-time cost of researching, designing and testing new products for SMC. Art. 1.9. All tooling developed, purchased, modified and created by Ablecom pursuant to the PDA are to be marked as the property of SMC. Art. 3.3. A tooling payment schedule is also provided. Art. 3.8.
Pursuant to article 3.2 of the PMA, Super Micro performs quarterly testing to determine whether its purchases from Ablecom are consistent with market prices. Four quarterly reports for FY 2009 and one report on the fourth quarter of FY 2010 were submitted to CBP. The fourth quarter FY 2009 report states, in pertinent part:
The company has done a cost segregation study in Taiwan and determined that the rate between 5% to 10% was reasonable for cost sharing agreement with design and support work done by its Taiwan office. In addition, in looking at comparable companies in [the] U.S. (i.e. Flextronics and Sanmina), their gross margin for the last two quarters (December 2008 thru March 2009) were between 1.95% and 5.90%. For their latest calendar years ended 2008, they had between an average gross margin of 4.3% and 7.6% respectively. Given the manufacturing and logistical nature of the work which Ablecom is doing, we assume they are at or below the low end of this range.
Approach: The Company selected five chasses [sic] which were considered high runners during the fourth quarter and requested cost information from Ablecom related to those chasses…. The company will select highest purchased chasses on a quarterly basis but not the same as selected the prior quarters in order to obtain a more diversified sampling throughout the year.
The company compared the costs to the price which the company was being charged during the quarter to determine if the gross margin which Ablecom was making was reasonable.
Based on the quarterly reports, for FY 2009 the gross margin calculations were as follows: Q1, -0.9 to 6.2 percent, with an average of 2.1 percent; Q2, 2.2 to 11.6 percent, with an average of 4.8 percent; Q3, 3.4 to 10.1 percent, with an average of 6.7 percent; Q4, 1.9 to 7.7 percent, with an average of 5.5 percent. Each report concluded that, based on the cost data and the margins for the sample products, SMC purchases from Ablecom were conducted at a reasonable level in line with the market.
It is stated that, in order to improve the study, comparable public companies in the chassis or power supply industry in Taiwan were included in the study in 2010. The Taiwanese companies’ average gross margin for quarters ending December 2009 and March 2010 were 12.2 percent and 10.5 percent, respectively. For Ablecom’s analysis, SMC selected a statistical sample of 13 chassis purchased from Ablecom, plus an additional seven models to ensure adequate coverage. The gross margin for the 20 chassis selected ranged from 3.4 percent to 15.6 percent, with a standard average of 9.8 percent and a weighted average of 10.5 percent. Based on these results, SMC believes that the purchases from Ablecom for the fourth quarter, FY 2010, are also in line with the market because the weighted gross average margin for those transactions is comparable to the industry benchmark.
According to the Audit Report, SMC uses transaction value as its basis of appraisement for all its imported merchandise, including related party transactions. However, Regulatory Audit found that SMC did not adequately demonstrate that their relationship with Ablecom had no influence on the price of their transactions and, consequently, that the use of transaction value was acceptable. SMC disputes that it is related to Ablecom.
Whether SMC and Ablecom are related parties within the meaning of 19 U.S.C. § 1401a(g)(1).
Whether transaction value is the appropriate basis of appraisement for transactions between the parties.
LAW AND ANALYSIS:
Relationship between SMC and Ablecom
The preferred method of appraising merchandise imported into the United States is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 ("TAA"; codified at 19 U.S.C. § 1401a). Section 402(b)(1) of
the TAA provides, in pertinent part, that the transaction value of imported merchandise is the "price actually paid or payable for the merchandise when sold for exportation to the United States" plus enumerated statutory additions.
Under 19 U.S.C. § 1401a(b)(2)(A)(iv), transaction value is to be used only if the buyer and seller are unrelated or, if they are related, their transaction value is considered "acceptable". 19 U.S.C. §1401a(b)(2)(B) provides:
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 closely approximates –
The transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States; or
The deductive or computed value for identical or similar merchandise;
But only if the 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.
See also 19 C.F.R. 152.103(j)(2).
“Related parties” are defined in 19 U.S.C. 1401a(g)(1), which provides:
For purposes of this section, the persons specified in the following subparagraphs shall be treated as persons who are related:
Members of the same family, including brothers and sisters (whether by whole or half
blood), spouse, ancestors, and lineal descendants.
Any officer or director of an organization and such organization.
An officer or director of an organization and an officer or director of another organization, if each individual is also an officer or director in the other organization.
Employer and employee.
Any person directly or indirectly owning, controlling, or holding with power to vote, 5 percent or more of the outstanding voting stock or shares of any organization and such organization.
Two or more persons directly or indirectly controlling, controlled by, or under common control with, any person.
According to counsel, the familial and ownership ties that exist between SMC and Ablecom, detailed in the FACTS above, are insufficient to create a “reasonable basis” to conclude that the parties are related for purposes of the Customs valuation laws. Counsel argues that corporations are legal persons and that SMC and Ablecom are separate legal entities. Further, the corporations SMC and Ablecom do not own shares in each other. Therefore, SMC cannot control or direct the activities of Ablecom, and Ablecom cannot direct or control the activities of SMC. In support of this position, Counsel cites section 141(a) of
the Delaware General Corporation Law, which states in relevant part that the business affairs of every corporation shall be managed by or under the direction of a board of directors. Thus, although two brothers of the President and CEO of SMC (Charles Liang) are directors of Ablecom, their actions concerning Ablecom are not controlled by SMC or Charles Liang.
By virtue of being President, CEO and Chairman of the Board of SMC, Charles Laing is related to SMC. See 19 U.S.C. § 1401a(g)(1)(B). His wife is Vice President and Treasurer of SMC, and thus also related to the company. Id. While holding these positions of control in SMC, Charles Liang and his wife have owned between 10.5 and 30.7 percent of Ablecom voting stock, also making them related to Ablecom. See 19 U.S.C. § 1401a(g)(1)(F). This fact pattern indicates that Ablecom and SMC are controlled by or under the common control of Charles Liang and his wife. Under the Customs Valuation Laws, two or more persons that are directly or indirectly controlled by or under common control with any person are related. See 19 U.S.C. § 1401a(g)(1)(G). See also Headquarters Ruling Letter (“HQ”) 547608 (Feb. 21, 2002). Therefore, we find that Ablecom and SMC are related.
Counsel also argues that Ablecom and SMC deal with each other as unrelated parties. According to counsel, Ablecom was unwilling to disclose to SMC its actual costs, profit and general expenses associated with sales to SMC, and SMC does not have sufficient control over Ablecom to require disclosure of this information. However, we note that Ablecom does in fact provide this information to SMC so that the latter can conduct its quarterly price testing as provided for under the PMA.
Another argument made by counsel is that CBP cannot disregard the use of transaction value solely because the buyer and the seller are related. “Reasonable doubt” must exist as to the acceptability of the price. In support of this position, counsel cites selected portions of past CBP rulings: HQ 563400 (March 29, 2006) (“Where Customs and Border Protection … 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.”); HQ 548065 (September 6, 2002) (“This regulation clearly indicates that Customs is not required to question the acceptability of the related party price.”); and, HQ H062635 (Nov. 30, 2009) (“In this case … Customs has been satisfied that the relationship between the seller and the importer did not influence the price actually paid or payable of the branded products. Therefore, we find that absent evidence to the contrary it may be appropriate to appraise the generic products under transaction value and for Customs to continue to recognize that the relationship between the buyer and the seller also does not influence the price of the generic products.”).
All three rulings cited by counsel discuss the interpretation of 19 C.F.R. § 152.103(l), which states:
The port director shall not disregard a transaction value solely because the buyer and seller are related. There will be related person transactions in which the validation of the transaction value using the procedures contained in § 152.103(j)(2) may not be necessary.
Interpretive Note 1. Customs 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, if Customs has no doubts about the acceptability of the price, the price will be accepted without requesting further information form the importer. If Customs does have doubts about the acceptability of the price and is unable to accept the transaction value without further inquiry, the importer will be given an opportunity to supply such further detailed information as may be necessary to enable Customs to examine the circumstances of the sale. In this context, Customs will examine relevant aspects of the transaction, including the way in which the buyer and seller organize their commercial relations and the way in which the price in question was arrived at in order to determine whether the relationship influenced the price.
HQ 563400 concerned whether the “circumstances of the sale” test, prescribed by 19 U.S.C. § 1401a(b)(2)(B) supra and the regulation cited above, had been met for a sale between related parties. CBP found that sufficient information had not been submitted to establish that the test had been met and, consequently, that the goods could not be appraised using transaction value. In HQ 548065, the reliance by CBP on the transaction value between related parties was protested by the importer. However, CBP was able to show that not only were CBP auditors and the port in agreement that transaction value should be used, but also that counsel for the importer met with CBP staff and also agreed that transaction value was the appropriate method of appraisement. Based on these facts, and relying on 19 C.F.R. § 152.103(l), CBP found that it is not required to question all related party prices. In HQ H062635, the issue was whether generic pharmaceuticals produced by a party related to the importer could be appraised at a lower price than branded pharmaceuticals produced by the same related party. CBP had been previously satisfied that the relationship between the buyer and the seller did not influence the price of the branded products and, based on that fact, found that the lower price for the generic drugs constituted a valid transaction value.
We find that these rulings do not support counsel’s assertion that CBP must have reasonable doubt before it can disregard a claimed transaction value. To the contrary, they demonstrate that there must be a reasonable basis for CBP to accept transaction value between a related buyer and seller without further investigation. In this case, there was no reasonable basis for CBP to accept the transaction value. Moreover, this issue arose from a Focused Assessment conducted by Regulatory Audit’s San Francisco office, which is authorized to examine the business records of an importer in order to ascertain the correctness of any entry, determine an importer’s liability for duty, fees and taxes, or to ensure compliance with U.S. Customs laws. See 19 U.S.C. § 1509(a). In the exercise of Regulatory Audit’s authority, reasonable doubt about an importer’s claim is not required. See Id.
Circumstances of the Sale
When a buyer and seller are related, transaction value is an acceptable basis of appraisement only if 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 C.F.R. § 152.103(l). While the fact that the buyer and seller are related is not in itself grounds for regarding transaction value as unacceptable, where a CBP audit raises questions about the acceptability of the price so that the port 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.
“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. HQ 543568, dated May 30, 1986. In this instance, no information regarding test values has been submitted or is available; consequently, the circumstances of the sale must be examined in order to determine the acceptability of transaction value.
Under the circumstances of sale approach, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The CBP Regulations specified in 19 C.F.R. Part 152 provide illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. In this respect, CBP 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(l)(1)(i)-(ii). In addition, CBP 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(l)(1)(iii). These are examples that illustrate that the relationship has not influenced the price, but other factors may be relevant as well.
In order to determine if Ablecom’s gross margin was reasonable, SMC conducted quarterly reviews to compare Ablecom’s profit margin on chassis purchased by SMC with the profit margins of “comparable companies” in the U.S. and Taiwan selling the same or similar products. In each instance, SMC determined that its purchases from Ablecom were conducted at a reasonable level in line with the market and, therefore, that Ablecom’s profits were reasonable.
CBP has found that an importer must have objective evidence of how prices are set in the relevant industry in order to establish the “normal pricing practices of the industry” in question, and present evidence that the price between related parties was settled in accordance with the industry pricing practices. See HQ 542261 (Mar. 11, 1981), in which Customs determined that where the transfer price was defined with reference to prices published in a trade journal (the posted price), and the posted price was commonly used by other buyers and sellers as the basis of contract prices, the transfer price was acceptable. In such instances, the determination could be made that the transfer price was settled in a manner consistent with the normal pricing practice in the industry. See also HQ 088815 (Sept. 28, 2011), HQ H037375 (Dec. 11, 2009), and HQ 548482 (July 23, 2004). CBP does not consider the industry in question to consist of other functionally equivalent companies if those companies do not sell goods of the same class or kind. See HQ 548482 (July 23, 2004).
The reports of the quarterly reviews conducted by SMC do not discuss normal pricing practices in the computer chassis manufacturing industry. In addition, the reports do not address the methods used by the companies claimed to be comparable to Ablecom to price their products. As a result, the reports do not provide CBP with the information necessary to conclude that the prices at which Ablecom sold products to SMC were not influenced by their relationship. The fact that Ablecom may earn operating profits comparable to companies identified in the quarterly reviews, by itself, is not persuasive.
Moreover, the terms of the PMA allow SMC to influence the prices it is charged by Ablecom for computer chassis. Ablecom is not free to set its own prices. By contract, Ablecom must make best efforts to reduce costs on a continuing basis to make its prices to SMC more competitive than market prices and must pass on cost reductions to SMC in the form of a price reduction whenever there is a decrease in manufacturing costs. However, if Ablecom’s manufacturing costs increase, Ablecom cannot increase the prices at which it sells to SMC without first having the written consent of SMC to do so. In addition, whenever there is a change in the market price, Ablecom must negotiate a mutually acceptable price reduction or increase with SMC. Based on these facts, we find that transaction value is not the appropriate method of appraisement for sales between Ablecom and SMC.
Based on the information submitted, transaction value is not the appropriate method of appraisement for sales between related parties Ablecom and Super Micro Computer.
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, Regulations and Rulings, Office of International Trade, will make the decision available to CBP personnel and the
public at www.cbp.gov, by means of the Freedom of Information Act and other methods of public distribution.
Monika R. Brenner, Chief
Valuation and Special Programs Branch