OT:RR:CTF:VS H215658 CMR

Alan R. Klestadt, Esq.
Harry L. Isacoff, Esq.
Grunfeld, Desiderio, Lebowitz,
Silverman & Klestadt LLP
399 Park Avenue
New York, NY 10022-4877

RE: Reconsideration of Headquarters Ruling Letter H097035; First Sale

Dear Messrs. Klestadt and Isacoff:

This is in response to your request on behalf of your client for this office to reconsider our decision in Headquarters Ruling Letter (HQ) H097035, dated November 15, 2011, in which we advised the Port of Newark on Protest Number 4601-09-150323 involving the question of the acceptability of a first sale claim between related parties.

FACTS:

We will not repeat the facts of HQ H097035 herein but will focus only on the points raised in your request for reconsideration.

You state that CBP discounted the sales between the related manufacturer and the related middleman based on two observations – (1) “the factory actually delivered the freight to the forwarder” which caused CBP to view the terms of sale as FOB and not ex-works and, (2) the middleman’s purchase orders to the factories noted that payment would be made via a letter of credit when it was actually made via wire transfer. You argue that the sales between the related parties were bona fide sales and that the related middleman did bear risk of loss for the goods.

In addition, you argue that the comparison transactions set forth in H097035, between another middleman and its related Vietnamese manufacturer were arm’s length transactions and should be accepted as evidence that the related parties in the first sale at issue settled prices in a manner consistent with the normal pricing practices in Vietnam. You submit that in HQ H097035, CBP ignored its own precedent and adopted a new standard for the all costs plus a profit test. With regard to the “equivalent profits” language of the “all costs plus a profit test”, you argue that consideration must be given “to the specific assets, functions, activities and risks taken by each party.” You further submit that CBP’s position that the subsidiary’s profit had to equal or exceed the parent’s profit in order to meet the all costs plus a profit test was an arbitrary and artificial standard and a departure from over 30 years of CBP precedent.

With regard to the two examples submitted of unrelated subcontractors producing merchandise for related manufacturers to sell to their related middleman, you submit that the analysis ignored the operative fact, that is, that the “independent producers accepted orders for the same goods at the same prices established by the related parties.” You argue that the only relevance of these transactions is “that the unrelated subcontractors accepted these orders and sold the finished goods at prices which were equivalent to the prices set between” the related parties in the transactions at issue.

You argue that HQ H097035 disregarded previous Customs and Border Protection (CBP) precedent and is inconsistent with prior CBP guidance in the area of “first sale” evaluations.

ISSUES:

I. Was it error in HQ H097035 to conclude that the parties acted according to FOB terms of sale and not ex-works as specified on the purchase orders and commercial invoices? II. Did CBP fail to follow precedent in HQ H097035 in considering the comparison transactions between another related parent-middleman and related subsidiary-manufacturer by requiring the subsidiary’s profit to equal or exceed the parent’s profit in sale of merchandise of the same class or kind in order to meet the all costs plus profit test set forth in 19 CFR 152.103(l)(1)(iii)?

III. Was it error to view the unrelated subcontractor transactions in context of the complete transaction rather than just as evidence that a party in Vietnam would produce goods for the price paid to the related manufacturer?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised 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 preferred 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 certain statutory additions. 19 U.S.C. § 1401a(b)(1).

In Nissho Iwai American Corp. v. United States, 16 C.I.T. 86, 786 F. Supp. 1002, reversed in part, 982 F. 2d 505 (Fed. Cir. 1992), the Court of Appeals for the Federal Circuit reviewed the standard for determining transaction value when there is more than one sale which may be considered as being for exportation to the United States. The case involved a foreign manufacturer, a middleman, and a United States purchaser. The court held that the price paid by the middleman/importer to the manufacturer was the proper basis for transaction value. The court further stated that in order for a transaction to be viable under the valuation statute, it must be a sale negotiated at arm’s length, free from any non-market influences, and involving goods clearly destined for the United States. See also, Synergy Sport International, Ltd. v. United States (Ct. of Int’l Trade, 1993).

In accordance with the Nissho Iwai decision and our own precedent, we presume that transaction value is based on the price paid by the importer. In further keeping with the court’s holding, we note that an importer may request appraisement based on the price paid by the middleman to the foreign manufacturer in situations where the middleman is not the importer. However, it is the importer’s responsibility to show that the "first sale" price is acceptable under the standard set forth in Nissho Iwai. That is, the importer must present sufficient evidence that the alleged sale was a bona fide "arm’s length sale," and that it was "a sale for export to the United States" within the meaning of 19 U.S.C. § 1401a.

In Treasury Decision (T.D.) 96-87, dated January 2, 1997, the Customs Service (now Customs and Border Protection (CBP)) advised that the importer must provide a description of the roles of the parties involved and must supply relevant documentation addressing each transaction that was involved in the exportation of the merchandise to the United States. The documents may include, but are not limited to purchase orders, invoices, proof of payment, contracts, and any additional documents (e.g. corre-spondence) that establishes how the parties deal with one another. The objective is to provide CBP with "a complete paper trail of the imported merchandise showing the structure of the entire transaction." T.D. 96-87 further provides that the importer must also inform CBP of any statutory additions and their amounts. If unable to do so, the sale between the middleman and the manufacturer cannot form the basis of transaction value.

In H097035, this office evaluated all of the information presented to support the argument that the first sale between related parties should serve as the basis for appraisement of the goods and we found the submitted information insufficient evidence that the claimed sale met the arm’s length requirement of 19 U.S.C. § 1401a(b)(2)(B). However, we will address the issues you have raised in your request for recon-sideration.

Ex-works or FOB

In your submission, you argue that there is no support for CBP’s presumption that the related-party factories were operating under an FOB shipping contract and not an ex-factory one. You submit the presumption by CBP contradicts the “documented facts.” In making your argument, you cite to the International Chamber of Commerce’s publication Incoterms 2010: ICC Rules for the use of Domestic and International Trade Terms, ICC Services Publications (Paris 2010). Specifically, from page 15 of that publication you cite:

The seller has no obligation to the buyer to load the goods, even though in practice the seller may be in a better position to do so. If the seller does load the goods, it does so at the buyer’s risk and expense. In cases where the seller is in a better position to load the goods, FCA, which obliges the seller to do so at its own risk and expense, is usually more appropriate. [Our emphasis added]

First we note that you refer to Incoterms 2010, when in fact Incoterms 2000: ICC Official Rules for the Interpretation of Trade Term, ICC Publishing S.A. (Paris 1999) is the appropriate reference as the shipments at issue in the protest which was the subject of HQ H097035 occurred prior to the issuance of Incoterms 2010. In Incoterms 2000: ICC Official Rules for the Interpretation of Trade Terms, at page 27, we find the following with regard to “ex-works”:

. . . if the parties wish the seller to be responsible for the loading of the goods on departure and to bear the risks and all the costs of such loading, this should be made clear by adding explicit wording to this effect in the contract of sale. (footnote omitted) This term should not be used when the buyer cannot carry out the export formalities directly or indirectly. In such circumstances, the FCA term should be used, provided the seller agrees that he will load at his cost and risk.

Nonetheless, in the portion of Incoterms 2010 cited by you, it states in its discussion of “ex-works” that if the seller loads the goods, it is done at the buyer’s risk and expense. In this case, we were not provided with a sales contract between the parties. The documentation presented to CBP as evidence of the sales consisted of purchase orders, invoices, air waybills, and proof of payment. The purchase orders and invoices between the middleman and the manufacturers indicated the shipping terms were ex-factory. Each contained a statement to the effect that title and risk of loss passed to the middleman at the factory. The statement was consistent with the use of the term ex-factory. However, the actions of the parties were not consistent with the use of the term ex-factory.

The factories transported the merchandise to the port of export and they were identified as the shippers in the shipping documents. This office was informed the factories did not receive a separate payment for this service. In HQ H097035, the presumption was made that the factories were operating under an FOB shipping contract and not an ex-factory one because the factories incurred the cost of inland freight with no separate compensation for doing so, meaning the invoice price included the costs of the goods and inland freight. In HQ 544875, dated March 2, 1992, CBP examined the inclusion of foreign inland freight charges in the appraisement of certain merchandise claimed to have been sold at an ex-factory price. In the decision, CBP stated:

In situations where an ex-factory price is asserted, but where foreign inland freight charges are included in the same invoice as the price, Customs requires a written explanation from the importer stating that the foreign inland freight charges were charged separately as part of an accommodation agreement between the buyer and seller. See HRL 543744, dated July 30, 1986; and Customs Telex UNCLAS 6689, dated July 17, 1985. This information is necessary to overcome the presumption - raised by the existence of the foreign inland freight charges on the invoice - that the sale was on other than ex-factory terms.

Further in HQ 547886, dated July 30, 2002, CBP stated with regard to accommodation agreements between a seller and buyer on a claimed ex-factory sale: In order to determine whether a claimed accommodation agreement is legitimate, Customs will examine relevant documents from the importer, e.g., those relating to insurance, cartage, loading, and inspection. HRL 543744, dated July 30, 1986. In other words, Customs will examine the totality of the evidence to determine if the sales were truly ex-factory.

While the cited rulings dealt with the question of the inclusion of inland freight in determining the transaction value of merchandise, they are relevant to the question of whether the sales between the factories and the middleman were truly ex-factory or FOB, if transportation by sea or inland waterway, or FCA (Free Carrier) (may be used irrespective of the mode of transport). The parties chose to use incoterms on their purchase orders and invoices and, as parties engaged in international trade, should have been fully aware of the significance of the use of such terms. In this case, the actions of the parties did not comport with the terms of the purchase orders and invoices. While the purchase orders and invoices indicated terms of ex-factory which meant the price on the invoice reflected the cost of the goods and nothing else and that the buyer undertook responsibility for the goods at the factory door, this was not the situation. There was no separate payment from the middleman to the factories for the cost of inland freight, so the price on the invoice included that cost. In addition, the factories were identified as the shippers on the shipping documents. We did not err in HQ H097035 in presuming the parties acted according to FOB terms of sale (or FCA) and not ex-works as specified on the purchase orders and commercial invoices. No information was presented to overcome the presumption that the sale was on other than ex-factory terms.

Additionally, you argue that CBP discounted bona fide sales between the middleman and its related factories. HQ H097035 did not actually determine whether or not there were bona fide sales between these parties. The decision pointed out the concerns raised by the use of ex-works on the purchase orders and invoices and the actions of the parties with regard to inland freight discussed above. Further, the decision pointed out the inaccuracy of the purchase orders with regard to the method of payment. Most significantly, our decision noted that even if we were to ignore the apparent conflicts or inaccuracies of the documents presented to CBP and accepted that title passed from the manufacturer to the middleman at the factory, and in other words, presumed there were bona fide sales, the sales at issue would still have to meet the requirements of 19 U.S.C. § 1401a(b)(2)(B) for acceptability. For the reasons set forth below, those requirements were not met.

All Costs Plus a Profit Test

For purposes of establishing that the related parties’ sales met the circumstances of the sale test of the statute, you submitted two transactions between a different middleman and its Vietnamese related manufacturer. These sales were submitted to demonstrate that the related parties at issue settled prices in a manner consistent with the normal pricing practices of the apparel industry in Vietnam. The three comparison sales were for merchandise similar to that sold by the related parties at issue and were at prices which were either claimed to be identical or comparable to the prices charged by the related party manufacturer at issue. However, as the comparison sales were between related parties, it is necessary to show the relationship between those parties did not influence the sale. As evidence that the relationship of the comparison related parties did not influence the sale, you submitted only profit and loss statements of each company, parent/buyer and subsidiary/seller, for two successive years (2007 and 2008) encompassing the time frame of the entries at issue. The profit and loss statements were submitted to show that the comparison companies met the all costs plus a profit test set forth in 19 CFR 152.103(l)(1)(iii) which states:

If it is shown that the price is adequate to ensure recovery of all costs plus a profit which is equivalent to the firm’s overall profit realized over a representative period of time (e.g., on an annual basis), in sales of merchandise of the same class or kind, this would demonstrate that the price has not been influenced.

You submit that CBP’s position that the subsidiary’s profit had to equal or exceed the parent’s profit in order to meet the all costs plus profit test was an arbitrary and artificial standard and a departure from over 30 years of CBP precedent. We disagree. HQ H097035 relied on prior CBP decisions, specifically HQ H106603, dated July 25, 2011, and HQ H016585, dated December 30, 2008.

In arguing that the submitted profit and loss statements for the related parties of the comparison transaction showed that the all costs plus a profit test was met, you submit that because the price paid by the comparison middleman was sufficient to ensure its related manufacturer’s recovery of its costs and realization of a profit, the test has been met. However, recovery of costs and realization of a profit, any profit, is not the test. The regulations require the profit to meet specific criteria, i.e., the profit must be equivalent to the firm’s overall profit realized over a representative period of time, in sales of merchandise of the same class or kind.

In HQ H106603, dated July 25, 2011, CBP stated:

A very important consideration in the all costs plus a profit example is the “firm’s” overall profit. In applying the all costs plus a profit test, CBP normally considers the “firm’s” overall profit to be the profit of the parent company. Thus, if the seller of the imported goods is a subsidiary of the parent company, the price must be adequate to ensure recovery of all the seller’s costs plus a profit that is equivalent to the parent company’s overall profit. See HRL 546998, dated January 19, 2000. The regulations do not give us the definition of “equivalent” profit; however, if the profit of the seller is equal to or higher on the U.S. imports than the firm’s overall profit, the purchase price would not be artificially low for Custom’s purposes.

In HQ 546052, dated October 27, 1995, in assessing the applicability of transaction value to transactions between related parties, Customs stated:

There is no information with regard to how the seller deals with unrelated purchasers, nor is there any indication as to whether the price was adequate to ensure recovery of all costs plus a profit equal to its overall profit realized over a representative period of time in sales of merchandise of the same class or kind. [Emphasis added].

Further, in HQ 545800, dated June 28, 1996, cited by you, in discussing a related party transaction, Customs stated with regard to the circumstances of the sale test and the question of “profit equivalent to the firm’s overall profit”:

. . . the evidence submitted by counsel is not sufficient to show that the price of the imported merchandise was sufficient to recover all costs plus a profit equivalent to the firm’s overall profit realized over a representative period [of] time. . . . this cost information does not indicate whether the price charged by Standard [the seller] is sufficient to cover all its costs and earn a profit equal to its overall profit over a representative period of time. . . . Since no evidence has been submitted on how much it costs for Standard to produce the imported sweaters, we cannot ascertain whether it has been able to recover all its costs plus earn a profit equal [to] its overall profit over a representative period of time through its pricing practices with Tundra. [Emphasis added]. Based on the language in the cited decisions, it is apparent that HQ H097035 is not the first decision issued by this office which interpreted “profit equivalent to” to mean “profit equal to.” See HQ 546052 and 546052, supra. HQ H097035 does not create a new definition of “equivalent”, but merely follows previously issued decisions.

As to the decisions cited by you for support that CBP should accept the related party transactions as arm’s length, we believe those rulings may be distinguished based on the facts of each case. For instance, you cite HQ 546998, dated January 19, 2000, for CBP precedent of related companies that maintained operating profits within one percentage point being found to satisfy the all costs plus a profit test. However, HQ 546998 did not compare operating profits; it compared cost markups. Further, CBP was presented with a range of uncontrolled (arm’s length) adjusted full cost markups in a Comparable Industry Set (CIS) of six companies as an indicator of normal pricing practices of the industry. CBP was presented with more information to support the arm’s length nature of the transaction in HQ 546998 than it was in HQ H097035. In addition, we believe it may further support HQ H097035 as the information showed that the subsidiary/seller had a higher full cost markup than its parent. You cite HQ 546211, dated June 10, 1996, for the proposition that CBP has “never defined the term ‘equivalent’ to mean that the seller’s overall profit must equal or exceed the firm’s profit under the all costs plus profit test.” However, we note that in HQ 546211, it was found that “the transfer price was sufficient to recover all costs plus a profit that exceeded [the seller’s] overall profit based on the company’s 1993 financial statements.” The seller’s related party sales were the most profitable part of its operation. Information was presented regarding sales to unrelated parties and how the price in question between the related parties was derived. Based on the information presented in that case, CBP found transaction value to be an acceptable basis for appraisement.

You also cite HQ W548419, dated December 27, 2009, as a decision wherein CBP held that the profits for two related companies met the all costs plus a profit test even though the parent company realized a higher profit than its subsidiary. However, in that decision, CBP was provided with “a comparison of the manufacturer’s full cost markup with the weighted average full cost markups of twelve European companies in the same general industry group as determined by four digit standard industrial classification (SIC) codes.” [footnote omitted] See HQ W548419. CBP stated in its analysis:

In this case, we note that the manufacturer’s full cost markup falls within the range earned by similarly situated companies in the industry and is above the median. In this regard, the information submitted supports a finding that the price was settled in a manner consistent with the normal pricing practices of the [XXXXX] industry. Although the data submitted indicates that the consolidated return for the Group is higher than the manufacturer’s markup, the middleman bears greater risk in the transaction. In light of and adjusting for the additional risk borne by the middleman in the particular circumstances of this case, we find that the information submitted supports a finding that 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. When viewed in context, we see that the decision in HQ W548419 did not turn on merely a comparison of annual financial statements and simple profit comparisons, but was based on much more. Information was submitted which supported finding that the price was settled in a manner consistent with the normal pricing practices of the industry. That information, along with the facts of the particular case, led CBP to conclude that 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.

Finally, with regard to HQ H032883, dated March 31, 2010, CBP reviewed multiple transfer pricing studies and updates, the parent company’s “Enterprise Pricing Model” (EMP) document, and a Verification Report by the Canada Border Service Agency. The decision was not based merely on application of the all cost plus profit test. In making its decision that the price between the related parties was not influenced by the relationship, CBP examined the relevant aspects of the transaction, including how the companies organized their commercial relations, as well as how the price was arrived at by the parties. Among other things, the percentage of profit for the subsidiary in sales of work in progress (WIP) goods to its related parent exceeded the median profit of companies examined in the subsidiary’s 2007 transfer pricing study and the gross profit amount of the subsidiary in finished goods (FG) sales to its parent was higher than the gross profit amount in finished goods sales to unrelated parties. The net profit margins of sales of finished goods from the subsidiary to its related parent and to unrelated parties were found to be similar. CBP determined the related party prices were settled in a manner consistent with the way the seller settled prices in sales to unrelated buyers based on this information. With regard to the all costs plus a profit test, CBP did look at the information provided by the parties and determined that the subsidiary earned a healthy margin on the sale of goods to its related parent. What may not be clear from the decision is that the subsidiary’s gross profit margin for WIP goods is nearly the exact percentage called for in the EMP based on the transfer pricing studies. Further, the subsidiary’s gross profit margin on the sample FG transaction was greater than the subsidiary’s total gross profit in sales of FG goods which included sales to unrelated parties. Therefore, the quantity and depth of information considered in finding a healthy profit margin for the seller in HQ H032883 and ultimately finding that the prices between the related parties was not influenced by the relationship cannot compare to the paucity of information provided in HQ H097035 to show that the related parties in the comparable submitted transactions operated at arm’s length.

By contrast, you submitted profit and loss statements of the comparison middleman and its related manufacturer for the years 2007 and 2008. The income statement for the manufacturer states at the top: “The accompanying notes are an integral part of the financial statements.” The statement also had a “code” column for each item listed. We did not receive any notes to the income statement and there was no explanation of the codes. A simple comparison of the numbers on the submitted income statements is insufficient. We believe HQ H032883 is clearly distinguishable from HQ H097035 for this reason and does not provide support to your arguments.

Accordingly, for the reasons stated in HQ H097035 and further expanded on herein, the submitted comparison sales between related parties cannot serve to show that the related party sales at issue were arm’s length sales.

Unrelated Subcontractors’ Prices

In HQ H097035, two examples were presented to CBP in which unrelated subcontractors produced merchandise to sell to the related manufacturers for the same price that the related manufacturers then charged their related middleman. You submit that because these unrelated factories accepted these orders at the same price as the related manufacturers charged their related middleman, that this is proof the relationship between the related parties did not influence the price. You take issue with the analysis of these examples in HQ H097035 because the decision considered the prices in the context of the transactions of which they were a part. You submit that these “independent producers accepted orders for the same goods at the same prices established by the related parties” and that “[t]hese transactions represent the best information available to establish that the relationship between the parties did not influence the price paid or payable for the goods.”

CBP cannot ignore the context of the submitted examples as part of transactions between the related parties. Had the middleman dealt directly with the unrelated factories and negotiated the prices, rather than the related factories, then the fact that the factories agreed to produce the goods for the same price as the related factories would be more persuasive. However, that was not the case. Examples of unrelated manufacturers producing identical or similar goods for unrelated buyers at or about the same price as that paid by the middleman for goods from its related manufacturers would similarly have been more persuasive.

You submitted these examples to support the argument that the middleman and its related manufacturer “organized their commercial relations and arrived at prices in a manner that was not influenced by the relationship.” However, the two examples shed no light on how the related parties arrived at prices sold by the related manufacturer to its middleman/parent. In addition, for the reasons stated in HQ H097035, CBP found that the transactions in the context of the multi-tiered transaction raised concerns with the acceptability of the related party transactions of which they were part and which are the subject of other protests pending decision at the port. With regard to the analysis of the transactions involving the subcontractor examples, we note that you argue that passage of title, passage of risk of loss and the realization of profit are each single factors in analyzing whether there is a bona fide sale. We would point out that passage of title and passage of risk of loss are key factors in determining whether a sale has occurred.

CBP has considered your arguments for reconsideration of HQ H097035 and we are not persuaded that the decision should be modified. We understand that the protest which was the subject of the request for internal advice in HQ H097035, Protest No. 4601-09-150323, has been denied. Per 19 C.F.R. § 174.31(a):

Any person whose protest has been denied, in whole or in part, may contest the denial by filing a civil action in the United States Court of International Trade in accordance with 28 U.S.C. 2632 within 180 days after the date of mailing of notice of denial, in whole or in part, of a protest.

HOLDING:

CBP affirms the decision in HQ H097035.

Sincerely,

Myles B. Harmon, Director
Commercial and Trade Facilitation Division