Ruling Request; Transaction Value; Related Party Transactions; Post-Importation Adjustments

February 19, 2015 HQ H238027 OT:RR:CTF:VS H238027 YAG CATEGORY: Valuation [******] RE: Ruling Request; Transaction Value; Related Party Transactions; Post-Importation Adjustments Dear Mr. [***]: This is in response to your ruling request, dated January 18, 2013, inquiring whether the Importer/Buyer’s [***] basis of appraisement of the imported merchandise is acceptable under transaction value. We regret the delay in responding. You have asked that certain information submitted in connection with this ruling request be treated as confidential. Inasmuch as this request conforms to the requirements of 19 CFR §177.2(b)(7), the request for confidentiality is approved. The information contained within brackets and all 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 decision. FACTS: The Importer/Buyer [***] is a wholly owned subsidiary of [***], (the “Seller”), a publicly traded Swiss corporation. The Seller manufactures watches in Switzerland and sells them to the Importer/Buyer in the United States. The Importer/Buyer is the U.S. distributor and importer of record for these watches. According to the Importer/Buyer, the traditional Swiss watch supply chain runs from producer to wholesaler to retailer. Therefore, [***] pricing approach involves a three-tiered sales/pricing structure. This approach recognizes that certain brands and segments command very different consumer retail prices based on their respective market position. Further, to protect the brand market position, the pricing policy is consistent worldwide. The methodology for determining intercompany product prices relies on external market factors. In other words, the recommended retail price in the United States is determined by external factors, such as prices of competing brands, similar watches in a collection, and the pricing hierarchy within the brand. Additionally, pricing is consistent with the pricing of the same product in other countries; thus, the companies’ transfer pricing system is designed to be consistent on a global basis. The parties establish a U.S. price list annually at which the Importer/Buyer will purchase all watches. The Importer/Buyer provides regular information and reports related to the U.S. market and local competitive conditions (including reports on retail sale, pricing competitive data, etc.). However, the prices are actually set by the Seller (parent company) in Switzerland via recommended Swiss market retail prices that ensures consistency across brands and geographic markets. Accordingly, transfer prices are set as a percentage of the recommended Swiss market retail price, excluding VAT taxes and are substantially the same for all of the related company distributors worldwide. Pricing is set at the retail level and then discounts are applied backwards through the supply chain. Wholesale prices are determined by deducting the retail margin on sales at recommended retail price (according to the Importer/Buyer, this approach is consistent for all distributors, related or unrelated). Once the pricing between companies has been established, the Importer/Buyer issues a purchase order to its parent company in Switzerland, the Seller. In response to the purchase orders, the Seller issues an invoice to the Importer/Buyer. Sales terms are Free on Board (“FOB”) or Ex-Works. Under the FOB term, risk of loss passes to the buyer when the goods are delivered on board the ship, and the buyer has paid the transportation costs and insurance to the destination port. Under the Ex-Works term, risk of loss passes when the seller delivers the goods to the buyer at the seller’s premises or other named place. The parties’ policies dictate that title passes simultaneously with risk of loss. The Seller produces standard commercial documentation to ship the products to the Importer/Buyer, and the payments are completed through a funds transfer or intercompany accounts. The Importer/Buyer claims that the company sets its prices in accordance with the normal pricing practices of the industry. The Swiss watch industry is a longstanding, mature industry, dominated by a small number of large global companies with broad portfolios and well-known brands. The Importer/Buyer further states that its competitors in the Swiss watch industry share similar organizational structures, experience similar trends and risks, and undertake similar business approaches with regard to key functions. The Swiss watch industry competitors of the Importer/Buyer are characterized by a parent/principal entity responsible at a group level for carrying out and making a majority of the strategic decisions over brand development, manufacturing and design, marketing and advertising functions, and oversight of distribution networks and consumer pricing. On the other hand, wholesale distributors in the industry have limited functions and risks and perform routine operations. Thus, in the Swiss watch industry, the principal company, which bears the entrepreneurial risk, receives the residual profit, and local distributors earn a routine arm’s length margin for distribution services. Pricing in the tiered-supply chain evolves from a common industry starting point – Swiss retail prices to consumers (adjusted for regional and country market factors in order to reach international pricing consistency). Swiss consumer retail prices provide a stable point of origin for overall pricing practices. Prices to wholesale and retailers are then set in a manner to provide routine (limited) profit for services rendered, and the remainder (entrepreneurial profit) goes to the principal. The reported assets of the Importer/Buyer’s Swiss watch competitors are also indicative of a common industry practice of centralized organizational structures. Additionally, these companies produce consolidated operating margins (across the companies’ watch and jewelry segments) that are within a consistent range, further demonstrating that companies with similar functions, risks, operating structures, and pricing practices each have a similar range of combined operating margins. As support, a paper, “Swiss Watch Industry - Industry Practice Report,” dated January 2013 and prepared by Ernst & Young, LLP, was submitted for our review. On August 30, 2012, the Importer/Buyer filed a request for renewal of a bilateral Advance Pricing Agreement (“APA”) with the Internal Revenue Service of the United States (“IRS”) and the Swiss Federal Tax Administration. The Importer/Buyer provided a copy of its renewal request to this office as well as the necessary waivers in order for CBP to access the Importer/Buyer’s confidential information in relation to the company’s renewal request. We also participated in the opening conference between the Importer/Buyer and the IRS held on February 7, 2013. On July 7, 2014, the Importer/Buyer provided its concluded bilateral APA between the IRS and the Importer/Buyer for our review. This APA covers the following transactions: (1) the purchase of watches from the foreign Seller for distribution in the U.S. wholesale market (the transfer pricing method (“TPM”) is the comparable profits method (“CPM”), the profit level indicator (“PLI”) is an operating margin (“OM”), and the arm’s length range is between [***]% and [***]%, with a median of [***]%); (2) the purchase of watches from the foreign Seller for distribution in the U.S. retail market (the TPM is CPM, the PLI is an OM, and the arm’s length range is between [***]% and [***]%, with a median of [***]%); and (3) the license by the Importer/Buyer to the foreign Seller of the [***] trademark and trade name (the TPM is the comparable uncontrolled transaction (“CUT”) method, and the arm’s length royalty rate point charged is [***]% of the Seller’s ex-factory net sales. For the first two transactions, the tested party is the Importer/Buyer. The term of the Importer/Buyer’s APA is for seven tax years from December 31, 2011 through December 31, 2018. This ruling pertains to transaction 1 (the purchase of watches from the foreign Seller for distribution in the U.S. wholesale market), since this is the sale for export for customs purposes. The arm’s length range for transaction 1 (the purchase of watches from the foreign Seller for distribution in the U.S. wholesale market) was established on the basis of an objective, third-pricing data for distributors (comparable companies) of durable and nondurable goods. The Importer/Buyer’s original objective was to select a set of watch and jewelry distribution companies; however, the Importer/Buyer was unable to identify a sufficient number of such companies to develop a reliable application of the CPM for tax purposes. Therefore, companies which perform similar functions and assume similar risks as the Importer/Buyer were chosen. It is important to note that although companies that perform similar functions, incur similar risks, use similar intangible assets, as well as sell similar products, were considered for the analysis, the final set of comparable companies represents a set of companies that sell a variety of products, not limited to the Swiss watch industry. Further, under the terms of the APA, the Importer/Buyer may be required to make retroactive price adjustments to meet federal income tax obligations. It is the Importer/Buyer’s position that these post-importation adjustments are all part of an objective formula used to determine transaction value. The Importer/Buyer states that it will flag for reconciliation the prices declared at entry as provisional, due to the potential post-importation adjustments to value. Additionally, the Importer/Buyer asserts that it meets the circumstances of the sale test by showing that the prices between the Importer/Buyer and the Seller are not influenced by the relationship between these companies. The following documents were provided for our review: (1) the Importer/Buyer’s APA for the years 2011 through 2018; (2) Circumstances of the Sale Analysis, issued by Ernst and Young, LLP; (3) the list of all transfer prices currently in effect (by brand); (4) the Importer/Buyer’s APA renewal request transmitted to the IRS, together with the company’s financial statements and all other supplemental information transmitted to the IRS; (5) IRS Form 8821 authorizing CBP to receive the Importer/Buyer’s confidential information with respect to the APA renewal; (6) Swiss Watch Industry – Industry Practices Report, dated January 2013 and prepared by Ernst and Young, LLP; and, (7) the Importer/Buyer’s account activity GAAP billing file, as well as corresponding intercompany invoices/credit memos, the company’s internal trial balance workbook, the aggregate APA reconciliation workbook, and supplemental responses to CBP questions, dated November 13, 2013. ISSUES: Do the circumstances of the sale establish that the price actually paid or payable by the Importer/Buyer to the Seller is not influenced by the relationship of the parties and is acceptable for purposes of transaction value? Is the related party price fixed or determinable pursuant to an objective formula at the time of importation for purposes of determining transaction value? LAW AND ANALYSIS: 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). In order to use transaction value, there must be a bona fide sale for exportation to the United States. The bona fide sale for exportation is not at issue in this ruling request; accordingly, we limit this ruling to the examination of the related party price. There are special rules that apply when the buyer and seller are related parties, as defined in 19 U.S.C. §1401a(g). Specifically, 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 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 CFR §152.103(l). In this case, there are no “test values” available to us; therefore, the Importer/Buyer provided information examining the circumstances of the sale. Do the circumstances of the sale establish that the price actually paid or payable by the Importer/Buyer to the Seller is not influenced by the relationship of the parties and is acceptable for purposes of transaction value? Under this 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 Customs Regulations specified in 19 CFR Part 152 set forth 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 CFR §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 CFR §152.103(l)(1)(iii). Nonetheless, these are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well. See 19 CFR §152.103(I); see also HRL H037375, dated December 11, 2009; HRL H029658, dated December 8, 2009; and, HRL H032883, dated March 31, 2010. In this case, the Importer/Buyer argues that supporting information it submitted for CBP’s review evidences that the prices are settled in a manner consistent with the normal pricing practices of the Swiss watch industry. Further, the Importer/Buyer states that the totality of the information presented and a review of the examination of all relevant aspects of the transactions demonstrate that the price is not influenced by the relationship for purposes of the circumstances of sale test. The company submitted information regarding its own profitability versus that of its competitors, and a study of the Swiss watch industry prepared by Ernst and Young, LLP. This study includes both a qualitative and quantitative verification. The Importer/Buyer also submitted a range of information as to how it does business, from its bilateral APA to the way it establishes prices with its parent company in Switzerland. CBP has noted that the importer must have objective evidence on 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 transfer price was settled in accordance with these industry pricing practices. See HRL H029658, dated December 8, 2009; HRL 547672, dated May 21, 2002; HRL 548482, dated July 23, 2004; and, HRL 542261, dated March 11, 1981 (TAA. No. 19) (stating 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). It is questionable that the study of the Swiss watch industry, prepared by Ernst and Young, LLP, alone qualifies as an objective evidence, referenced in our prior rulings. However, in HRL H029658, CBP held that the Importer showed that the sales price was not influenced by the relationship for purposes of the circumstances of the sale test, based on the totality of the information considered, and, as a result, transaction value was the proper method of appraisement for the related-party import transaction. In HRL H029658, the Importer provided various evidence to show that the prices were at arm’s length, including: (1) a detailed description of its sales process and price negotiations; (2) a bilateral APA that was approved by the IRS (the Importer was a tested party under the APA, with CPM chosen as the best method to evaluate inter-company transactions); and, (3) a paper, prepared by their accountants, which provided details with respect to the pricing practices in the automotive industry. The evidence presented by the Importer did not fall strictly within a single illustrative example, specified in 19 CFR §152.103(l)(1)(i)-(iii), such as the normal pricing practices of the industry. Nevertheless, taken together, the documents provided by the Importer assisted CBP in reaching its conclusion that the relationship of the parties did not influence the price. In the present case, as stated in the FACTS portion of this ruling, the Importer/Buyer explains in detail how the related parties set their prices. The companies’ transfer price is designed to be consistent on a global basis, and the wholesale prices are established by deducting the retail margin on sales at recommended retail prices. This approach is consistent for all distributors. The parties establish a U.S. price list at which the Importer/Buyer purchases its products. This price list is set by the Seller, taking into account Swiss market retail prices as well as the information provided by the Importer/Buyer such as market conditions in the United States. Therefore, pricing is set at the retail level and then discounts are applied backwards through the supply chain. In support of this pricing structure, the Importer/Buyer submitted a paper, prepared by their accountants, detailing pricing practices in the Swiss watch industry. While this evidence provided by the Importer/Buyer is not entirely objective, as determined by our previous rulings, we find that the report, detailing the pricing practices of the watch industry, is highly relevant for our overall analysis of the Importer/Buyer’s pricing structure because it further substantiates the Importer/Buyer’s practice of setting its prices. In other words, the industry study paper confirms the fact that the Importer/Buyer sets its prices in accordance with the practices of the Swiss watch industry. The Swiss watch industry competitors of the Importer/Buyer are characterized by a parent entity that is responsible for carrying out a majority of strategic decisions. Therefore, the parent company, which bears the entrepreneurial risk, receives the residual profit, and local distributors earn a routine arm’s length margin for distribution services. Accordingly, a common industry starting point is the Swiss retail price to consumers, which indicates a pricing structure similar to the parties’ at issue. Furthermore, the industry report compared the profits of the Importer/Buyer to the reported assets of the Importer/Buyer’s Swiss watch competitors. Our review of the financial information present in the Swiss watch industry report indicates that the Importer/Buyer’s competitors produce consolidated operating margins that are within a consistent range, and similar to that of the Importer/Buyer. Therefore, this quantitative comparison of the Importer/Buyer’s operating margins to the operating margins of its competitors demonstrates that the companies with similar functions, risks, operating structures and pricing practices earn a similar range of combined operating margins. Finally, the Importer/Buyer submitted a recently concluded bilateral APA for our review. We find that even though the Importer/Buyer’s bilateral APA by itself is not sufficient to show that a related party transaction value is acceptable for Customs purposes, the underlying facts and the conclusions reached in the bilateral APA and especially the underlying documentation furnished to the IRS and provided to CBP, contain relevant information in examining the circumstances of the sale. See HRL 546979, dated August 30, 2000 and HRL 548233, dated November 7, 2003. In the past CBP has noted that whether the Importer’s transfer pricing methodology has been reviewed and approved by the IRS is a significant factor. See HRL 546979, dated August 30, 2000; and HRL H029658, dated December 8, 2009. In this case, the Importer/Buyer entered into a bilateral APA with the IRS and the foreign tax authority; therefore, the Importer/Buyer’s transfer pricing analysis has been reviewed and accepted by the IRS. We also reviewed the comparable companies selected by the Importer/Buyer’s bilateral APA and conclude that the products sold by the comparable companies are not of the same class or kind as the imported merchandise. Further, the comparable companies are distributors of durable and non-durable goods and do not belong to the Swiss watch industry. However, we note that all of the Importer/Buyer’s imported products are covered by the APA, reducing the possibility of profit manipulation. Thus, the Importer/Buyer has chosen to have all of its related party transactions covered by the APA. Further, the Importer/Buyer provided CBP with a waiver that enabled CBP to participate in the APA pre-filing conference. Additionally, the Importer/Buyer provided CBP all of the documents that were submitted to the IRS in the APA process that support the facts and statements made by the Importer/Buyer in the course of this ruling request. The fact that the foreign tax authorities have approved the APA mandated profit levels for the Importer/Buyer and, presumably, have made the determination that the seller is earning an overall profit that will allow it to cover its costs, is another factor to show that the relationship between the parties did not affect the price. We also take note of how the parties set their prices permitting the Importer/Buyer’s operating profit to fall within the interquartile range established by a reference to unrelated comparable companies. Finally, we once again reference the usefulness of the industry report in our analysis of the circumstances surrounding the sale of the imported watches in this case. Accordingly, even though none of the information provided strictly falls under the three illustrative examples under 19 CFR §152.103(l)(1)(i)-(iii), we find that the sales price will not be considered influenced by the relationship for purposes of 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/Buyer and the related Seller organize their commercial relations and the way in which the price in question is arrived at. As a result, we determine that transaction value is the proper method of appraisement for the related-party import transactions. Is it acceptable to take post-importation price adjustments (upward and downward) into account in determining transaction value? As noted above, the Importer/Buyer’s APA utilizes the CPM. As a consequence of utilizing the CPM approach, the Importer/Buyer may be required to make retroactive price adjustments (downward and upward) to meet its federal income tax obligations and to show that its prices are arm’s length if the Importer/Buyer’s profit margins fall outside the interquartile range specified in the transfer pricing study. On May 30, 2012, CBP published a notice of HRL W548314 that revoked a prior valuation ruling concerning the treatment of post-import adjustments made pursuant to a methodology specified in the importer’s formal transfer pricing policies. This ruling became effective on July 30, 2012. See Customs Bulletin, Vol. 46, No. 23, dated May 30, 2012. In HRL W548314, CBP proposed a broader interpretation of what is permitted under transaction value to allow a transfer pricing policy/APA to be considered a “formula” in the transfer pricing context, provided certain criteria are met. HRL W548314 specifically referred to the adjustments made pursuant to a company’s formal transfer pricing policies or APAs. In order to claim the post-importation adjustments (upward and downward), all of the following factors must be met: A written transfer pricing policies in place prior to importation and the policy is prepared taking IRS code section 482 into account; The U.S. taxpayer uses its transfer pricing policy in filing its income tax return, and any adjustments resulting from the transfer pricing policy are reported or used by the taxpayer in filing its income tax return; The company’s transfer pricing policy specifies how the transfer price and any adjustments are determined with respect to all products covered by the transfer pricing policy for which the value is to be adjusted; The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the United States; and, No other conditions exist that may affect the acceptance of the transfer price by CBP. Therefore, if the Importer/Buyer meets the above referenced factors, CBP will accept the adjusted values, because the prices would be established pursuant to a “formula” prior to importation, even though the prices were not fixed at the time of importation. In this case, the Importer/Buyer has a bilateral APA in place prior to importation and prepared in accordance with section 482 of the IRS code, confirming the operating margins, which were verified by other substantiating information. According to the terms of the APA, if the results of the Importer/Buyer’s actual transactions produce an operating margin within the arm’s length range, then the amounts reported on the company’s U.S. tax return must clearly reflect it. For any APA year, if the operating margin is outside the arm’s length range, then the company’s tax return must clearly reflect any adjustments to bring the Importer/Buyer’s operating margin to the nearest edge of the arm’s length range. Therefore, the Importer/Buyer is obligated to use its APA in filing its income tax return and report any adjustments to the IRS. The APA covers all of the imported goods and specifies the adjustments to be made. Under the CPM methodology, adjustments will be made annually if needed to bring profits into the appropriate range, so that the final values of the imported merchandise declared to CBP will be at arm’s length. Any post-importation price adjustments will be made at a brand level. Allocations of the adjustments will be applied proportionally across all products of that brand, imported for the period of the adjustments, so that the brand’s operating margin would conform to the adjusted overall operating margin of the Importer/Buyer’s U.S. distribution. The company will book its adjustments as Cost of Goods Sold (“COGS”) affecting the value of the imported products. Since these adjustments are adjustments to the profit and booked as COGS, the adjustments directly relate to the value of the merchandise. Also, pursuant to our review of the provided documentation, there are no other conditions that may affect the acceptance of the transfer price by CBP. As long as the Importer/Buyer maintains and provides accounting details from its books and/or financial statements to support the post-importation adjustments upon making a claim with CBP, the Importer/Buyer may claim downward and upward post-importation adjustments. Moreover, in W548314, dated May 16, 2012, we determined that the Importer in that case needed to show that the relationship of the parties did not influence the adjusted prices. In this case, even though we decline to rely solely on the Importer/Buyer’s APA in order to determine that the circumstances of the sale test is met, we note that this APA further confirms that the prices are already at arm’s length since the Importer/Buyer’s profit falls within the interquartile range, specified in the APA. Thus, were the Importer/Buyer to fall outside of the range of the acceptable operating profit margins (making the provisionally declared prices influenced by the relationship) and were the Importer/Buyer required to make adjustments to get within the range, transaction value would still be an appropriate method of appraisement because the Importer/Buyer already established that it meets the circumstances of the sale test based on our analysis in this ruling. In that instance, prices would need to be adjusted accordingly for the price to remain at arm’s length for customs valuation purposes. Finally, the Importer/Buyer states that it will flag for reconciliation the price declared at entry as provisional due to the potential of price adjustments. Thus, price adjustments, if any, should continue to be timely made through the reconciliation process. HOLDING: Based on the information presented, we find that transaction value is the appropriate method of appraisement in this case. We find that the Importer/Buyer may take into account downward and upward post-importation adjustments, to the extent necessary, to the provisional values of the imported merchandise declared to CBP, provided that the Importer/Buyer maintains and provides upon request accounting details from its books and/or financial statements to support the claimed adjustments. Please note that 19 CFR §177.9(b)(1) provides that “[e]ach ruling letter is issued on the assumption that all of the information furnished in connection with the ruling request and incorporated in the ruling letter, either directly, by reference, or by implication, is accurate and complete in every material respect. The application of a ruling letter by a Customs Service field office to the transaction to which it is purported to relate is subject to the verification of the facts incorporated in the ruling letter, a comparison of the transaction described therein to the actual transaction, and the satisfaction of any conditions on which the ruling was based.”    Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns. Sincerely, Monika R. Brenner, Chief Valuation & Special Programs Branch