CBP Revises Longstanding Policy of Disallowing Transfer Price
Adjustments under Transaction Value for Related Party Transactions

August 16, 2012

In a Customs Bulletin and Decision dated May 30, 2012 (Cust. Bul. and Dec., vol. 23, no. 46), CBP announced to the trade community that it was revoking a long standing position that post-import transfer price adjustments pursuant to a related party transfer price agreement invalidated the use of transaction value as the basis of appraisement.

While the new ruling (HQ W548314) provides that post-import transfer price adjustments pursuant to a related party transfer price agreement may no longer invalidate the use of transaction value as the basis of appraisement, it does so under limited circumstances. Before discussing these conditions, we need to understand the background surrounding the use of transfer price as an acceptable transaction value for the basis of the appraisement of goods in related party transactions.

I. Transaction Value - Tests for Determining the Acceptability of Transaction Value for Related Party Transactions

Merchandise imported into the United States is appraised for customs purposes in accordance with 19 U.S.C. §1401a (the “value law”). The regulations concerning customs value are contained in Part 152 of the CBP Regulations (19 CFR Part 152).

The primary method of appraisement of imported merchandise 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). If there is no transaction value, then other valuation methods (such as transaction value of identical or similar goods, deductive value, computed value, and the derived, or fallback method) will be applied, in sequence, to arrive at the correct method of appraisement.

If the buyer and seller are related, as defined in 19 U.S.C. §1401a(g), then before it can be concluded that transaction value applies, it must first be determined whether the relationship between the parties has affected the price for the imported merchandise. See 19 U.S.C. §1401a(b)(2)(A)(iv). The term “price actually paid or payable” means the total payment made, or to be made, for imported merchandise by the buyer to, or for the benefit of, the seller (exclusive of costs, charges, or expenses incurred for transportation, insurance, and related services incident to the international shipment of the merchandise from the country of exportation to the place of importation in the U.S.). 

In determining transaction value, the price actually paid or payable is determined without regard to its method of calculation. It may be the result of discounts, increases, or negotiations, or it may be arrived at by the application of a formula. However, a decrease or a rebate in the price after the date of importation is to be disregarded for the purposes of determining transaction value. 19 U.S.C. § 1401a(b)(4)(B). 

While the fact that the buyer and seller are related is not sufficient by itself for treating the transaction value as unacceptable, if CBP has doubts about the acceptability of the price, the importer will be advised and given the opportunity to provide further information to support the use of transaction value. 

Under the value law, transaction value between a related buyer and seller is acceptable if the importation meets either of two tests: 1) test values or 2) circumstances of sale. 19 U.S.C. § 1401a(b)(2)(B).

A. Use of Test Values

The term "test values" refers to values previously determined pursuant to actual appraisements of imported merchandise. For example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of merchandise. Headquarters Ruling Letter ("HRL") 543568, dated May 30, 1986. If there are no previously accepted test values, the “circumstances of sale” method must be used to determine the acceptability of transaction value.

B. The Circumstances of Sale Method

The circumstances of sale method requires an examination of the how related parties conduct business to determine whether their relationship affects the sale. The Statement of Administrative Action (H.R. Doc. No. 103-316, 103rd Cong., 2d Sess. (19_4))("SAA"), and the Customs Regulations (19 C.F.R. 152.103(j)(2) provides three examples of how the circumstances of sale test may be satisfied. The first two are when: 

1. The pricing between the related parties is consistent with normal industry pricing practice; or
2. The pricing between the related parties is consistent with the way the seller deals with unrelated buyers.

The SAA also provides that the circumstances of sale test may be satisfied if the related party price is adequate to ensure recovery of all costs plus a profit that is equivalent to the parent company’s overall profit realized over a representative period of time in sales of merchandise of the same class or kind. 

Under the circumstances of sale test, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between the buyer and the seller did not influence the price actually paid or payable.

II. The Effect of Transfer Pricing on the Circumstances of Sale Test: Is There an Objective Formula at the Time of Importation?

Related party transactions often involve initial transfer prices that may be subject to adjustment after importation. It is common for the transfer price to be determined in accordance with the company’s transfer pricing policy/formula. Often times such policies provide the method for determining the transfer price, which may include the setting of an initial price and then making various adjustments to the price after the importation based on specified criteria. For example, the transfer pricing policy may provide for the transfer price to be initially set based on certain estimated costs and for adjustments to be made at the end of the year based on the actual costs incurred.

Further, adjustments may be made to account for certain additional expenses that may be incurred by the parties. In some cases, the transfer pricing policy may provide for year-end “compensating adjustments” to the transfer price. In other words, adjustments are taken to bring the profit margins of the companies within the range of profit margins established on the basis of the company’s transfer pricing policy/formula in order for the transfer price to be at arm’s length for tax purposes.  Depending on the circumstances, such adjustments could similarly affect whether the price is considered fixed or determinable by an objective formula at the time of importation.

A. Basis for Rejecting Transfer Prices

In a number of administrative rulings, CBP has determined that where the price is not fixed at the time of importation, transaction value is not applicable. CBP has also previously said that if a transfer price is subject to post-importation adjustments and those adjustments are within the control of either the buyer or the seller, the formula exception to the fixed price rule would not apply.

In the case of transfer prices, CBP has said that the events in the transfer pricing formula that trigger post-importation price adjustments (for example, the costs incurred or the profit earned) are to an extent within the control of the buyer and/or the seller. Accordingly, based on prior decisions, CBP concluded that many transfer pricing policies would not qualify as formulas within the meaning of 19 CFR §152.103(a)(1). In those cases, transaction value determined under 19 U.S.C. §1401a(b) could not be applied, even if the relationship between the parties did not affect the price.

As noted above, when transaction value cannot be applied, the merchandise must be appraised using one of the other valuation methods in 19 U.S.C. §1401a. In those cases, CBP has determined that when transaction value could not be applied because the transfer price was not “fixed,” the merchandise should be appraised using a modified transaction value under the derived or fallback method. However, under the value law, the fallback method may only be used when all previous valuation methods cannot be applied. Thus, before the importer may use a modified transaction value under the derived method, it must demonstrate that all other valuation methods, such as computed or deductive value, cannot be applied.

While importers have often asserted and CBP has accepted the claims of importers that other valuation methods (such as computed or deductive value) cannot be applied to determine the value of imported merchandise, CBP’s Regulatory Audit Division frequently challenges this assertion and has required importers to substantiate this claim or required them to implement costly and time-consuming computed or deductive value programs. These programs require importers to engage in a sort of dual valuation program - one valuation program for their tax-based commercial transactions and a separate valuation program for reporting the value of imported merchandise to CBP.

B. CBP Reconsiders Its View on Post-Import Transfer Price Adjustments

In its new ruling (HQ W548314, May 16, 2012) CBP said that it reconsidered its prior position and has now determined that the methodology for determining the transfer price can constitute an objective formula for purposes of applying transaction value and claiming post-importation adjustments. While its previous position on post-importation adjustments was consistent with its interpretation at the time, CBP now concludes that, notwithstanding the fact that there may be some element of control of the adjustments by the parties, additional considerations should be taken into account in evaluating whether an intercompany transfer pricing formula is an objective formula when it provides for post-importation adjustments to the price.

As a result of this change of position, transfer price adjustments, whether upward or downward, can to be taken into account in determining whether transaction value applies provided certain specified conditions are met.

When analyzing whether transaction value may be used between related parties where there may be post-importation adjustments, it is CBP’s view that certain factors should be examined to determine whether there is a fixed price pursuant to a formula. In HQ W548314, CBP identified a revised list of factors to be applied to determine whether an objective formula is in place prior to importation for purposes of determining the price within the meaning of 19 CFR §152.103(a)(1). These factors are:

1. There must be a written “Intercompany Transfer Pricing Determination Policy” in place prior to importation, and that policy must be prepared taking IRS code section 482 into account;
2. 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;
3. 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;
4. The company maintains and provides accounting details from its books and/or financial statements to support the claimed adjustments in the U.S.; and,
5. No other conditions exist that may affect the acceptance of the transfer price by CBP.
   

To the extent that a company’s transfer pricing policy is not prepared in recognition of IRS rules, CBP has said that the policy could be viewed as within the control of the parties, and, therefore, would not constitute a formula within the meaning of 19 CFR §152.103(a)(1).

III. Satisfying the Circumstances of Sale Test

The post-importation analysis has two requirements:

1. Is there a formula within the meaning of 19 CFR §152.103(a)(1) that is analyzed using the factors so that properly documented adjustments may be claimed if they occur; and
2. Do the parties satisfy the requirement under 19 U.S.C. §1401a to show that the relationship did not influence the price.

The five factors listed by CBP address the payable aspect of the price actually paid or payable in transaction value and whether potential post-importation adjustments, particularly downward adjustments, may now be accepted. If an import transaction involves post-importation adjustments and an importer seeks to claim downward adjustments (upward adjustments always require reporting), then its transfer pricing policy must constitute a formula within the meaning of 19 CFR §152.103(a)(1).

Importers are cautioned, however, that this rule does not mean that a related party transfer price that is subject to post-importation adjustment will automatically be accepted by CBP as a viable transaction value. In order to use transaction value, there must be a bona fide sale for exportation to the U.S. Further, the price between a related buyer and seller is acceptable only if the transaction satisfies the circumstances of the sale test. According to CBP, the fact that the fixed price requirement has been satisfied based on the acceptance of the importer’s transfer pricing policy, prepared for tax purposes, as a formula, does not by itself mean that the circumstances of the sale test is satisfied. The importer must still show that the relationship has not influenced the price.

In HQ W548314, the importer provided CBP with information regarding the circumstances of the sale. Detailed information had been provided by the importer regarding the seller’s sale price data for the imported products. The importer submitted detailed charts including data pertaining to the seller’s global sales of the imported products. CBP said that an examination of the data revealed that the price for a particular product can vary throughout the year even to the same customer. Based on the importer’s explanation of the differences in prices between related and unrelated parties and detailed documentation submitted, CBP found that the related party prices are settled in a manner consistent with the way the seller settles prices in sales to unrelated buyers. CBP further concluded that the importer presented an adequate explanation as to why the sales documentation was relevant to the transactions at issue and accounted for the differences in unit prices.

In short, CBP will continue to examine the manner in which the buyer and seller organize their commercial relations and the way in which the sales price was derived to determine whether the relationship influenced the price.

Showing 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 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). CBP notes that these are examples to illustrate that the relationship has not influenced the price and that other factors may be relevant as well.

Additionally, importers that want to apply the transaction value method are strongly encouraged by CBP to use Reconciliation to report the adjustments and to determine the transaction value. (CBP’s Reconciliation procedure allows an importer, using reasonable care, to file entry summaries with CBP with the best available information with the mutual understanding that certain elements, such as the declared value, will remain outstanding. At a later date, when the specifics have been determined, the importer files a Reconciliation entry which provides the final and correct information.)

If you have any questions about these or other customs issues, please contact George Tuttle, III at (415) 986-8780 or via email at george.tuttle.iii@tuttlelaw.com.

George R. Tuttle, III is an attorney with the Law Offices of George R. Tuttle in San Francisco.

The information in this article is general in nature, and is not intended to constitute legal advice or to create an attorney-client relationship with respect to any event or occurrence, and may not be considered as such.

Copyright © 2012 by Tuttle Law Offices. 

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