MEEKS, SHEPPARD, LEO & PILLSBURY

ATTORNEYS AT LAW

JEFFREY A. MEEKS* 1735 POST ROAD, SUITE 4RALPH H. SHEPPARD 570 LEXINGTON AVENUE FAIRFIELD, CT 06824ROBERT J. LEO 44TH FLOOR TEL: (203) 256-1401, FAX: (203) 256-1478TAYLOR PILLSBURY* NEW YORK, NY 10022 DIANE L. WEINBERG TEL: (212) 949-7120 100 NEWPORT CENTER DRIVE, SUITE 220ANDREA ABRAHAM FAX: (212) 949-7271 NEWPORT BEACH, CA 92660MICHAEL JACKSON* TEL: (949) 719-2712, FAX: (949) 719-2715 www.mscustoms.com

*ADMITTED TO A BAR OTHER THAN NEW YORK

U.S.  Customs  Law  and  Transfer  Pricing  

Has your client valued the product correctly and declared that value to U.S. Customs upon

importation into the U.S.? Has your client accounted for the issues that would impact that value?

These are some of the questions counsel to multinational companies should ask.

The valuation of merchandise is critical, since it determines how much duty is paid.

Undervaluation of imported or exported merchandise may lead to delays in shipments, additional

physical examinations, rejected shipments, and civil or criminal penalties, depending on the

circumstances. Overvaluation means lost revenue to a company, and may be seen by governments

as an indication of capital flight or money laundering. These potential, severe problems underscore

the importance of proper valuation or appraisement, and counsel's need to review and confirm that

appraisement.

The United States and most of its industrialized trading partners are signatories to the WTO’s

GATT (General Agreement on Tariffs and Trade) Valuation Agreement or Code, originally signed

and ratified by the U.S. in 1979, and enacted into law in 19 U.S.C. § 1401a. Proper appraisement is

important, and will be enforced by U.S. Customs, even if the merchandise is "duty free." The

following briefly explains the basics of U.S. valuation law, and serves as background to discussion

about the Agreement' impact on trade. The transaction value of imported merchandise is U.S.

Customs' primary method of appraisement, and is used in over 90% of all import transactions. U.S.

law, 19 U.S.C. § 1401a(b)(1), defines "transaction value" as:

The price actually paid or payable for the merchandise when sold for exportation to

the United States, plus, unless already included, amounts equal to:

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A. The packing costs incurred by the buyer with respect to the imported

merchandise;

B. Any selling commission incurred by the buyer with respect to the

imported merchandise;

C. The value, apportioned as appropriate, of any assist.

D. Any royalty or license fee related to the imported merchandise that the

buyer is required to pay, directly or indirectly, as a condition of the sale of

the imported merchandise for exportation to the United States; and

E. The proceeds of any subsequent resale, disposal, or use of the imported

merchandise that accrue, directly or indirectly, to the seller.

If your client receives a commission from the supplier for the sales in the U.S., or the U.S.

customer pays a royalty or license fee to your client any portion of which goes back to the

supplier/seller, the proper value might not be reflected on the import documents. Selling

commissions and fees paid to or for the benefit of the seller must be reflected in the value declared to

U.S. Customs under U.S. law 19 U.S.C. § 1401a. Your client should keep in mind that the price

paid or payable is not necessarily the contract or purchase order price but the amount actually

tendered by the buyer to the seller for the goods.

If your client is related to the supplier or seller, he or she should be aware that U.S. Customs

law treats "related parties" differently than non-related parties. While U.S. Customs will readily

accept transaction value as the appraisement method for imports when the buyer and seller are not

related to each other, they will hesitate to accept transaction value between related buyers and sellers

unless certain conditions are met. 19 CFR § 152.101 et seq. The importer of record must

demonstrate to U.S. Customs that the price charged by its related entity was either reached as result

of arm's length negotiations, or meets specified test values set forth in the regulations. Failure to

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satisfy U.S. Customs will result in use of another method of appraisement, which may result in a

higher value, and increased duties affecting the profit margin.

The following is a summary of the current state of U.S. Customs treatment of transfer pricing between related parties importing into the U.S.

I U.S. Internal Revenue Code SECTION 482 Sets forth arms length pricing requirements in transactions between related parties. There are

certain methods of valuation under the U.S. IRS transfer pricing rules. Under IRS rules, the goal is to use the transfer pricing method that produces the most reliable result.

II ADVANCE PRICING AGREEMENTS In 1991, IRS created Advance Pricing Agreements that permit the Government and the

taxpayer to agree on the facts to which the APA applies, the transfer pricing method, and an expected range of results.

APA is binding on IRS, not U.S. Customs.

III TRANSFER PRICING Goal of transfer pricing in related party transactions for IRS purposes is to “clearly

reflect income”. Goal in related party transactions for Customs purposes is the correct appraised value and

not income related to the merchandise. With their different goals, the transfer pricing determined by tax officials frequently differs

from the value determined by Customs officials in related party transactions.

IV Related Parties - Customs Issues Is transaction value acceptable (arm’s length)?

Circumstances of Sale Supporting evidence: Relevance of APA’s and tax transfer pricing studies

Test Values Based on customs value for previous entries for identical or similar goods

Post Importation Price Adjustments: Does transaction value apply? Treatment of post importation increases and rebates.

Importer’s obligation to use reasonable care to declare correct customs value.

V Legal Requirements U.S. Customs Value Law Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of

1979, 19 U.S.C. 1401a Implementing Regulations Part 152 of the CBP Regulations (19 CFR Part 152)

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V I U . S . C u s t o m s R u l i n g H Q 5 4 6 9 7 9 Customs ruled in August, 2000 that transfer prices are acceptable for transaction value

where a bilateral APA exists, Customs attended the APA Prefiling Conference, and reviewed the information submitted to IRS.

This enabled Customs to conclude that price was not influenced by the relationship for purposes of the circumstances of sale test.

VII CONFLICT BETWEEN IRS AND CUSTOMS IRS wants transfer pricing for imports to be at the lowest possible level in order to

maximize the taxable profit in the subsequent resale in the United States. Customs generally wants the highest appraised value for the imports because that will

result in collecting more duties. U.S. importer hopes for both a low value for Customs purposes and higher inventory value for tax purposes.

VIII IRC Section1059A Congress enacted section 1059A in 1986 as a result of a court case that

encouraged taxpayers to declare a lower Customs value and a higher value for tax purposes.

Section 1059A - importers may not claim a transfer price for tax purposes that is higher than the value claimed for Customs purposes, subject to certain adjustments.

It establishes a limit on the price an importer can claim for tax purposes.

IX TAX BASIS For tax purposes, taxpayer may increase declared Customs value of imports by

adding amounts for – International freight – Insurance – Post-importation transportation, construction, erection, assembly or technical assistance

– Any other amounts that are not taken into account in determining the customs value, which are not properly included in customs value, and which are appropriately included in the cost basis or inventory cost for tax purposes.

X IRS REPORTING REQUIREMENTS Importing taxpayer required to file IRS Form 5472 and explain any differences between

its inventory cost and value declared to Customs.

XI PROTECTION AGAINST IRS CHALLENGE Importing taxpayer should obtain both a Customs ruling on customs valuation and a

Section 1059A ruling.

XII CUSTOMS GENERAL ANNOUNCEMENT ON TRANSFER PRICING Customs does not accept IRS findings of arms length under section 482 for an

acceptable transaction value. In 1993, Customs announced that the importer must justify its transfer price by

– demonstrating the price was not influenced by the relationship, based on the circumstances of sale, or

– establishing that, even if the price was so influenced, that the transfer price closely approximates a test value.

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XIII STATUTORY ADDITION FOR ROYALTY OR LICENSE FEES Royalty/license fees are dutiable if they are determined to be a condition of sale for export.

– Whether a royalty or license fee is dutiable will depend on: – Whether the buyer had to pay them as a condition of sale, – Whether imported merchandise was manufactured under patent, – Whether the royalty was involved in the production or sale of the imported merchandise.

XIV ROYALTIES These above factors are the “Hasbro II” factors, and negative responses to the first and

second questions, and an affirmative response to the third, suggest that a royalty fee is not dutiable.

XV ROYALTIES

For Example, generally royalties paid on U.S. tablets are dutiable where finished active is imported and manufactured under patent.

XVI Transfer Pricing Methods for Tangible Property Transactional

– Comparable Uncontrolled Price (CUP) – Resale Price Method – Cost Plus Method

Profit Based – Profit Split – Comparable Profits Method (CPM)

Unspecified Methods

XVII Transfer Pricing Methods for Tangible Property (cont.) CPM

– Focused on operating profit of tested party – Most frequently used method in APA context Comparability standards lower Data readily available Easy to apply prospectively

XVIII Comparable Profits Method (cont.) Elements of the CPM – Tested Party

– Comparables – Profit level indicator

Operating margin Return on capital employed/return on assets Berry ratio (cost plus on operating expenses)

XIX EFFECTIVE JULY 30, 2012 New U.S. Customs policy issued on post-importation adjustments to value of goods - 46

CUST. BULL. 23 at 1 (May 30, 2012) Previously allowed reductions only if “formula” in place prior to importation into the

U.S. APAs and general transfer pricing policies were not considered to be prior formulas

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XX NEW CUSTOMS POLICY WILL ACCEPT IMPORTER’S RELATED PARTY PRICING IF:

Company has written transfer pricing policy in place prior to importation –That policy is prepared taking Section 482 into account

Company uses its TPP in filing its tax returns –Any resulting adjustment is reported or used in tax returns

XXI NEW CUSTOMS POLICY WILL ACCEPT IMPORTER’S RELATED PARTY PRICING IF:

Company’s transfer pricing policy specifies how TP and any adjustments are determined for goods at issue.

Company has documented support from its books and financial statements for the adjustments.

No other conditions or factors affect CBP’s acceptance of the transfer price

Of course, this summary is provided for informational purposes not as legal advice. It does show how different U.S. Customs treatment can be from the U.S. Internal Revenue Service’s treatment of transfer pricing.

If you have any questions about this area, please do not hesitate to contact Robert

Leo: MEEKS, SHEPPARD, LEO & PILLSBURY

570 LEXINGTON AVENUE, 44TH FL NEW YORK, NY 10022 1+(212) 949-7120 Robert.leo@mscustoms.com www.mscustoms.com