On September 23, 2011, U.S. Customs and Border Protection (CBP) posted to its website a request for advance public comments about a proposed revocation of CBP’s ruling HQ 547654 (Nov. 8, 2001). The proposal that CBP is considering would allow the importer that is the subject of the ruling to use transaction value in related party transactions that CBP currently views as having no transaction value. More importantly, it would broaden the definition of what is an objective transfer pricing “formula,” thereby allowing more importers to include post-importation downward price adjustments in their transaction value calculations. For importers of merchandise subject to ad valorem duty, these adjustments could result in significant duty savings.
This advisory summarizes the facts and legal analysis in HQ 547654, and then describes CBP’s proposal, its key implications and three noteworthy limitations. Companies may want to review how the proposed changes could affect their import transactions and consider participating in CBP’s comment period. The comment deadline is October 23, 2011.
Summary of HQ 547654
Two noteworthy features of the customs value law played a key role in the ruling that CBP is considering revoking — restrictions on the use of transaction value between related parties1 and the disregard for postimportation price reductions.2 In HQ 547654, the related seller and importer followed a written policy that specified that the transaction value should be the anticipated U.S. resale price, less international freight, duty, U.S. fixed costs and the importer’s profit. The importer explained to CBP that the policy required frequent price adjustments to ensure that profits remained consistent with the policy. As an alternative, the importer asked CBP whether it could file quarterly reconciliation entries to deduct the importer’s U.S. fixed costs from declared values, once all costs were known. The importer suggested that deductions would be based on the ratio of fixed costs to sales for any group of products.
CBP simply assumed the acceptability of transaction value and ruled on the reconciliation/post-importation price adjustment, but CBP rejected the importer’s proposal, stating: “No formula for the proposed adjustments is provided for in the Policy or in your description of the pricing structure. We have consistently held that where the price is not fixed at the time of importation or determinable by an objective formula agreed to prior to importation, transaction value is not applicable.” CBP objected primarily to the buyer and seller’s control over certain factors used to adjust the price after importation.
Proposed Changes to Treatment of Post-Importation Adjustments
Ten years later, CBP is notifying importers that it is “re-examining its approach to the applicability of transaction value in the context of post-importation adjustments.” CBP’s Notice is available at http://www.cbp.gov/xp/cgov/trade/trade_outreach/public_comment.xml. CBP now believes that, even though certain elements of the price are within the control of the related buyer and seller, transaction value might be appropriate in cases like HQ 547654. In particular, CBP now appears willing to accept that a “policy” like this importer’s, which determines prices after importation, could “be considered an objective formula” as long as the policy was established and followed prior to importation.
In its website notice, CBP indicates that the importer has requested reconsideration of HQ 547654 and has provided additional information. The importer provided an inter-company memorandum that distinguishes between fixed and variable costs, confirms that variable costs are set and allocated to individual entries prior to importation, and explains that fixed costs are also set prior to importation and are only allocated after the fact. The importer also provided a joint study by the buyer and seller’s finance departments to show how the profit margin is set based on comparable sales in uncontrolled markets and how studies are frequently updated.
CBP is therefore considering changes to its prior ruling, so that the importer may use transaction value, and so that post-importation adjustments could be used to decrease the transaction value. In CBP’s view, the adjustments are not the type of rebates or price decreases that should be disregarded. Instead, the “adjustments represent an element of the determination of the prices actually paid or payable.” While CBP would permit the use of transaction value and allow post-importation adjustments that decrease transaction value, CBP would require the importer to file reconciliation entries to provide information necessary for final appraisement.
Implications for Importers
The most important result of CBP’s proposal would be a more flexible definition of a “formula” for determining transaction value. HQ 547654 confirms that CBP’s current position is that a policy that leaves any cost or element of value within the control of the buyer and seller after importation is not a sufficiently definite formula to permit the use of transaction value. CBP’s notice, in contrast, would consider a policy that leaves “certain costs” under the parties’ control to be a sufficiently objective formula for transaction value purposes, “if the transfer pricing policy is set before importation and is used by the parties.”
This broader view of a formula could allow more importers to agree upon transfer pricing policies with their related sellers, to use the policies to determine transaction values and to adjust those values after importation, and to reduce duty liability when post-importation adjustments decrease prices.
Another possible effect of CBP’s proposal would be to provide additional guidance about when this use of transaction value is acceptable. At least with respect to related party transactions that lead to post-importation price adjustments, the proposal defines the type of materials importers should submit to CBP (including the inter-company memorandum and the pricing studies described above) for consideration of a transaction value request. The proposal also outlines eight circumstances that were present in the particular case in CBP’s ruling and that might now lead CBP to find that transaction value is appropriate despite the post-importation price adjustments. These eight factors were:
- the importer presented a written “Intercompany Transfer Pricing Determination Policy,” which sets out how the transfer price is to be determined prior to the importation;
- the importer/buyer is the U.S. taxpayer, and it uses its transfer pricing methodology in filing its corporate income tax returns and in determining the transfer price for the products covered by the transfer pricing policy;
- the company’s transfer pricing policy specifically covers the products for which the value is to be adjusted;
- the policy specifies what adjustments must be made to the transfer price, and how those adjustments are to be determined;
- the adjustments, although to a certain extent within the “control” of the parties, do not result in value manipulation;
- if adjustments are made, the company provides detailed explanations and calculations of the adjustments incurred in the United States and claimed after the importation;
- the relevant transfer pricing policy, pursuant to which adjustments are claimed, is in effect prior to the importation; and
- there is an absence of other circumstances that may indicate that the compensating adjustments do not result in an arm’s length price between the parties.
Importers would be able to look to these factors for guidance about whether their own post-importation adjustments would be a bar to the use of transaction value.
CBP’s apparent willingness to permit the use of transaction value where a policy dictates post-importation price adjustments could also have implications for importers whose transfer prices are governed by Advance Pricing Agreements (APAs) or formal transfer pricing studies. In its notice, CBP notes that APAs often require “year-end ‘compensating adjustments.’” These adjustments would ensure that profits or other metrics were consistent with the provisions of the APA. Similarly, CBP notes that formal transfer pricing studies could provide for post-importation adjustments. CBP’s proposal suggests that where a formal, written transfer pricing methodology is established prior to importation and followed by the parties, whether in a policy, an APA or a transfer pricing study, CBP would apply the same reasoning to post-importation adjustments.
Limitations of CBP’s Proposal
Importers should, however, recognize at least three limitations to the applicability of CBP’s proposal. First, demonstrating the acceptability of transaction value between related parties, even without adjustment, traditionally has been difficult. CBP’s proposal would not change this; it would not expand the circumstances in which CBP would find that the relationship between a buyer and seller did not influence the price. In HQ 547654, CBP expressly stated that the ruling was “based on the assumption that the . . . proposed structure yields a price that meets one of the related party tests.” CBP’s new notice states that the importer “may use the transaction value method of appraisement.” The eight factors enumerated in CBP’s notice, however, focus solely on how the post-importation adjustments might affect the acceptability of the transaction value. CBP then reminds importers that, in addition to these factors, companies would still need to “be prepared to show that transaction value is acceptable under one of the two tests: (1) circumstances of the sale, or (2) test values.”3
Second, under CBP’s proposal, “it is contemplated” that importers will be required to use CBP’s formal ACS Reconciliation Prototype (“Reconciliation”) to account for these types of post-importation upward or downward adjustments, and Reconciliation adds costs to the import process. Under Reconciliation, an importer must file an entry at the time of importation, and then file a Reconciliation entry within 21 months from the date of the entry summary (or 12 months, in the case of entries involving NAFTA claims). Reconciliation also requires an importer to maintain records documenting its value adjustments, and importers are subject to reasonable care and informed compliance requirements for the original and Reconciliation entries. If CBP’s notice is indicative of a view that CBP could mandate the use of Reconciliation, thus denying importers the right to adjust values declared through Post Entry Amendments or protests, the proposal could create an unwelcome burden for importers that have traditionally been satisfied to disregard downward adjustments, either because the adjustments are very minor or because the imported merchandise is free of duty.
Third, importers would benefit from CBP’s broader interpretation of a transfer pricing formula only if CBP takes several more steps. CBP’s notice merely describes a possible proposal; it does not include the proposed ruling that would modify HQ 547654. This rare “advance” comment request shows CBP is giving this question appropriate consideration, but it also extends the timeline for completing a revocation. If, after expiration of the advance comment period and review of comments received, CBP decides to proceed with revocation, CBP must still publish the text of a proposed ruling in the Customs Bulletin and provide an additional 30 days for comment, pursuant to 19 U.S.C. § 1625(c). Only thereafter could CBP finalize a new ruling.
In summary, CBP’s proposal could offer many importers opportunities for duty savings by allowing downward adjustments of transaction values after importation. The more flexible interpretation of a transfer pricing formula that would allow these adjustments could be especially significant for importers adhering to an internal transfer pricing policy, but it could also have implications for importers whose transactions and adjustments are dictated by APAs or formal transfer pricing studies. The proposed ruling could also provide useful guidance about the circumstances in which CBP would accept such adjustments. Nonetheless, the proposal has limitations. The proposal — which is still several steps from becoming a binding revocation — would be useful only for related parties if they could otherwise demonstrate that their relationship did not influence their transfer prices, and if they were prepared to participate in Reconciliation.
As noted above, CBP will accept comments on its proposal until October 23.