Customs Valuation Implications of Year-End Transfer Price Adjustments

Dear Friends:

Just a quick reminder for those of you working at multinational companies which operate on a calendar year basis – do not forget to ask your tax colleagues whether any retroactive transfer pricing adjustments were made at, or before, year end (assuming they do not send this information to you on their own).  

If such adjustments were made (whether upward or downward), please be sure to consider the customs valuation implications here in the United States and elsewhere.  The failure to declare upward transfer pricing adjustments is a very common enforcement issue in many jurisdictions (largely because the issue is so easy to identify and often involves significant amounts/penalties); whereas downward adjustments could lead to a refund of customs duties, taxes and fees in some jurisdictions (including the US, Canada, etc.).  A quick note to your tax colleagues now could save a potential headache down the line, or put some money back in the company’s pocket. 

We regularly assist clients with (i) the internal discussions with tax to identify whether any adjustments or other additions to value exist, and (ii) reporting any relevant adjustments/additions to value to Customs Authorities where needed.  If you would like any assistance with these issues, please let us know. 

Best regards,
Ted

Advertisements

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

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

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

 

Interesting Design Services/Assist Ruling

Dear Friends,

U.S. Customs and Border Protection (“CBP”) recently issued a ruling on a common customs valuation issue for the consumer goods/retail industry that we wanted to make sure you saw.  The ruling, Headquarters Ruling H287490, involved foreign product design services and whether such costs are to be included in the dutiable value of the goods those design services were indirectly used to produce.

In the ruling, the prospective importer, a U.S. apparel company, entered into agreements with unrelated designers in the Netherlands for services related to the creation of a new line of sleepwear.  Pursuant to these agreements, the designers would create an initial design package (concepts, patterns, color palettes, sketches, trims) and provide input on concept and marketing samples.  The importer will use the initial design package to create a technical package (“tech pack”) of garment patterns, bills of materials, size specifications and concept samples that it will then provide free of charge to an unrelated manufacturer in China for use in the production of market samples.  Using input from the designers, the importer will modify the market samples and send the modifications to the Chinese manufacturer for final production of the sleepwear garments.

In analyzing whether the foreign design fees are assists that should be added to the price actually paid or payable , CBP examined whether the design work is “necessary for production of the imported merchandise.”  CBP explained that design work necessary to production “does not merely convey a general concept as to what [ ] should be created, but instead imparts detailed instructions as to how [it] is to be created ….”  Citing its own precedent, CBP contrasted design work lacking in detail necessary for production (e.g., preliminary sketches) with more detailed plans, such as bills of materials and samples that a producer relies on for guidance when manufacturing.

Since the tech packs provided by the importer to the Chinese manufacturer include detailed plans, CBP concluded it is an assist within the meaning of 19 U.S.C. § 1401a(1)(A).  CBP then examined whether the foreign design work is a “dutiable step” in the production of that assist.  In its analysis, CBP focused on two factors: (1) whether the design activity was undertaken with the knowledge or intent that it would be used to produce the assist, and (2) whether the design activity plays a significant or crucial role in the production of the assist.  Applying these factors, CBP noted that the design activities performed in the Netherlands contribute significantly to the creation of the tech pack provided to Chinese manufacturer by the importer.  The designers generate the overall garment design and specify details such as their color, shape, pattern and material—features that are directly incorporated into the detailed production instructions provided to the manufacturer in the tech pack.  Moreover, CBP concluded that the designers are fully aware of the fact that their contributions will influence the instructions provided to the manufacturers since they will expect to review, and provide input on, both the concept samples and market samples.  For these reasons, CBP ruled that the designers’ fees must be included in the value of the assist.

This is an important reminder for all companies that provide U.S.-developed tech packs to foreign manufacturers for use in the production of articles imported into the United States.  If you do so, you should be asking whether the tech packs are based (in whole or in part) on design services provided by anyone outside of the United States – whether a design services company or a buying agent (since it Is common for buying agents to provide some level of design input/services).  If so, the extent of those services should be reviewed in light of the guidance provided in Headquarters Ruling H287490.

We hope this is helpful.  If you have any questions about this ruling, or its impact on your business, please let us know.

Best regards,
Ted

An Interesting Customs-Related Whistleblower Case

Dear Friends,

We are writing to let you know about a recently unsealed customs-related False Claims Act (“FCA”) case involving low value e-commerce shipments imported under “Section 321” (so-called “de minimis” value shipments that are permitted to enter the United States without entry duty and tax free).  There are a number of details that make this case interesting.

Facts

The original whistleblower complaint was filed by an aggrieved former employee in May 2016.  As is customary, the case remained under seal until the United States decided to join the litigation.  Once the United States entered the case, the complaints were unsealed in July 2017.  While this is only the most recent in a series of False Claims Act (“FCA”) cases involving customs valuation, this is the first known False Claims Act case specifically involving Section 321.

The complaint asserts that the Defendant, a UK-based online retailer of women’s apparel, routinely split individual U.S.-bound orders into shipments that fell below the de minimis threshold for the explicit purpose of avoiding the payment of customs duties.  Under Section 321, shipments below the specified dollar threshold (historically $200, but recently increased to $800) to a single customer on a single day may be entered duty and tax free.  U.S. law expressly forbids the splitting of shipments to get under the dollar threshold.

The complaints include eyebrow-raising allegations— e.g., an excerpt from an employee handbook with detailed instructions on how and why orders were supposed to be split; an alleged conversation among supervisors “boasting” about duty evasion and acknowledging its illegality.  The government’s complaint is too large to attach here.  If you would like to see it, however, just reply to this message and we will send it to you.

Observations

While some of the facts alleged seem to suggest this is a more extreme case, it nevertheless holds important insight for all companies importing into—or even just selling into—the United States.  A few thoughts:

  • Extraterritorial reach of U.S. customs law. This is one of the few cases we are aware of where the government has pursued only a non-U.S. entity for violations of U.S. customs law.  The government’s complaint goes on at length to establish why it has jurisdiction over the Defendant (which counted the United States as its most important market).  This suggests a willingness on the part of the U.S. government to hold entities outside the United States liable for U.S. customs violations.  While the U.S. government has regularly exercised such jurisdiction in other trade contexts, this is rare in the customs context.  In addition, it appears that the U.S. government will have help in this context. The New York Times has an interesting article on this case that focuses on the U.S. law firms that are seeking potential UK and EU whistleblowers for future cases.
  • Risk of high volume, low value shipments.  The case challenges common assumptions about the customs risk associated with selling in the U.S. market.  One common assumption is that high volume, low value shipments present a lower customs risk than larger value commercial shipments, particularly when sent by express courier or U.S. mail, and especially when the seller is not the importer of record into the United States.  This case provides a powerful counterpoint to that line of thinking.  The FCA authorizes the government to collect “treble damages”—that is, three times whatever damages it actually suffered as a result of the false claims. In this case, the potential loss of revenue to the government might be in the single digit millions of dollars, so treble damages is a meaningful sum.  The False Claims Act, however, also authorizes a penalty on a per infraction basis (recently raised to $10,000 per infraction).  This apparently modest FCA penalty provision could prove to have enormous impact in the e-commerce space.  Just a few hundred offending monthly shipments across a 5 year window could easily yield a mandatory penalty in the range of hundreds of millions of dollars.

Recommendations

We have recommended in the past, and wish to reiterate again, the importance of having not only effective internal controls over customs matters, but also an effective avenue for employees to notify company leadership about potential compliance issues (to reduce the feeling that they need to go outside the company to effectuate change).  We have significant experience advising companies on how to test and improve trade-related internal controls in a cost-effective manner and would be happy to discuss that experience with you.

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

Best regards,
Ted