U.S. Customs and Border Protection

U.S. Department of Homeland Security Washington, DC 20229

November 25, 2015

HQ H254700

OT:RR:CTF:VS H254700 YAG

CATEGORY: Valuation

Port Director, Port of Savannah U.S. Customs and Border Protection 1 East Bay Street Savannah, GA 31401

Re: Internal Advice Request; Applicability of Transaction Value; Related Party Transactions

Dear Port Director: This is in response to your internal advice request, dated June 23, 2014, regarding the proper method of appraisement of imported merchandise, purchased by Makhteshim Agan of North America (“MANA”) from its related suppliers.

FACTS:

Makhteshim Agan Industries, Ltd. (“MAI”) is a leading manufacturer and distributor of crop protection products, located in Israel. MAI relies on a network of buy/sell distributors around the world to engage in sales and marketing activities of the group’s products. MANA, based in Raleigh, North Carolina, is a U.S.-based subsidiary of MAI. It is primarily engaged in the distribution of pesticides (namely insecticides), herbicides, and fungicides. MANA also distributes certain fine chemical products, which are used in the fragrance industry (these are sold under the name “aroma”). The majority of products sold by MANA are purchased outside the United States from its related suppliers.1 MANA also sells products that are purchased in the United States from domestic corporations.

1 MANA purchases (1) herbicides and fine chemicals from Agan Chemicals Ltd. & Agan Aroma Chemical Ltd (“Agan”), located in Israel; (2) insecticides and fungicides from Makhteshim Chemical Works Ltd. (“MCW”), located in Israel; (3) various crop protection products from Celsius, located in China (Celsius gets the products from its unrelated manufacturer, so MANA commonly applies the first sale rule; and, therefore, the transfer price is not at issue in these transactions); (4) herbicides from MA Poland; and, (5) limited insecticides and herbicides from Irvita Plant Protection and Quena Plant Protection (collectively “related suppliers”).

1 On December, 20, 2013, CBP completed a Focused Assessment (“FA”) Pre- Assessment Survey (“PAS”) of MANA for the period of July 1, 2011 to June 30, 2012. In connection with CBP’s focused assessment, CBP reviewed MANA’s internal controls for calculating value and concluded that MANA represented an unacceptable risk. As part of the FA, CBP also determined that MANA’s documentation supporting its position that related party transactions were conducted at arm’s length was insufficient. Consequently, CBP concluded that MANA failed to provide sufficient information to allow CBP to determine the correct basis of appraisement, or the correct value and related duties and fees. MANA disagreed with the Regulatory Audit’s conclusions and submitted the following documents for CBP’s review: (1) Company’s response to CBP’s Audit Report issued in November of 2013; (2) MAI’s Global Transfer Pricing Study for fiscal year ended December 31, 2011 (Masterfile document);2 (3) MANA’s FY 2012 Economic Analysis; (4) MANA’s FY 2011 Economic Analysis; (5) Prior Disclosure correspondence, dated March 7, 2014, with exhibits; (6) Deductive value example; (7) Memorandum from Ernst & Young, LLP, dated September 2011, providing FY 2010 transfer pricing update; and, (8), MAI’s transfer pricing policy for 2012. This internal advice followed.

MANA states that its transfer pricing methodology is the principal mechanism for setting prices and declaring value for products purchased from its related party suppliers. In fact, the company’s determination of the transaction value is driven by its transfer pricing study, prepared by KPMG, LLP for tax purposes. This global transfer pricing study, as applied to MANA, stipulates that MANA operates on a guaranteed local margin concept. This means that MANA is compensated as a limited risk distribution company and is guaranteed a return for its activities. According to MANA, the proposed price to a related party supplier is determined by projecting the selling price in the United States, less the profit margin stipulated in the global transfer pricing document, less projected local cost of sales (additional processing costs incurred in the United States), and less projected allocable local general and administrative expenses. The proposed transfer prices are submitted to the respective group supplier for approval. Questions arising from the proposed transfer prices are resolved through discussions with the group supplier, MANA, and the group’s tax director. Additional authorizations and analysis is performed where the proposed MANA transaction price is insufficient to cover the group’s costs.

The multiple transfer pricing documentation provided by MANA, which included MAI’s global transfer pricing study, MANA’s fiscal years 2012 and 2011 economic analysis, 2010 transfer pricing update, and MAI’s transfer pricing policy for 2012, provides comprehensive information concerning the multinational company’s corporate structure, distributed products, functional and risk analysis of MAI and its distributors, and some overview of the crop protection industry to which MANA belongs. Apart from identifying MAI’s competitors in the crop protection industry, there was no quantitative or qualitative information provided with respect to MANA’s direct competitors in the United States. Regarding MAI’s global transfer pricing study, the Transactional Net Margins Method (“TNMM”) was selected as the most appropriate method to test the arm’s length nature of

2 The Masterfile document serves as the basis for the transfer pricing analysis for the global buy/sell distribution transactions and contains background on the company, products, industry, and intercompany transactions. The Economic analysis documents, on the other hand, contain the economic analysis and arm’s length results for the buy/sell distribution transactions on a regional basis.

2 the tested transactions3 for tax purposes. For MANA’s operations in North America, the Comparable Profits Method (“CPM”) was selected as the best method. The parent company’s distributors were identified as the least complex entities, and the operating margin was selected as the most appropriate Profit Level Indicator (“PLI”). A benchmarking exercise to compile a set of independent companies performing functions comparable to those performed by the parent company’s distributors was performed on a regional basis. None of MANA’s transfer pricing studies (or updates) identified comparable companies based on product comparability for customs purposes. In fact, most of the comparable companies identified distribute pharmaceutical and medical products and do not belong to the crop protection industry.

Finally, MANA reconciles transfer prices paid to related party suppliers to appropriate profit margins, as specified in its transfer pricing documentation. The cumulative effect of the year-end transfer pricing adjustments for the periods from 2009 to 2012 resulted in the net decrease of the price MANA paid for the imported merchandise, purchased from its related suppliers. MANA has not sought a reduction of duties for the years 2009-2012; however, on March 7, 2014, the company submitted a prior disclosure covering 2009-2012 adjustments. Also, effective in July 2013, MANA enrolled in the Reconciliation program.

ISSUES:

I. What is the proper method of appraisement for transactions between MANA and its related suppliers?

II. Should post-importation adjustments to the value of the merchandise, resulting from MANA’s reconciliation of profit in accordance with its transfer pricing policies, be taken into account for purposes of determining customs value?

LAW AND ANALYSIS:

Merchandise imported into the United States is appraised for customs purposes in accordance with Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (TAA; 19 U.S.C. §1401a). The primary method of appraisement is transaction value, which is defined as “the price actually paid or payable for the merchandise when sold for exportation to the United States,” plus amounts for certain statutorily enumerated additions to the extent not otherwise included in the price actually paid or payable. See 19 U.S.C. §1401a(b)(1). Transaction value is an acceptable basis of appraisement only if, inter alia, the buyer and seller are not related, or if related, an examination of the circumstances of the sale indicates that the relationship did not influence the price actually paid or payable, or the transaction value of the merchandise closely approximates certain “test values.” 19 U.S.C. §1401a(b)(2)(B); 19 CFR §152.103(l).

3 In the tested transaction, the distributors purchase crop protection products from the principals for sale in their local markets.

3 I. What is the proper method of appraisement for the transactions between MANA and its related suppliers?

Test Values

The importer or the buyer may demonstrate that the transaction value in a related party transaction is acceptable by showing, that the value closely approximates any one of the following “test values,” provided these values relate to merchandise exported to the United States at or about the same time as the imported merchandise: (1) transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States; (2) the deductive value or computed value for identical merchandise or similar merchandise; or (3) the transaction value of imported merchandise in sales to unrelated buyers of merchandise, for exportation to the United States, that is identical to the imported merchandise under appraisement, except for having been produced in a different country. 19 U.S.C. §1401a(b)(2)(B); 19 CFR §152.103(j)(2)(i). If one of the “test values” is met, it is not necessary to examine the question of whether the relationship influenced the price. 19 CFR §152.103(l)(2)(iii).

MANA argues that the application of the test value analysis shows that the relationship between the parties did not affect the price of the imported merchandise. MANA states that the transaction value under examination is valid because it closely approximates the deductive value of similar or identical merchandise. To illustrate this point, MANA submitted an example of calculating the value using the deductive method of appraisement.

In interpreting the test values provisions specified in the valuation law, it has been CBP’s longstanding position that test values refer to values previously determined pursuant to actual appraisements of imported merchandise. See Headquarters Ruling Letter (“HRL”) 542580, dated November 4, 1981; HRL 543568, dated May 30, 1986; HRL 544455, dated March 19, 1995; HRL 547982, dated May 20, 2002; HRL 548503, dated June 2, 2004, etc. Thus, for example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of merchandise under section 402(d) of the TAA. See HRL 542580, dated November 4, 1981 and HRL 543568, dated May 30, 1986. As we stated in HRL 544455, dated March 14, 1995, we have no legal authority to utilize values for the same entries of merchandise, based on different valuation methods, as evidence that the questioned transaction value closely approximates a test value. See also HRL H206715, dated January 29, 2015. Accordingly, we are not persuaded by MANA’s arguments with respect to the applicability of the test value approach and reiterate that it continues to be CBP’s position that in determining whether a test value closely approximates an instant transaction value, the test value has to reflect a value previously accepted as a customs value.

Circumstances of the Sale

4 Under the circumstances of the sale approach, the transaction value between a related buyer and seller is acceptable if an examination of the circumstances of the sale indicates that although related, their relationship did not influence the price actually paid or payable. The Customs Regulations specified in 19 CFR Part 152 set forth illustrative examples of how to determine if the relationship between the buyer and the seller influences the price. See also HRL H029658, dated December 8, 2009; H037375, dated December 11, 2009; and, HRL H032883, dated March 31, 2010. In this respect, CBP will examine the manner in which the buyer and seller organize their commercial relations and the way in which the price in question was derived in order to determine whether the relationship influenced the price. If it can be shown that the price was settled in a manner consistent with the normal pricing practices of the industry in question, or with the way in which the seller settles prices with unrelated buyers, this will demonstrate that the price has not been influenced by the relationship. See 19 CFR §152.103(l)(1)(i)-(ii). In addition, CBP will consider the price not to have been influenced if the price was adequate to ensure recovery of all costs plus a profit equivalent to the firm’s overall profit realized over a representative period of time. 19 CFR §152.103(l)(1)(iii). These are examples to illustrate that the relationship has not influenced the price, but other factors may be relevant as well.

MANA states that its transfer pricing methodology is designed to provide a guaranteed profit margin in the United States. This guaranteed profit margin is supported by the North American Economic Analysis, which determines the appropriate profit margin by comparing MANA’s operating profit to operating profit of functionally comparable companies. Thus, MANA asserts that its price is settled in a manner that represents unrelated buyers and sellers. We disagree.

The fact that MANA earns a guaranteed profit margin is not indicative of the fact that the declared prices are at arm’s length for customs valuation purposes. Furthermore, according to MANA, its related suppliers do not sell the merchandise to unrelated parties in the United States. Therefore, it cannot be shown that the price was settled in a manner consistent with the way in which the seller settles prices with unrelated buyers.

Additionally, CBP repeatedly ruled that the mere fact the importer/buyer allegedly earned an operating profit comparable to other functionally equivalent companies is not sufficient to establish either the normal pricing practice of the industry or that the related party price was settled in a manner consistent with the normal pricing practices of the industry in question. See HRL 548482, dated July 23, 2004; HRL 548095, dated September 19, 2002; HRL H029658, dated December 8, 2009; HRL 037375, dated December 11, 2009; H138203, dated October 11, 2011; and, HRL H260036, dated February 24, 2015. We also note that the pricing practices must relate to the industry in question, which generally includes the industry that produces the goods of the same class or kind as the imported merchandise. See HRL 546998, dated January 19, 2000; see also HRL 548095, dated September 19, 2002. In this case, a set of functionally comparable companies was used to determine a target operating margin range. Our review of these comparable companies indicates that these companies were chosen based on their functional comparability with MANA. The comparable companies, none of

5 which are in the in the crop protection industry, sell a variety of pharmaceutical and medical products. Accordingly, in line with previous rulings, we find that MANA has failed to show that the prices will be settled in a manner consistent with the normal pricing practices of the crop protection industry.

Finally, we are unable to determine that the related party price is not influenced by the relationship for purposes of the circumstances of the sale test, based on the totality of the information provided and our review and examination of all relevant aspects of the transaction. Our general approach takes into account every aspect of the transactions at hand to determine whether transaction value is adequate. However, in this case, MANA failed to submit information regarding its own profitability versus that of its competitors. Even though, MAI’s global transfer pricing study briefly discusses the crop protection industry, there is no qualitative review of the industry to confirm that companies in the industry price products in a consistent manner. Moreover, there is no available quantitative data of other companies in the crop protection industry that would further support the profitability figures presented to CBP in MANA’s transfer pricing studies and updates, prepared for tax purposes. Thus, the transaction value method of appraisement is not applicable in this instance.

Alternative Methods of Appraisement

When transaction value is eliminated as the appropriate method of appraisement, imported merchandise must then be appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. §1401a(a). The alternative bases of appraisement, in order of precedence, are: the transaction value of identical or similar merchandise (19 U.S.C. §1401a(c)); deductive value (19 U.S.C. §1401a(d)); computed value (19 U.S.C. §1401a(e)); and, the “fallback” method (19 U.S.C. §1401a(f)).

The transaction value of identical or similar merchandise is based on sales, at the same commercial level and in substantially the same quantity, of merchandise exported to the United States at or about the same time as the merchandise being appraised. Since we have not been provided any information concerning the transaction value of identical or similar merchandise, we are not able to value the imported merchandise under this method of appraisement at this time. However, if such information is available, the imported merchandise should be valued under the transaction value of identical or similar merchandise method of appraisement.

Under the deductive value method, imported merchandise is appraised on the basis of the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation. 19 U.S.C. §1401a(d)(2)(A)(i)-(ii). This price is subject to certain enumerated deductions. 19 U.S.C. §1401a(d)(3). Pursuant to 19 U.S.C. §1401a(a)(2), if the value cannot be determined on the basis of the transaction value of identical or similar merchandise, the merchandise shall be appraised on the basis of the computed value, rather than the deductive value, if the importer makes a request to that effect to the

6 customs officer concerned. See also 19 CFR §152.102(c). In this case, MANA states that the process of setting the related party price starts with MANA’s selling price in the United States to unrelated third parties and the resulting profit margin takes into account various and reasonable additional processing costs and general expenses. Therefore, given the methodology according to which MANA sets its prices, we find the deductive value method of appraisement to be applicable in this case.

II. Should post-importation adjustments to the value of the merchandise, resulting from MANA’s reconciliation of profit in accordance with its transfer pricing policies, be taken into account for purposes of determining customs value?

As noted above, MAI’s global transfer pricing study utilized TNMM methodology, and CPM was selected as the best method for MANA’s operations in North America. As a consequence of using the CPM approach, MANA is required to make retroactive price adjustments (downward and upward) to meet its federal tax obligations and to show that its prices are at arm’s length for tax purposes.4

Considering our determination that MANA failed to meet the circumstances of the sale and test values tests and, thus, cannot use transaction value as a method of appraisement, we find that it is not necessary for us to determine whether MANA meets the factors, specified in HRL W548314, dated May 16, 2012, in order for its transfer pricing policy to be considered an objective formula for purposes of appraising the merchandise under transaction value. Accordingly, we need to address the treatment of post-importation adjustments under the deductive method of appraisement.

The price determined under deductive value (19 U.S.C. §1401a(d)) is to be reduced by an amount equal to the following: “(i) any commission usually paid or agreed to be paid, or the addition usually made for profit and general expenses, in connection with sales in the United States of imported merchandise that is of the same class or kind, regardless of the country of exportation, as the merchandise concerned…” See 19 U.S.C. §1401a(d)(3)(A)(i). Additionally, 19 CFR §152.105(e) supplements the statutory provisions in 19 U.S.C. §1401a(d)(3)(A)(i) and states the following:

(e) Profit and general expenses; special rules. (1) The deduction made for profit and general expenses (taken as a whole) will be based upon the importer's profit and general expenses, unless the profit and general expenses are inconsistent with those reflected in sales in the United States of imported merchandise of the same class or kind from all countries, in which case the deduction will be based on the usual profit and general expenses reflected in those sales, as determined from sufficient information. Any State or local tax imposed on the importer with respect to the sale of imported merchandise will be treated as a general expense.

4 In HRL W548314, dated May 16, 2012, CBP examined the issue of claiming post-importation adjustments to value in related-party sales and set forth certain factors to consider. CBP held that companies may claim “compensating adjustments” and other post-importation adjustments based on tax transfer pricing documentation and APAs for purposes of appraising the imported merchandise under the transaction value method of appraisement.

7 (2) In determining deductions for commissions and usual profit and general expenses, sales in the United States of the narrowest group or range of imported merchandise of the same class or kind, including the merchandise being appraised, for which sufficient information can be provided, will be examined.

19 U.S.C. §1401a(g)(2) states that “for purposes of this section, merchandise (including, but not limited to, identical and similar merchandise) shall be treated as being of the same class or kind as other merchandise if it is within a group or range of merchandise produced by a particular industry or industry sector.” Furthermore, 19 U.S.C. §1401a(h)(5) defines “sufficient information” as: the term sufficient information . . . (ii) deducted under subsection (d)(3) of this section as profit or general expense (iii) added under subsection (e)(2) as profit or general expense; . . . means information that establishes the accuracy of such amount, difference, or adjustment.

In this case, MANA used its transfer pricing documentation prepared for tax purposes in which the profit range is not calculated on the basis of comparable companies that produce merchandise within a group or range of merchandise produced by a particular industry or industry sector such as the crop protection industry. Although the company did not initially claim the adjustments for 2009-2012, it submitted a prior disclosure in 2014, claiming refunds on the basis of cumulative adjustments taken in 2009-2012. In other words, MANA recalculated its original profit on the basis of profitability of comparable companies, utilized in MANA’s transfer pricing documentation, that distribute pharmaceutical and medical products. Once again, the facts presented in the company’s transfer pricing documentation do not lead us to conclude that the comparable companies used reflect a group or range of merchandise produced by the crop protection industry. Therefore, in this case, MANA has failed to establish that its profit and expenses, as initially reported to CBP, are inconsistent with those usually reflected in sales of merchandise of the same class or kind as the imported merchandise. Thus, MANA has not demonstrated that value adjustments are warranted. Accordingly, we find that MANA may appraise its merchandise under the deductive value method of appraisement on the basis of its amount of profit and general expenses, as was originally reported to CBP.

HOLDING:

In conformity with the foregoing, transaction value is not the appropriate method of appraisement for sales between MANA and the related suppliers. The deductive value method of appraisement, using the amount of profit and general expenses originally reported to CBP, should be used to value the imported merchandise.

This decision should be mailed by your office to the party requesting Internal Advice no later than 60 days from the date of this letter. On that date, the Office of Regulations and Rulings will make the decision available to CBP personnel, and to the public on the CBP Home Page at www.cbp.gov, by means of the Freedom of Information Act, and other methods of public distribution.

8 Please do not hesitate to contact us at (202) 325-0042 if you have any questions or concerns.

Sincerely,

Monika R. Brenner, Chief Valuation and Special Programs Branch