Supporting Transaction Value with Transfer Pricing Data: Lessons from Recent U.S. Customs and Border Protection Rulings

The single biggest challenge for companies in supporting customs valuation for related-party sales is demonstrating that the sales price was unaffected by the relationship, thus allowing the importer to use the transaction value method of appraisement. The customs rules and guidance in this area generally have been elusive, leaving business without a practical road map to guide them through this challenge.

Recent rulings from the U.S. Customs and Border Protection (CBP) Office of Regulations and Rulings provide welcome new direction in this area. The rulings give significant attention to data found in transfer pricing studies and indicate how to successfully present such data to satisfy the customs requirements, thus providing a better road map for business in managing this complex issue.

Transfer Pricing, Customs Rules

While the objective of both income tax transfer pricing rules and customs related-party valuation rules is the same—arriving at arm’s-length prices—the rules are different. As a result, documentation prepared to support income tax transfer pricing purposes is not generally, in and of itself, sufficient to support the customs analysis.

The vast majority of importers declare import values based on the transaction value method—the price paid or payable for merchandise. Ease of documentation and recordkeeping often are primary reasons that a business prefers using transaction value.

However, when importers purchase from related parties, special rules apply in order to use transaction value. Transaction value is an acceptable appraisement method between related parties if:

• an examination of the circumstances of the sale indicates that the relationship between the parties did not influence the price actually paid or payable; or
• the transaction value of the imported merchandise approximates certain test values.

Test values are not commonly used, and importers usually attempt to demonstrate the acceptability of transaction value under the “circumstances of sale” test.

Circumstances of Sale

The circumstances of sale test examines the relevant aspects of a transaction to determine that the relationship between the buyer and seller did not influence the price. The U.S. Customs regulations give three examples of how companies can demonstrate that the relationship did not influence the price. Under the first, a company shows that the price was settled in a manner consistent with the normal pricing practices of the industry in question. Under the second example, it shows that the price was settled in a manner consistent with the way the seller settles prices for sales to unrelated buyers, and under the third, the price is shown to be adequate to ensure recovery of all costs plus 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.

These examples are non-exclusive. However, because they are the only examples provided in the U.S. regulations and the only examples discussed in CBP’s April 2007 Informed Compliance Publication, Determining the Acceptability of Transaction Value for Related Party Transactions, they have tended to be the frame of reference. ¹Customs in the April 2007 guidance said an advance pricing agreement or a transfer pricing study by itself is not enough to support use of the transaction value method. See 16 Transfer Pricing Report 40, 5/16/07.

Unfortunately, none of these examples align directly with transfer pricing concepts, and importers have had limited success in their attempts to use transfer pricing data to support one of these examples. Moreover, CBP made clear in the 2007 Informed Compliance Publication that “an importer that relies solely on an APA or transfer pricing study to conclude that transaction value is acceptable would not be exercising reasonable care.” CBP went on to say that some aspects of a transfer pricing study may contain underlying facts relevant to a circumstances of sale analysis, but offered no guidance in how to analyze that data.

Recent Rulings

CBP recently issued three rulings in response to Internal Advice Requests (HQ W563467, HQ H029658, and HQ H037375) that address the support required to satisfy the circumstances of sale test. In the first ruling, the importer fails to provide sufficient support, but the second two importers meet the test.

Auto Sales: Transaction Value Not Allowed

The first ruling, HQ W563467, dated June 22, 2009, involves sales of automobiles from a foreign manufacturing subsidiary of a U.S. auto company to a U.S. importing distributing company. The U.S. importer requested refunds through the U.S. reconciliation program related to post-entry transfer pricing adjustments. CBP port officials objected to the importer’s use of transaction value, and CBP headquarters determined the importer failed to demonstrate that it met the circumstances of sale test.

While CBP acknowledged that the primary activity was in accord with the importer’s transfer pricing policy, CBP criticized the importer for not developing and submitting appropriate supporting documentation, stating that “if the importer believes that information in the transfer pricing study and/or in some other supporting documentation is relevant to the application of the [circumstances of sale] test, the importer should identify that information, explain why it is relevant, and submit the relevant documentation to CBP.”

Auto Sales: Transaction Value Allowed

HQ HO29658, issued Dec. 8, 2009, stands in sharp contrast. The ruling approves the use of transaction value on the importation of foreign automobiles and parts into the United States by a U.S. distributor of the foreign automaker. ²See 18 Transfer Pricing Report 946, 1/14/10; 18 Transfer Pricing Report 1041, 1/28/10. As would be expected, much of the discussion of the foreign automaker’s approach to pricing sounds similar to the approach discussed by the U.S. automaker in HQ W563467. In this case, however, the importer provided CBP with a significant amount of information explaining the circumstances of sale from a variety of perspectives. CBP did not find any factor determinative, but noted these factors as material to its conclusion:

• The importer provided a third-party report on pricing practices of the automotive industry, as well as descriptive evidence of its process for setting prices consistent with those described in the report.

• The importer provided a transfer pricing comparables study, with an explanation of how the accumulated data supported its position.

• The importer provided information on historic consistency of its profits as the purchaser and reseller of imported products.

• The importer had entered into a bilateral advance pricing agreement and provided CBP with access to all documentation provided to the IRS.

Health Care Products Ruling

Three days later, on Dec. 11, 2009, CBP issued perhaps its most useful guidance in the form of HQ HO37375. This ruling involved a variety of imported health care products entered under transaction value, and like those of the first ruling, the transactions were flagged for reconciliation. A transfer pricing study had been conducted using the resale price method, comparing the profits of the importer to other similarly situated companies. No APA was in place.

CBP concluded that the importer’s explanation of why its transfer pricing study should be viewed as meeting the circumstances of sale test was correct. Factors important to CBP’s determination included:

• The transfer pricing study, which analyzed companies that were in the same industry as the importer, including some competitors. The consistent gross margins on resale of imported products among these companies allowed CBP to conclude that the importer’s pricing was consistent with the market as a whole and in accordance with normal industry practice.

• Internal comparables provided by the importer in the form of gross margins earned on products manufactured by unrelated parties. Although the margins were not consistent, the importer was able to provide an explanation of the extra marketing and distribution costs undertaken with regard to products produced by related parties, allowing CBP to reach the conclusion that the margins as adjusted were comparable.

Conclusion

It is notable that in the latter two rulings CBP found different types of circumstances material to its conclusion. This is an encouraging sign for importers, who have often felt a lack of guidance limits their approaches to establishing transaction value. It is also clear that CBP expects both an explanation of the significance of particular circumstances of sale the importer believes relevant, and objective documentation supporting the explanation. With a supported explanation, two importers received a positive ruling; without it the importer failed to meet its burden of proof.

Bridging the gap between transfer pricing and customs valuation remains one of the most complex areas of customs law. While these rulings do not provide a definitive link, they do provide clear guidance on paths that may be effective.