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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Increase in CEE-Driven Enforcement Activities

Dear Friends,

We wanted to share with you some developments we are seeing with regard to U.S. Customs and Border Protection (CBP) enforcement activities.  Specifically, we are seeing an increased focus on antidumping/countervailing duty issues, and an increase in the number of “commercial fraud” investigations being initiated.  In both cases, the Centers of Excellence and Expertise (CEEs) are playing prominent roles.

We are seeing Import Specialists tied to various CEEs issue an increasing number of Requests for Information (CF-28s) focused specifically on antidumping/countervailing duty order compliance (e.g., whether an imported article should have been entered as a Type 03 entry subject to an order).  These CF-28s have most often involved the AD/CVD orders with broad, ambiguous scopes (e.g., orders on aluminum extrusions, steel products, various orders on pipe, etc.).  The same Import Specialists are issuing CF-28s to multiple importers, which (we believe) demonstrates that the CEEs are working as intended – as an Import Specialist learns that one importer may have an issue, he/she wonders whether other importers in the same industry also have that issue and starts issuing CF-28s to other companies covered by the CEE, etc.  Given the potential exposure for failing to deposit estimated AD/CVD upon importation, we recommend that all importers re-confirm that they are properly declaring any such imports.

On a related note, we are seeing an increasing number of formal investigations being initiated by CBP; again, driven primarily by the CEEs.  The number of formal “commercial fraud” investigations declined dramatically following the split of the U.S. Customs Service into CBP and U.S. Immigration and Customs Enforcement (ICE) in 2003.  Since most of the enforcement personnel went with ICE and began focusing on different issues, the number of commercial fraud investigations declined.  While there have been blips of activity since then (e.g., the issue several years ago of Import Specialists including investigation language in routine CF-28s), formal investigations were not very frequent.  That may now be changing.  In recent months, we have seen several CEE-based Import Specialists launch formal investigations into different matters (e.g., antidumping/countervailing duty issues, NAFTA and other preference claims, etc.).  Some, but not all, of these investigations were preceded by a CF-28.  As a result, it is important to pay close attention to any CF-28s you receive, and to recognize the investigation risk (and prior disclosure opportunity) they represent.

We hope this is helpful.  If you have any questions, please let us know.

Best regards,
Ted