Interesting First Sale Ruling

Dear Friends,

We wanted to make sure you saw a U.S. Customs and Border Protection (“CBP”) Headquarters Ruling involving first sale that was just recently published.  Since many companies rely on first sale for meaningful duty savings, this ruling should be of interest to you.

First Sale Recap

As you know, in certain multi-tiered transactions (for example, involving a factory, a middleman and a U.S. purchaser/importer), the “first sale” principle of customs valuation allows the importer to declare as the customs value the price the middleman pays to the factory, rather than the price the importer pays to the middleman.  A first sale is viable for customs purposes three conditions are satisfied:  (1) it is a bona fide sale; (2) the merchandise is clearly destined to the United States at the time of the sale; and (3) it is an arm’s length price.  It is this third requirement that can the most difficult to satisfy, particularly where the factory and the middleman are related parties.  

The Ruling (HQ H272520)

This ruling focused on the arm’s length requirement for the first sale.  If an importer wants to use a related party price as the customs value, the importer must be able to establish that the parties’ relationship did not influence the price.  There are a few established ways for an importer to accomplish this, but the most common way is using what CBP refers to as the “all costs plus a profit” test, which is derived from an interpretive note in the CBP regulations.

Succinctly, the “all costs plus a profit” test involves comparing the profitability of a factory (usually a subsidiary of the middleman) with that of middleman (usually the parent of the factory).  In such a case, CBP would take the view that the factory’s profit margin must be equal to, or greater than, the profit margin earned by the middleman in order to be considered to be arm’s length.

In this ruling, the outcome of the “all costs plus a profit” test was different in different years.  In some years, the test was satisfied (so first sale was deemed viable for entries from those years).  In another year, the factory did not have a profit equal to, or greater than its parent company, so first sale was not allowed.

Key Takeaways

There are two key takeaways from this ruling:

First, this ruling was issued in response to a request for internal advice from the Port of Los Angeles after the port issued a CBP Form 28 Request for Information to an importer.  This is significant because it shows that CBP at the port/CEE level is questioning first sale.  All importers who utilize first sale should be thinking of these issues and be ready to respond.

Second, companies that are relying on first sale as a duty savings strategy need to be focused on whether they have objective evidence that related-party first sales qualify as arm’s length sales.  If a factory covers its costs and earns a profit, that is some indication that the factory’s sales are at arm’s length, but it may not be sufficient to satisfy the “all costs plus a profit” test, as this ruling demonstrates.  Companies should ensure that they have performed adequate diligence of this issue before claiming first sale.

To that end, just because a factory’s profit isn’t high enough to satisfy the “all costs plus a profit” test doesn’t mean that first sale is categorically unavailable.  Under the statute, a related party first sale can be a valid customs value if the circumstances of sale indicate that the relationship did not influence the price.  As this ruling indicates, this is a question to be proved, not assumed.  Working in conjunction with our in-house team of economists, we have developed secondary economic analyses that are useful in precisely these circumstances—establishing economically sound, empirical data which support the conclusion that the sale between a related factory and middleman is arm’s length. 

We have produced these economic analyses for various clients, and would be happy to discuss these, or any other first sale issues with you further.  If such a discussion would be helpful, just let us know.

Best regards,

Ted

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Review of 2017 ITRAC/ACE Data

Dear Friends:

Just a quick note to remind you that one element of an effective internal customs compliance program involves a review of the company’s import data on (at least) an annual basis.  This is the time to review the 2017 data. 

The goal of internal controls is to effectively mitigate the risk associated with the company’s activities.  Thus, the starting point is understanding the company’s risk profile.  One way to do that from a customs perspective is to review the company’s import data (the same data that U.S. Customs and Border Protection looks at to select audit candidates).  The import data (whether ITRAC data obtained from CBP HQ, or ACE reports you are able to download).  This data includes general entry information, such as tariff classifications, values, preferential tariff programs used, etc.; as well as information regarding CBP’s review of a company’s import shipments (e.g., whether a CBPF-28 or CBPF-29 was issued).  It also identifies each of the links in the company’s international supply chain (i.e., foreign manufacturers, carriers, customs brokers and sureties).  In short, the import data is a useful tool for monitoring the effectiveness of your import compliance program, identifying areas of potential cost and duty savings, customs valuation reconciliation and identifying links in the international supply chain for security purposes (i.e., C-TPAT-related information). 

Given how useful this information is, we recommend that all companies obtain their import data and review it (at least) annually.  Due to the volume of data involved, and the way it is presented by CBP, we have developed simple macros that can extract the most relevant data and summarize it in a table format so that trends, issues and opportunities can be more easily identified.  If you would like to have us run your data through those macros and provide the summaries, please let us know.  If not, no problem, but please review it yourself and confirm that your controls are working effectively (e.g., your data does not know show the use of unapproved brokers, unauthorized preference claims, incorrect tariff classifications, etc.).  The business is always evolving.  You need to make sure your controls are keeping pace!

We hope this this helpful. 

Best regards,
Ted

 

More Private Party-Initiated Trade Enforcement Actions

Dear Friends,

We wanted to bring to your attention two recent qui tam case settlements involving the underpayment of customs duties.  They are as follows:

  • Further to our message below where Z Gallerie agreed to settle with the U.S. Department of Justice (“DOJ”) for $15 million, the DOJ recently announced that Bassett Mirror Co. (“Bassett”) agreed to pay $10.5 million to settle allegations that it violated the False Claims Act (“FCA”) by underpaying antidumping duties.  Total settlements in this case have now reached $25.5 million.  The underlying complaint, initiated by a competitor, alleged that between January 2009 and February 2014, several companies deliberately misclassified wooden bedroom furniture as non-bedroom furniture on its official import documents to avoid paying antidumping duties.  A copy of the most recent DOJ press release is available here.
  • DOJ announced that a textile importer, American Dawn, and three company executives, agreed to pay more than $2.3 million to settle allegations that they violated the FCA by intentionally misclassifying goods in order to pay lower duty rates.  The underlying complaint, initiated by a former employee, alleged that for more than a decade American Dawn intentionally misclassified certain textile articles, including bath towels and shop towels, as polishing cloths in order to pay a lower duty rate.  The press release is available here.

These cases and settlements are interesting for a few reasons.

First, both cases were initiated by whistleblowers under the FCA.  In Bassett/Z Gallerie, a competitor initiated the court action and, in American Dawn, it was a former employee.  The whistleblowers in these cases with receive a sizeable portion of the settlements.  This incentive will continue to feed the trend of there being an increasing number of private-party initiated trade enforcement actions.

Second, DOJ appears to be settling these cases for less than is available to it under applicable laws.  Under the FCA, maximum liability includes the unpaid duties, three times the unpaid duties, $11,000 for each false claim (i.e., each import entry), plus attorneys’ fees.  In addition, under the Tariff Act of 1930, maximum penalties include the full value of the imported merchandise (because the government alleged intentional evasion of duties, rather than negligence or gross negligence).  Considering that the PRC-wide rate for wooden bedroom furniture is ~216%, the importers could have been liable for many millions more than the government ultimately agreed to settle for.  It is unclear why the government would agree to what could be considered “generous” settlements , particularly since they appear to be “global” in nature (they resolve not just the FCA liability, but the liability imposed under the Tariff Act of 1930, as well), but it is unlikely that such generous terms would be afforded by CBP in an stand alone administrative proceeding.

Finally, in both press releases, government agencies restated their commitment to protecting the economy by investigating alleged evasions of customs duties.  For example, in the American Dawn settlement announcement, the director of the CBP field office in Atlanta stated, “[t]his settlement agreement is another example of CBP’s day to day collaborative efforts between U.S. Customs and Border Protection Officers at ports of entry, Import Specialists with the Centers of Excellence and Expertise, and Immigration & Customs Enforcement Homeland Security Investigations to protect the American public and the U.S. economy.”

In light of this, all importers should make sure that they effective internal controls in place over customs matters that include a mechanism for employees to raise legitimate compliance-related concerns.  In our experience, companies can generally protect themselves from enforcement actions (FCA or otherwise) by having reasonable internal controls.

We hope this is helpful.  If you have any questions, or if you would like to discuss these issues further, please let us know.

Best regards,

Ted

CFIUS Reform/Issues

Dear Friends,

I wanted to let you know that, earlier this week, one of my partners, Rod Hunter, testified before a subcommittee of the US House of Representatives Committee on Financial Services, which is looking at ways to improve the effectiveness of the Committee on Foreign Investment in the United States (CFIUS) (an inter-agency committee authorized to review transactions that could result in control of a U.S. business by a foreign person, in order to determine the effect of such transactions on the national security of the United States).  This is a hot topic right now for a variety of reasons (e.g., CFIUS is expanding its view of what constitutes “national security”; Congress is looking to possibly expand the types of transactions subject to CFIUS review to include, not just mergers or combinations, but certain joint ventures with foreign partners as well, etc.).

Rod previously served as senior director for international economics at the National Security Council (NSC), the White House office that coordinates international trade policy and supervises national security reviews conducted by the CFIUS.  At Baker, he represents clients on matters before CFIUS, as well as trade policy.

His recommendations for the committee concentrated on improving CFIUS’s legal authority and the challenges with turning CFIUS into a technology control regime.  Rod’s full testimony is attached as is the Committee’s Memorandum.

If you (or your colleagues) have any questions about CFIUS, or how its evolution may impact your business (e.g., future acquisitions, combinations or deals), please let me know.

Best regards,
Ted

 

Border Searches of Personal Electronic Devices

Dear Friends,

We wanted to highlight for you an interesting development regarding searches and seizures of personal electronic devices by U.S. Customs and Border Protection (CBP) at the border.   

CBP recently announced that, in fiscal year 2017 (which ended September 30, 2017), it searched the personal electronic devices of 30,200 travelers (inbound and outbound), which is up over 60% from the prior year.  Devices include any communication, electronic, and digital devices, including computers, tablets, removable media, disks, drives, tapes, mobile phones, cameras, music and other media players.  These searches and seizures are stated to be conducted to identify and respond to terrorism threats, smuggling attempts, illegal immigration, etc. and have been the subject of multiple lawsuits.  CBP also updated its directive “Border Search of Electronic Devices” (CBP Directive No. 3340-049A).   

What You Should Know

CBP has broad authority to search individuals, and their belongings, entering or exiting the country.  There is no reasonable suspicion, probable cause, or warrant requirement.  Encrypted and passcode protected content may also be searched.  Travelers that refuse to assist CBP in accessing protected content may have their devices detained. 

In addition to reviewing content stored on the device (a ‘basic search’), CBP may also conduct an ‘advanced search’ if there is reasonable suspicion of activity in violation of laws enforced or administered by CBP (e.g., customs, export control, immigration laws, etc.).  An advanced search is any search in which an Officer connects external equipment, through a wired or wireless connection, to an electronic device not merely to gain access to the device, but to review, copy, and/or analyze its contents.

Not all device content is treated equally.  For example, CBP treats content stored on the device differently than content stored remotely (CBP may only access content stored on the device).  In addition, CBP must initiate specific procedures when a traveler contends that certain content is privileged or sensitive. 

Considering the prominent role of electronic devices in today’s society, CBP’s updated Directive, and the Trump Administration’s focus on border security, device searches at the border will likely continue to increase.

Recommendations 

If your company has executives or employees who travel frequently, we recommend preparing those individuals to respond appropriately if/when CBP Officers ask to search their devices (e.g., do employees have to provide their passcodes, if requested by CBP?).  For example, updating your company’s travel policies to address this issue and then publishing the updates internally could be a good start to preparing employees for this eventuality.  In addition, we recommend that all companies review their company’s data storage policies to ensure the company’s most sensitive data is stored remotely, rather than locally on devices (or that employees have only limited amounts of sensitive data stored locally).  While these are not traditional “customs compliance issues,” they are nevertheless important issues the in-house trade compliance team should be raising internally.

We are working with clients on these issues and would be happy to discuss how best to implement the recommendations discussed above with you further.  If you would like to do so, please let us know.

We hope this is helpful.

Best regards,
Ted

 

Intercompany Customs Valuation Issue – India

Dear Friends,

Happy New Year!  It is hard to believe it is 2018 already . . . .

We wanted to bring to your attention a recent report out of India involving a customs valuation investigation that could have meaningful consequences for other multinationals who do business there. 

The article published in The Indian Express earlier this week details a customs investigation by the Directorate of Revenue Intelligence (“DRI”) (as you may know, DRI is a group within the Central Board of Excise and Customs responsible for investigating and pursuing violations of India’s Customs Act) into the intercompany pricing of a multinational enterprise.  DRI alleged that the Indian subsidiary of this multinational undervalued goods purchased/imported from related parties over a 6-year period and, as a result, failed to pay approximately $96 million (Rs. 612.72 crore) in customs duties.

There are several interesting/important take-away’s from this article. 

The first is the substantive customs valuation issue involved, as it may be a common one among multinationals.  From the article, it appears that the intercompany distribution agreement required the Indian distributor to spend a certain amount in the Indian market advertising and promoting the product (which is not unusual).  DRI took the position that that the amounts the distributor spent on advertising and promotion in the local market were for the benefit of the seller and, therefore, were part of the “price actually paid or payable” (i.e., part of the customs value) for the imported goods.  What is interesting is DRI’s characterization of normal distributor expenses as being for the benefit of the seller, rather than being for the benefit of the distributor (i.e., the amount the distributor spends advertising promoting the product helps justify the margin the distributor earns on resale of that product).  This characterization has a major impact on how the expenses are treated for customs purposes.

The second take-away is to remember that DRI is quite aggressive, particularly when it comes to multinationals, and even more particularly when it comes to intercompany customs valuation issues.  We are currently assisting several clients with customs-related disputes with DRI and can attest to this personally.

While the article does not say whether DRI’s conclusions are being further challenged in court (one would expect/hope so), all multinationals that do business in India should take this as a warning and review their intercompany agreements/practices to identify any additional customs risk.  If you would like any assistance doing so, please let us know.

We hope this is helpful.

Best regards,
Ted

 

GSP Expiration Part II

Dear Friends,

Unfortunately, it appears increasingly likely that Congress will not renew the Generalized System of Preferences (“GSP”) program before it expires on December 31, 2017.  While the program may get renewed in 2018, and that renewal may be retroactive, there will be a period when GSP is not in effect.  U.S. Customs and Border Protection (“CBP”) has published a notice (copy available here) that advises importers of GSP-eligible merchandise to continue entering the merchandise using the “A” Special Program Indicator and to deposit the Normal Trade Relations duties (i.e., the regular, non-preferential duties) during any lapse in the program (e.g., as of January 1, 2018).  This will make it easier for CBP to process refunds IF Congress renews the GSP program retroactively. 

Any of you who regularly import using GSP should make sure that your brokers are familiar with CBP’s notice (in addition to making sure your finance colleagues are aware of the potential increase in costs).

If you have any questions about these issues, please let us know.

Best regards,
Ted