In last month’s article, we looked at how an importer might use a Transfer Pricing Study or an Advanced Pricing Agreement (APA) to validate the customs value for imports from related parties under the Transaction Value method. Transaction value is defined as the “price actually paid or payable” for the imported merchandise, and it is the preferred method of valuation, unless precluded. The problem, of course, is that many transfer pricing agreements between related parties do not satisfy the strict requirements of Customs and Border Protection (CBP) for use in substantiating the declared value as an acceptable transaction value. As noted, CBP looks to see whether the companies used for the comparison are in the same industry as the foreign exporter (CBP says a comparison of competitors is the best measure) and whether they are selling the same class or kind of products. CBP will reject companies that are selected based solely on similarities of function and risk and not industry and products.
In this installment, we will examine what an importer can do to substantiate its transfer price as an acceptable transaction value if it does not have a transfer pricing study or if its transfer pricing study does not meet the requirements of CBP.
The “All-Costs-Plus-a-Profit” Method
The valuation statute and regulations provide that CBP may not disregard a transaction value solely because the buyer and seller are related. 19 C.F.R. § 152.103(l) interpretative note (iii) provides:
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.
This method examines whether the related party price compensates the seller for all its costs plus a specified amount of profit (i.e., a profit that is equivalent to the firm’s overall profit realized over a representative period of time in sales of merchandise of the same class or kind). According to CBP, this is the most objective method of meeting the circumstances-of-sale test when there are no sales to an unrelated buyer. This method does not rely on the existence of an APA or transfer pricing study to support the transfer price. It is concerned solely with whether the price includes all costs to manufacture the goods, plus an acceptable profit, with the amount of profit being equal to or greater than the firm’s overall profit for sales of merchandise of the same class or kind.
“Overall Profits of the Firm” Means the Profit of the Parent Company
In applying the “all-costs-plus-a-profit” test, CBP considers the “firm’s overall profit . . .” to be the profit of the parent company. 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.
Thus, the profits of the parent entity would be utilized for comparison with the profit on the intercompany sales by the foreign supplier to importer, but again, CBP will be focusing on the parent company's overall profit in sales of the “same class or kind” of merchandise.
The regulations do not give us the definition of "equivalent" profit; however, if the profit of the foreign 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 CBP's purposes. See HQ H065024, dated July 28, 2011; HQ H238990, dated April 7, 2014.
Evaluation of the “Same Class or Kind” of Merchandise
19 C.F.R. § 152.102(h) defines the merchandise of the same class or kind as merchandise, including, but not limited to, identical merchandise and similar merchandise, within a group or range of merchandise produced by a particular industry or industry sector. See 19 C.F.R. § 152.102(h). Merchandise of the same class or kind is broader than identical or similar merchandise. It is sufficient if the sale is of merchandise which is within a group or range of merchandise produced by a particular industry or industry sector. In HQ 545842, dated March 12, 1996, CBP said:
In this case, merchandise of the same class or kind as the uniforms at issue would not be limited to uniforms. We consider textile uniforms to be within the textile garment industry or industry sector. Thus, we may look to the sales of textile garments manufactured by other Honduran producers for comparison purposes in order to determine whether the manufacturer's “actual” profit and general expenses may be used.
The rulings make it clear that the profit comparison must relate to the profit realized in sales of merchandise of the same class or kind. See HQ 236154 of April 8, 2015. If the firm sells different classes of merchandise, the relevant profit is the profit that pertains only to sales of merchandise of the same class or kind. Thus, depending on the resale activities of the parent company, it may be necessary to look only at the profitability of the parent company within a particular business group or activity.
In HQ 236154 of April 8, 2015, CBP considered whether the U.S.-based parent sold merchandise that was within the same class or kind of merchandise as that sold to it by its Asian subsidiary, which manufactured and sold goods such as electronic throttle controls, pneumatic controls and electronic sensors. CBP noted that in addition to selling the identical or similar merchandise provided by its Asian subsidiary, the US parent also designed and manufactured its own line of adjustable foot pedals and arm rest controls. According to the information submitted, the US parent did not track profits on sales of individual types of goods but treated all of the goods it sold as a single class of goods for profit allocation purposes because they were sold to the same class of users. CBP said that while it was true that adjustable foot pedals, arm rests, and joysticks are not similar or identical to the imported electronic throttle controls, pneumatic controls and electronic sensors, it concluded that the items represented merchandise of the same class or kind, as defined in 19 CFR 152.102(h) because it was selling all of its products for specialty vehicles, such as heavy trucks, transit buses, off-road equipment and military applications. Thus, even though not identical or similar, all of the products were found to belong to the same industry sector.
In conclusion, an importer can substantiate its intercompany transfer price using the “all costs, plus a profit method,” provided the selling price includes all costs to manufacture the goods, plus an acceptable profit, with the amount of profit being equal to or greater than the firm’s overall profit for sales of merchandise of the same class or kind.
In supporting its intercompany price, the parties will need to be prepared to provide records and documents related to costs and profit, such as financial statements, accounting records including general ledger account activity, bills of materials, inventory records, labor and overhead records, relevant selling, general and administrative expense records, and other supporting business records, including how it makes adjustments for purchase price and production variance accounts, as well as its end of year cost true-ups.
If it is ultimately determined that transaction value does not apply, the importer will need to consider the application of one of the subsequent alternative methods of valuation, such as computed or deductive value.
If you have any questions about these or other customs matters, please contact George R. Tuttle, III at firstname.lastname@example.org or at (415) 986-8780.
George R. Tuttle, III, is an attorney with the Law Offices of George R. Tuttle in the San Francisco Bay Area.
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 © 2016 by Tuttle Law Offices.
All rights reserved. Information has been obtained from sources believed to be reliable. However, because of the possibility of human or mechanical error by our offices or by others, we do not guarantee the accuracy, adequacy, or completeness of any information and are not responsible for any errors, omissions, or for the results obtained from the use of such information.
Tuttle Law Offices
San Francisco Bay Area
1100 Larkspur Landing Circle, Ste 385
Larkspur, CA 94939