Request for internal advice; transfer price; related parties; transaction value; arm’s length

HQ W547231 December 16, 2001 RR:IT:VA 547231 KDW CATEGORY: VALUATION Port Director U.S. Customs Service 111 West Huron Street Buffalo, NY 14202 RE: Request for internal advice; transfer price; related parties; transaction value; arm’s length Dear Port Director: This is in response to your request for Internal Advice, dated April 2, 1998, referred by the National Commodity Specialist Division regarding the validity of the transfer pricing method, used by [General Electric Lighting] ([GE]) in transactions with the related seller, [General Electric] Canada ([GE]C), for determining transaction value. In addition, we have reviewed your request for confidentiality pursuant to section 177.2(b)(7) of the Customs Regulations chapter 19, with respect to certain information submitted. Accordingly, that information has been bracketed and will be deleted from any published versions. In making our determination, we considered your request and subsequent submissions made by Counsel for [GE] on September 19, 2001, and October 15, 2001, as well as our meeting with counsel and representatives from [GE] on September 19, 2001. We regret the delay in responding. FACTS: [GEJ imports finished lamps (light bulbs) into the United States. [GE] purchases the lamps from [GE]C, a related company, and from other unrelated manufacturers. In addition, [GE] manufactures some lamps in the United States. The lamps purchased by [GEI from unrelated manufacturers are generally not identical to those purchased from [GE]C. All of the lamps imported or manufactured by [GE] are ultimately sold to unrelated customers in the United States. [GEI asks Customs to accept its transfer price as viable transaction value for merchandise imported from [GE]C. [GEI states that its transfer pricing policy is designed so that [GE] will earn the same profit margin on sales of lamps sourced from [GEIC as it earns on sales of lamps sourced from unrelated manufacturers. Since the lamps from the unrelated manufacturers are not identical to those sourced from [GE]C, [GE] states that prices cannot be determined by reference to those transactions. Instead [GEI uses a resale price or "market back" approach for arriving at the value it reports to customs. Based on the transfer pricing policy, it appears that the price is derived by first dividing the lamps into five categories and then identifying a separate gross margin for each lamp category. The category margins are based on the previous year's margins earned by [GEJ for sales of lamps purchased from the unrelated manufactures. [GEI states that it subtracts these gross margins from its resale prices for merchandise imported from [GEJC. In addition, [GEI shows in its example that it subtracts the duty and distribution costs to arrive at the projected profit percentage and calculate the transfer price. Under its circumstances of sale analysis, [GE] states that it uses its experience in purchases from unrelated suppliers to its related suppliers, insuring those prices are established by market forces and not influenced by the relationship. [GE] states that this approach is acceptable to the Internal Revenue Service and thus should be "evidence that the use of this method is a circumstance of sale which indicates that the price was not influenced by the relationship." We note that no information was submitted in support of this statement. Second, [GEJ states that its transfer price covers all costs plus a profit equivalent to that realized on its sales to unrelated parties. Finally, [GEJ explains that test values are unavailable since [GE]C does not sell to unrelated parties in the United States and it is unaware of sales by any Canadian competitor to the United States. You find that [GE]'s transfer price does not meet either of Customs' methods for determining whether the relationship affected the price and thus, transaction value is inappropriate. You state that [GEI dictates to [GE]C as to what price to sell their product, and undoubtedly has control over the price. Further, you indicate that [GE] cannot have a transfer price without a fixed formula, and that the formula cannot change every time the market changes. However, you state that even if [GEJ has a formula price, the transfer price is unacceptable because [GE] has control over the price, which indicates that the relationship influences the price. It is our understanding, based on statements of counsel at our meeting on September 19, 2001, that the method used in calculating the profit level is solely for projecting a profit range for the next year's prices. We assume therefor, for purposes of this ruling that the prices from [GE]C to [GE] are fixed at the time of exportation. It is also our understanding that no adjustments to the price after importation of the merchandise are scheduled or anticipated. Next, in analyzing the transactions under the "circumstances of sale" approach, you note that [GE]'s approach is somewhat contradictory in that it attempts to compare its transactions with [GEIC to those with third parties, while at the same time denying that any comparable transactions exist. In addition, you find that [GE]'s transfer price does not include all costs plus a profit, as claimed. You point out that [GE]'s profit is that of its subsidiary [GE]C, and that if all costs had been recovered, the overall profit should be that of the parent, referring to Headquarters' Ruling (HRL) number 543144 dated December 2, 1983. You do not agree with [GE]'s assertion that the resale price should be multiplied by the gross margin, but rather you state that the gross operating margin is the applicable figure as shown in the 1996 Operating Results submitted by [GE]. Also, you do not agree that the contribution margin is the gross margin as stated. Further, you do not believe that [GE]'s request conforms to the company's own policy for calculating their transfer price. Instead, you suggest that the gross margin is a profit ratio or operating margin as stated in [GE]'s financial data. You calculated a transfer price using [GE]'s rationale, and substituting the gross margin for comparison. You found that different transfer prices exist for the same product code on several invoices in the same month and year. In reviewing the "Sales of Component Parts By North American Production Division" policy, you note that [GE]'s transfer price omitted all fixed costs, and thus, fails to include all costs plus a profit. Also, you conclude that if all costs had been included, the overall profit should relate to the overall profit of the parent, not the subsidiary. Your analysis of [GEI Lighting's General Policy Statement on transfer pricing indicates that the calculations use the profit margin of [GE]C, the seller, not [GE], the buyer, and a resale price established by [GEI from a resale in the United States. Where we have found inconsistencies in the submitted descriptions with regard to the company's pricing methodology, we relied on the written policy as bearing out the price structure. We note that counsel and [GE]'s representatives during the meeting with Customs confirmed that the method used by the company is that which is described in the corporate policy. Without [GE]'s financial data, you were unable to determine a transfer price. You suggest that appraisement is proper under Section 4020 derived from methods set forth in Section 402(e), under the circumstances and based upon the facts presented. The National Import Specialist (NIS) reviewed this internal advice, and agreed with you that the evidence submitted fails to demonstrate that the prices paid by [GEJ to [GEIC are acceptable for establishing transaction value. The NIS states that apparently, no previously accepted values could serve as test values, and that no evidence was presented to show that the prices were determined consistent with industry practice or with the way the seller deals with unrelated buyers. Finally, the NIS concludes that the subject lamps should be appraised under the computed value method provided for in Section 402(e). ISSUE: Is [GE]'s transfer price acceptable for purposes of transaction value? If not, what is the appropriate method of appraisement for subject lamps? 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 (19 U.S.C. 1401a; TAA). The preferred method of appraisement of imported merchandise for customs purposes is transaction value. Transaction value is the price actually paid or payable for the merchandise when sold for export to the United States, plus certain enumerated additions. 19 U.S.C. 1401a(b)(1). When examining a related party transaction for purposes of transaction value, the first inquiry is whether the relationship has influenced the price. Pursuant to section 402(b)(2)(A)(iv), the transaction value of imported merchandise shall be acceptable only if the buyer and the seller are not related, or if the buyer and the seller are related, the transaction value is acceptable under section 402(b)(2)(B). That section provides that transaction value between a related buyer and seller is acceptable if the buyer demonstrates that the declared transaction value meets one of two tests: circumstances of the sale and test values. No evidence was submitted in support of the latter test, Test Values, therefore, our analysis of [GEI's transfer price is limited to whether the circumstances of the sale indicate that the price was not influenced by the relationship to the seller. If the circumstances of sale indicate that although the parties are related, they buy and sell from one another as if they were unrelated, transaction value will be considered to be acceptable. Statement of Administrative Action (SAA), reprinted in Customs Valuation under the Trade Agreements Act of 1979, Department of the Treasury, U.S. Customs Service (October 1981) at 54; 19 CFR 152.1030)(2), discusses the factors considered in making this determination. To make this determination, Customs will examine the manner in which the buyer and seller organize their commercial relations and the way in which the prices in question were derived. If the importer can show 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 deals with unrelated parties, Customs will find that the price has not been influenced by the relationship. Or, if the importer can show that the price is adequate to ensure recovery of all costs plus a profit equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind, this would demonstrate that the price has not been influenced. See HRL546449 dated Jan. 6, 1998 and 19 CFR 152.103(l)(1)(iii). Based on its submission, it appears that [GEJ claims that its transfer price is acceptable for transaction value purposes because it believes that the price is adequate to ensure recovery of all costs plus a profit. [GE] states that the profit from the sales of lamps to [GEI in the United States is greater than the overall profit of [GE]C. [GEI claims that this proves the transfer prices include all costs plus an acceptable profit. You claim, however, that this is not proof that the transfer price is acceptable for transaction value, because if all costs had been recovered the overall profit should be that of the parent company. We agree that the firm's profit refers to the profitability of the company as a whole with regard to goods of the same class or kind rather than that of the subsidiary seller. In HRL 543144 dated December 2, 1983, we examined a similar situation where the subsidiary of the buyer acted as the seller. We stated that "in the context of a parent-subsidiary relationship, where the subsidiary is the seller, the reference in the regulations and Statement of Administrative Action to the firm's overall profit must relate to the overall profit of the parent, not the subsidiary." Our reasoning was that the parent could adjust the profit of the subsidiary as it pleases. To accept only the subsidiary's overall profit as proof of an arm's length transaction would thwart the clear of intent of the statute. Customs considers the profit of the company as a whole, or the "firm's profit", and examines the profit margin for goods of the same class or kind. [GEI is the parent in this case, therefore, if the transfer price is to be considered acceptable for transaction value, the profit margin included in the price must relate to [GE]'s overall profit margin for goods of the same class or kind. [GEJ submitted [GE]C's Summary of Operations for the fiscal and calendar year 1996 and [GEIC's statement for the same year regarding the sales and operating margin (profit) of products exported to the United States by lamp type category and the overall Canadian sales and operating results. [GEI also submitted an update of its operating results for Canada and U.S. and North America for the year 2000. In addition, [GEI submitted a copy of its corporate Transfer Pricing Policy effective January 1, 1994, for Sales of Finished Lamps Among [GE] Lighting Affiliates. As we noted above, we have relied on the corporate transfer pricing policy in analyzing the company's price structure. The methodology attempts to achieve an arm's length price by gathering the costs to the seller and calculating a profit margin by working backwards from the resale of goods purchased from an unrelated party by [GE]. On its face, the methodology may yield an arm's length price if the calculated price includes all costs plus a profit equivalent to the [GE]'s overall profit realized over a representative period of time in sales of merchandise of the same class or kind. Upon review of the financial documents submitted, we are unable to tell what the exact calculations are or were, because the documentation is incomplete for both 1996 and 2000. Specifically, we have profit and loss information and operating results for [GEIC in 1996, but no financial information for [GE]. For 2000, we have operating results for both [GE] and [GEIC, but no profit and loss information for either. We note and you point out that the profit calculation should include the deduction of both variable and fixed costs, in order to produce an acceptable margin. In addition to lacking sufficient profit information, we do not have any information as to costs for the products in question. Without a description of the costs, we are unable to determine whether all costs were included. As to the profit level, [GE] indicates that the method it uses to calculate its profit range is acceptable to the Internal Revenue Service. However, as we point out above, the company submitted no documents to support this claim. We have no information that the company is subject to an Advanced Pricing Agreement, or that the IRS has in any way reviewed the pricing for the company. Accordingly, this argument is unpersuasive. Nonetheless, we reiterate that even if the company had submitted proof of an APA with IRS, this alone would not indicate it had met Customs standard for meeting the circumstances of sale test. In order to demonstrate under the circumstances of sale test that the relationship does not affect the price using the costs plus profit measure, the importer must submit to Customs a description of how the price was calculated and contemporaneous documentation to support that calculation. Documentation may include: profit and loss statements, financial statements, income tax returns, a copy of the company's APA with IRS, costing sheets, invoices, purchase orders, shipping documents, profit projection statements, and sample calculations. Each document should be specifically related to the others by date and product. Finally, the description of the price calculation should include a specific explanation of how the profit is currently being calculated and identify all costs included in the price. In this case, although we find that the method as stated in [GE]'s written transfer pricing policy may be acceptable for calculating a price which includes all costs plus a profit as described above, the documentation submitted is insufficient to verify whether this method was actually used or the specific calculations used. Specifically, as discussed above, the documentation is not specifically related one item to the other, and no cost information was submitted. Accordingly, we cannot find that transaction value may serve as a basis of appraisement for the shipments in question. Thus, an alternative method of appraisement may be used. You suggest that appraisement is proper under Section 4020 derived from methods set forth in Section 402(e), under the circumstances and based upon the facts presented. However, the valuation statute sets forth a hierarchy for applying the various methods of appraisement that must be followed. In order to use the method you suggest you must first eliminate all other methods of appraisement preceding it. The first alternative basis of appraisement is the transaction value of identical or similar merchandise. Section 402(c) of the TAA provides that the transaction value of identical or similar merchandise is the transaction value, accepted as the appraised value under section 402(b), of merchandise identical or similar to the merchandise currently being appraised which was exported to the U.S. at or about the time that the merchandise currently being appraised was exported to the U.S. [GEI claims, and you do not dispute, that identical uncontrolled transactions do not exist. Further you advise that the lamps vary widely by style and technology, and [GEIC believes that it is the only manufacturer of the particular type of lighting imported by [GE]. Accordingly, transaction value of identical or similar merchandise may not be applicable. The next basis of appraisement is deductive value. Under the deductive value method, merchandise is appraised on the basis of the price at which it is sold in the U.S. in the condition as imported, and in the greatest aggregate quantity. 19 U.S.C. § 1401a (d)(2)(A)(i)(ii). The sale in the U.S. must occur either at or about the time of importation, or before the close of the ninetieth day after the date of importation. This price is also subject to certain enumerated deductions. 19 U.S.C. § 1401a (d)(3). In this case, the merchandise under consideration is "finished" lamps. As such, we presume that the lamps are resold in the United States in the condition as imported. Therefore, the merchandise may be appraised using deductive value. The company should provide sufficient information to you to support the deductive value of its merchandise. HOLDING: Based on the documentation provided, transaction value is not an acceptable method of appraisement for the shipments from [GE]C to [GE]. Although the method described by [GE]'s written transfer pricing policy may be acceptable for establishing an arm's length transaction, which meets the circumstances of sale test, the documentation does not support that the calculations are acceptable for purposes of transaction value. Accordingly, it may be appropriate, based on the facts provided, to appraise the subject merchandise using the deductive value method. This decision should be mailed by your office to the party requesting internal advice no later than sixty days from the date of this letter. On that date the Office of Regulations & Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act, and other public access channels. Sincerely, Virginia L. Brown Chief, Value Branch