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HQ 548095





September 19, 2002

RR:IT:VA 548095 MMC

CATEGORY: VALUATION

Area Director
U.S. Customs Service
JFK Airport, Building 77
Jamaica, New York 11430

RE: Internal Advice Request; related parties; transaction value

Dear Area Director:

This is in response to your February 7, 2002, memorandum requesting internal advice pertaining to the appraisement of the merchandise covered by entry number 765-1332202-4. The merchandise consists of handbags of various materials, scarves and belts. The merchandise was imported by [XXX] USA (VUSA/importer) and obtained from its related company [XXX] SpA (VSpA) for sale to the importer's customers, some of whom are related companies, in the United States.

Counsel for the importer submitted comments in letters to your office dated April 19, September 10, and November 7, 2001. These letters were in response to January 30, and May 9 2001 Requests for Information and an October 12, 2001 Notice of Action. Although the declared value was based on the price VUSA paid VSpA, the Notice of Action indicates that the merchandise is properly appraised at the price paid by the ultimate consignee in the U.S. Counsel disagrees with that conclusion and claims the declared value is correct and has submitted documentation to support the claim that the VUSA-VSpA related party price is an acceptable transaction value. In reviewing the matter, this office has considered all documents from the port including the entry package. Additionally this office held a March 29, 2002, conference call with importer's counsel. As a result of the conference, counsel provided an April 1, 2002 supplemental submission that included among other things a complete copy of a transfer pricing study. We are assuming that there are no other Agreements, inter-company agreements, memorandum of understanding or pricing documents between or among the parties other than those contained in the file.

Business proprietary information provided with this request will be accorded confidential treatment pursuant to 19 C.F.R. § 177.2(b)(7). Such information is designated by brackets, and will be redacted from the public version of this letter

FACTS:

[XXX] Group is an Italian multinational group in the high fashion industry in the business of designer apparel, perfume, cosmetics, watches, optical wear and shoes. It is wholly owned by [XXX] HS.p.A. [XXX] is acknowledged worldwide as one of the leading brands in the high fashion sector and a significant symbol of Italian fashion. According to counsel, the importer's major competitors are other prominent fashion houses including Versace, Ungario, Gucci, Christian Dior and Channel. Finally, counsel indicates that VSpA is the licensor of the Valentino trademark.

The [XXX] Group has entered into contract manufacturing agreements with related party manufacturers in Italy and a limited number of unrelated 3rd parties that presently manufacture [XXX] products on the basis of the specific design and quality requirements provided for by the [XXX] Group.

VUSA is a company within the [XXX] Group. Its functions include acting as a holding company that controls several corporations that operate U.S. boutiques. Additionally, it carries out trading activities including selling goods both to wholesalers and retailers. While not involved in the production cycle, VUSA is responsible for marketing and branding, outbound logistics, and sales. VUSA sells the imported merchandise to unrelated wholesalers in the U.S.(approximately 75% of volume and revenue) with the remainder sold to [XXX]'s U.S. boutiques.

VUSA purchases the imported goods from [XXX] S.p.A (VSpA/seller). VSpA is also a member of the [XXX] Group. VSpA is responsible for the production cycle of the merchandise. Its activities include management and coordination of high fashion activity, design and creation of patterns, choice and development of fabric and accessories, coordination of all fashion events, and advertising and trademark protection. Additionally, it manages contract manufacturers including their selection, quality control and inventory. The goods include designer apparel, perfume, cosmetics, watches, optical wear and shoes. Services include promotion and advertising.

On December 26, 2000, an entry of handbags of various materials, scarves and belts was made. In a January 20, 2001 request for information and a follow up request dated May 9, 2001, Customs asked the importer for a sample of one of the items covered by the entry at issue, documents concerning that style, and copies of all contracts, agreements etc. that were relevant to the transaction. Additionally, Customs asked the importer to answer a series of specific questions.

In response, counsel provided two separate submissions dated September 10, 2001 and April 19, 2001. These submissions included a portion of a Transfer Pricing Study, a Distribution and Service and Supply Agreement between VSpA and VUSA, a Royalty Agreement between VSpA and [XXX] VCI the precursor to VUSA, a December 12, 2000 freight invoice to VUSA for the shipping costs of the goods from VSpA to VUSA, and a Licensing Agreement between VCI and a third party.

According to the importer's transfer pricing study, all of the importer's transactions are conducted as follows: The related manufacturer purchases raw materials and then makes them into goods. The goods are then sold by the manufacturer to VSpA. VSpA then pays the manufacturer. After making payment to the manufacturer, VSpA sells the goods to VUSA. The goods are then drop-shipped from the manufacturer to VUSA. VUSA then pays VSpA for the goods. VUSA issues its purchase orders via computer directly to VSpA. No hard copy is available. Proof of payment was submitted as part of the April 19, 2001 submission. Freight and insurance documents for the transaction were provided.

In response to the additional questions, counsel indicated that the importer would not incur any additional costs for assists, buying commissions or selling commissions in connection with the subject shipment, and no additional proceeds would accrue to the seller (VSpA). Although counsel indicates that the importer would not in its estimation incur additional costs for assists, it is not clear whether in fact the importer did supply assists to other parties in the transaction. With respect to the remainder of the questions, Counsel indicated that "portions of the transfer pricing study (study) are directly responsive" to the questions.

Essentially, it is the importer's position that the study, which compares VUSA's profitability to that of other companies, establishes that the related party sale is an arm's length transaction. The study provides four main categories of information. The first section is an overview of the [XXX] Group, including its organizational and operational structure, and an explanation of inter-company transactions for both tangible goods and services. The second section describes worldwide operations, including the high fashion industry in Italy and the U.S. The third section discusses a "comparable companies search". This search includes the identification of potential comparable companies, short business descriptions of each, the actual identified comparable companies, a financial analysis of them, and an analysis of VUSA's budget. The fourth and final section provides an explanation of the IRS §482 Regulations and available Methods under those regulations and an explanation for the method chosen and its application to the subject goods.

For the transaction between VUSA and VSpA the comparable profits method (CPM) was chosen. According to the study, the selection of the CPM method was done largely because distribution (wholesale) returns of the comparable companies at the operating profit/margin level (as opposed to gross margin under the full resale price method) provided a reasonable reference point for VUSA.

The study states that the search for comparable companies looked for independent designers and wholesalers of men's, women's and children's apparel. Companies that act primarily as manufacturers and retailers were not deemed functionally comparable to VUSA. Comparable companies included those with the Standard Industrial Code (SIC) 5137-wholesale distribution of men's, women's and children's clothing and accessories, including hosiery, lingerie, millinery and furs, and 5136-companies engaged in the wholesale distribution of men's and boys' apparel and furnishings, sportswear, hosiery, underwear, nightwear, and work clothing. The initial search was under SIC code 5137 but only produced 36 companies so the search was broadened to include the second SIC category and broadened the number of companies to 56. Of these, the comparable companies had to be a wholesale clothing distributor, with no retail or manufacturing activities. In addition, they had to source goods from unrelated manufacturers and own no intangibles (trademarks) etc. Based on the criteria the field was narrowed to 16 of which 6 where chosen. The six were Active Apparel Group, Aris Industries, Donkenny Inc, Happy Kids, Inc. Niches, Inc. Stage II Apparel Group.

Counsel indicates that the study concludes that the operating margins earned by VUSA (net profit as a percentage of net sales) are "comparable" to those earned by "other companies in the apparel industry who purchase from unrelated suppliers under similar circumstances." When the CPM method was applied, the operating margin for the unrelated companies was between -0.15% and 10.16%. VUSA's operating margin is 4%.

The Distribution Agreement (Agreement) indicates that VUSA is the non-exclusive distributor for the covered products in the U.S. and Canada. VUSA's obligations include distribution, promotion, and sales for the goods. The agreement refers to a "recommend price list" in several sections, although it does not indicate which party(ies) created the list. The Distribution Agreement is silent as to the nature of the relationship between VUSA and VSpA, be it principal/agent or buyer/seller.

Section 3 of the Agreement is entitled " Remuneration." It states in pertinent part that:

US (VUSA) shall be entitled to an arm's length gross margin, which shall result from SPA(VSpA) granting a resale price discount off the recommended Price List applied by US in the Territory. The resale price discount that US shall receive for the SPA products for the period this Agreement is in force shall be set at an amount that permits US to earn a gross margin to achieved [sic] a budgeted operating margin of 4.0% with respect to the sale and distribution of the SPA products on the wholesale market; and 0.0% with respect to the sale and distribution of SPA products on the retail market.

With specific regard to the sale of goods between SPA and US for the retail outlets, the parties agree that if the volume and project revenues of the retail operations of US do not allow SPA to recover its costs of production, either those born directly by it or those for which it pays another party, then the transaction price will be set such that SPA recovers only its costs of production. Further, the Parties acknowledge their mutual responsibility to be in the retail market in the Territory with the aim of increasing market awareness of SPA trademarks and products. The break-even budget for the retail line of business respects the fact that the retail outlets are historically loss leaders for growth and development of the wholesale line of business of US from which both SPA and US benefit.

The transaction price for the SPA products charged by SPA to US will be calculated based on annual budgets, prepared by US and confirmed by SPA, of revenues with respect to the sale and distribution of the SPA products, and the related operating expenses incurred by the US; and volumes per collection. The budgets will clearly segregate the forecast results of the retail operations from the wholesale operations. The budgets will be mutually agreed between US and SPA in the normal course of the budgeting cycle of the [XXX] Group. Based on the confirmed budget, a resale price discount percentage on the prices charged to the Customers, as set forth in the recommended Price List, is calculated to determine the transaction price charged by SPA so that US achieves the budgeted margin with respect to the sale and distribution of the SPA products at the retail and wholesale levels.

The difference in the supply price to US of SPA products and the selling prices charged by US to its customers represents an arm's length margin of US for expenses including, but not limited to: customs duties, freight, and brokerage; development and maintenance and operation of retails [sic] outlets and associated selling and operating expenses; development and maintenance of the wholesale distribution organization and associated operating expense including administrative expenses; maintenance of the showroom facility and other promotional allowances; compensation for development and maintenance of a sales organization fixed and variable expenses associated with warehousing and logistics; and other fixed and variable expenses incurred in operating the business in the Territory including any fee for services rendered by SPA to US pursuant to Subsection 3(f).

As the resale gross margin and resulting transaction prices are based upon budgets, to the extent that actual results vary from budgeted results, such variance is for the account and risk of the relevant Party. There will be no retroactive adjustment to transaction prices unless the variance from budget (either positive or negative; either in terms of volume or revenue) is greater than or equal to 20%. However, the Parties agree that transaction prices may be adjusted for prospective sales at any time by agreement between SPA and US should either party evidence to the satisfaction of the other that budget variance requires an adjustment to the transaction price.

For promotional and advertising planning services rendered by SPA to US during any period, US will pay SPA an arm's length commission equal to fifteen percent (15%) of the investment in advertising spaces made within the Territory. Said media buy is included in the total advertising program of the [XXX] Group as prepared by SPA for all group companies and confirmed by each group company, including US, for their respective markets. IN addition, to the extent that SPA incurs direct production cots directly related to, but not limited to, artwork and photography in support of the media plan as applicable to US, such costs will be charged at cost to US during the period. The expense incurred by US relative to these services provided by SPA are included in the cost base for the margin calculation pursuant to Subsection 3(d).

Section 4 is entitled "Purchasing and Payment" it states in pertinent part that:

Prices charged by SpA to US for products shall be in United States Dollars ($). All prices are calculated for delivery Ex-Works SpA port of shipment. The products are shipped with a duty list that reports Ex-Works prices. As such SpA export licenses, approvals or both shall be obtained by US at its cost. Similarly, all import licenses, approvals, or both shall be obtained by US at its cost. Prices to US do not include any federal, state, or local taxes that may be applicable to SpA products. US shall bear the expense of any applicable customs duties. Every shipment of SpA products will be accompanied by an original invoice from SpA to US. Cost of freight and duty shall be separately invoiced.

Section 6 is entitled "Delivery, Title, Risk of Loss, and Returns". It states in pertinent part that:

(a) Firm purchase orders are to be placed by US with SpA. Products shall be shipped as SpA shall deem appropriate, or as otherwise directed. As shipments are Ex-Works SpA port of shipment, title and risk of loss for SpA products shall remain with SpA until such time as the products are made available to US at SpA's premises, at which time title and risk of loss will shift to US. In this regard, US shall duly draw up an insurance contract sufficient to cover the value of each shipment.

A review of the Agreement, insurance contract and shipping documents indicate that VUSA in accordance with the Ex-Works terms of sale receives title to, and risk of loss of the merchandise from the time it leaves either SpA's premises or their designated port of shipment. According to the transfer pricing study, the merchandise is drop shipped from the manufacturer to the U.S. Although risk of loss shifts at the time of shipment, under the [XXX] Group's umbrella insurance policy the parent of both companies insures the merchandise during all intra-company shipments, including shipments to VUSA.

According to counsel, the unit cost breakdown of VSpA's price to VUSA for the submitted sample is based upon the following inputs:

Silk- [XXXX] L
Labor- [XXXX]
Lace- [XXXX]
Labels- [ XX]
[XXXX] L

For goods destined to the US, counsel states that VSpA applies a mark-up of [XXX]. This multiplier is designed to recover all VSpA's additional costs not detailed above. As such counsel states that this transfer price includes all costs plus a profit. This multiplier is slightly lower than multiplier used for the VSpA's wholesale sales within Italy because according to counsel,VSpA has to recover its commissions and delivery expenses relating to the sales within the home market.

[274,000 x 1.575=432,510.75 L or $205.96 per unit which equals the $206 unit price when entered].

According to counsel, domestic resale price is determined by adding 25% for freight and duty charges incurred by VUSA plus an additional 35% markup. Markup varies for each of the different Valentino collections and may be changed if market conditions require. Retail price equals $[XXXX]. [$206 + (206 x 25%)= $257.50 + (257.50 x 35%)= $347.63. VUSA charges its US customer $346]. Counsel cites 3(d) of the distribution agreement between VSpA and VUSA to indicate what expenses the domestic markup is intended to cover. In addition the mark up is calculated to provide VUSA with an annual operating profit margin of 4%.

Concerning royalties, VSpA entered into the supplied royalty agreement with its related subsidiary, [XXXX]. The royalty agreement grants VCI a license to use the [XXXXX] trademark in the US and the right to sublicense the trademark to 3rd parties. VCI was merged with VUSA at the end of 2000. VUSA assumed the duty for payment for the royalties. Counsel claims that trademark royalties paid to VSpA by VCI and now VUSA relate solely to merchandise imported by unrelated 3rd parties. According to counsel, none of these royalties are paid in connection with merchandise imported by VUSA.

Other agreements include one between VCI and VSpA for advertising costs incurred in the US, and a service supply agreement for advertising and promotion activity. Counsel indicated that VUSA is now responsible for payment of the fees under the "Service Supply Agreement- Advertising and Promotional Activity". Finally, counsel indicates that VSpA has an in house design and development department. All costs associated with that department are built into the multiplier.

Counsel's position is that the related party sale is an arm's length transaction and thus, an acceptable transaction value. Counsel also believes that the sale between the ultimate consignee and VUSA is a domestic sale and therefore is precluded from serving as a basis for transaction value.

Your position is two-fold. You believe that the evidence fails to establish that sales between members of the [XXXX] Group are free of non-market influences and that VUSA is a de facto selling agent for the [XXXX] Group. As such you conclude that the only statutorily viable sale for export is between VUSA and its ultimate consignees in the U.S. You claim that it was this sale that was the impetus for the entire production cycle.

ISSUE:

Whether the sales price between VUSA and its related company VSpA is an acceptable basis for transaction value under 19 U.S.C. § 1401a.

LAW AND ANALYSIS:

The preferred method of appraising merchandise imported into the United States is transaction value pursuant to section 402(b) of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979 (“TAA”; codified at 19 U.S.C. § 1401a). Section 402(b)(1) of the TAA provides, in pertinent part, that the transaction value of imported merchandise is the “price actually paid or payable for the merchandise when sold for exportation to the United States” plus enumerated statutory additions.

Under 19 U.S.C. § 1401a(b)(2)(A)(iv) transaction value is to be used "only if" the buyer and seller are unrelated or, if they are related, their transaction value is considered “acceptable.” The determination of whether a related party transaction value is acceptable requires two analyses. First, regardless of the relationship between the parties, Customs must determine whether there was a bona fide sale for exportation to the United States. Second, in the context of related party transactions, Customs must determine whether the sales price is an acceptable basis for transaction value given the relationship of the parties.

Bona Fide Sale for Exportation to the United States

The first question presented is whether the transaction between the VUSA and VSpA was a bona fide sale for export to the United States. "Sale" means a transfer of ownership from one to another for consideration. J.L. Wood v. U.S., 505 F.2d 1400, 1406 (1974). To determine whether a transaction is a bona fide sale Customs may consider the circumstances of the transaction including passage of title; assumption of the risk of loss; payment of consideration; ability of buyer to instruct the seller; ability of buyer to resell merchandise at any price and to any customer; and ability of buyer to order merchandise for buyer’s own account.

You believe that the transactions between VSpA and VUSA are not bona fide sales, but rather that VSpA and VUSA have a principal/agent relationship. You argue that VUSA is not free to sell the items at any price it desires because the Distribution Agreement states that the purported selling and resale prices are calculated so that VUSA achieves the budgeted margin with respect to the sale and distribution of the VSpA products at the retail and wholesale levels. Additionally, you note that to ensure the agreed upon profit margin, VSpA was not reimbursed for the promotional and advertising expenses incurred for fiscal 2000.

Furthermore, you indicate that subsection 1(b) of the Distribution Agreement states that "should VSpA at the direction of a customer or for other commercial reasons, make salesdirectly to customers within the territory, VUSA shall be remunerated by commission or other such appropriate basis for such sales in the territory." You argue that this language indicates an agency relationship because only a principal would demand remuneration on a sale in the territory to which the "agent" was not directly involved. Finally, you argue that the merchandise is covered by the parent company's insurance policy and that VUSA provides storage and facilitates the distribution of the imported merchandise, tasks associated with selling agents.

Although related to VSpA, counsel argues that VUSA does not act as an agent and that the sales between these parties are bona fide. Counsel states that the merchandise is purchased by VUSA on an ex-works basis. Additionally, VSpA pays VUSA for the goods as evidenced by the proof of payment supplied in their April 19, 2001 letter. Furthermore, VUSA may change the mark-up to its own customers thereby controlling the price for which the goods are sold. Finally, VUSA acts as an independent profit center.

A review of the evidence submitted leads to the conclusion that there is a bona fide sale between VSpA and VUSA. For a bona fide sale to occur, there must be transfer of ownership of the merchandise for consideration between the parties. Section 6 of the Distribution Agreement indicates that there has been a transfer of ownership between the parties (see pg. 6). The terms of sale between VSpA and VUSA were ex-factory port of shipment with VUSA taking title and assuming risk of loss for the merchandise at the point the goods were made available at VSpA's premises. When one party takes title and assumes risk of loss for the merchandise from another than a transfer of ownership has occurred. We note that while the insurance policy is held by the Valentino Group's ultimate parent HdP, that fact alone is not sufficient evidence to conclude that risk of loss did not pass between the parties and therefore a bona fide sale did not occur.

The importer has also demonstrated that the transaction meets the second requirement of a sale, that the transfer of ownership of the goods was for consideration. Baron's law dictionary Baron's Law Dictionary Third Edition, by Steven H. Gifis, Baron's Educational Series, Inc. 1991, p. 92. defines consideration as "the inducement to a contract, something of value given in return for a performance or a promise of performance by another, for the purpose of forming a contract." The importer has supplied proof that consideration was in fact exchanged. In his April 19, 2001 letter counsel includes a May 25, 2001 request to the importer's bank to debit its account in the amount of the submitted invoice for the benefit of VSpA. Furthermore, this request is confirmed by the importer with a submitted proof of payment dated the same day from the bank identified in the request. This is evidence that VUSA performed its part of the bargain (payment) and because payment was provided that VSpA must have fulfilled its part by supplying the goods. The documents submitted at entry (invoice, bill of lading, etc.) are further evidence of VSpA's fulfillment of its obligations under the contract.

We note that there is a legitimate prima facie question about the extent to which VUSA has control over its prices for resale of the merchandise in the United States. That question is allayed however by the fact that nothing in the distribution agreement prevents VUSA from altering the mark-up to their domestic customers if market conditions require it to meet the 4% profit requirement. In fact, subsection 3 (c) and (d) indicate that the price between VUSA and its US customers may vary from "the recommended price list" to include its incurred costs. Counsel's April 19, 2001, submission indicates that VUSA's price to its US customers is determined by adding 25% for freight and duty charges incurred by VUSA plus an additional 35% markup. According to counsel, the markup varies for each of the different [XXXX] collections and may be changed by VUSA if market conditions require. As such it appears that VUSA does have some control of the prices it charges domestic retailers.

Furthermore, counsel indicates in his November 7, 2001 submission that the importer transfers title and risk of loss to its resale customers after the goods arrive in the United States and has the authority to negotiate its own prices as well as the authority to select its own customers. Counsel also states that the importer provides instructions to the vendor regarding the ordered merchandise and purchases merchandise for inventory. These factors all support the conclusion that the importer is functioning as a buyer.

With respect to the distribution clause 1(b), while VSpA agrees to provide a commission in instances where it sells goods directly to U.S. customers, this is not the ordinary relationship of the companies. It merely recognizes VUSA's distribution rights for the merchandise in the territory and provides for those rare instances when such is not the case. Such an arrangement for anomalies by itself, does not indicate a principal/agent relationship. Finally, the fact that VUSA bought and sold merchandise for its own account indicates that it was not acting as an agent of VSpA. Although it may be true that VUSA is a distributor of VSpA’s merchandise, such an arrangement does not conclusively demonstrate that VUSA performed as an agent of VSpA.

Therefore, based on the information presented, we determine that the subject transactions were bona fide sales. There is also no question that these sales were "for exportation to the United States". The only remaining question is whether the related party price is an acceptable basis for transaction value.

Acceptability of Related Party Price

Although the valuation statute allows appraisement based on the transaction value between related parties, the statute requires that the price between such parties must be free of influence from the relationship or that the transaction value closely approximate certain test values. According to the statute:

(B) The transaction value between a related buyer and seller is acceptable for the purposes of this subsection if an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between such buyer and seller did not influence the price actually paid or payable; or if the transaction value of the imported merchandise closely approximates—

(i) the transaction value of identical merchandise, or of similar merchandise, in sales to unrelated buyers in the United States; or

(ii) the deductive value or computed value for identical merchandise or similar merchandise;
but only if each value referred to in clause (i) or (ii) that is used in comparison relates to merchandise that was exported to the United States at or about the same time as the imported merchandise. 19 U.S.C. § 1401a(b)(2)B)

Accordingly, the price between related parties may be an acceptable basis for appraisement under either of the two statutory analyses: the circumstances of sale method or the test values method. In this case, no information regarding test values has been submitted.

Circumstances of Sale

The circumstances of sale method requires an examination of the how related parties conduct business to determine whether their relationship affects the price. The Statement of Administrative Action provides two examples of how the circumstances of sale test may be satisfied: 1) the pricing between the related parties is consistent with normal industry pricing practice; and 2) the pricing between the related parties is consistent with the way the seller deals with unrelated buyers. See Statement of Administrative Action (“SAA”), H.R. Doc. No. 103-316, 103rd Cong., 2d Sess. (1994), reprinted in Customs Valuation under the Trade Agreements Act of 1979, at 53 - 54; Section 152.103(j)(2), Customs Regulations (19 C.F.R. 152.103(j)(2)). The SAA also explains that the circumstances of sale test may be satisfied if the related party price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm’s overall profit realized over a representative period of time in sales of merchandise of the same class or kind.

Counsel asserts that the transfer pricing study establishes that VSpA's price to VUSA has not been influenced by the relationship and as such is acceptable as the basis of transaction value. This is based on the fact that when the CPM method was applied, the operating margin for the comparable companies was between -0.15% and 10.16%, and that VUSA's 4% operating margin falls squarely within that range.

Counsel also indicates that Customs has previously accepted a transfer pricing study to show that a non-influenced price is one that enables the seller to earn a markup equivalent to that of other companies selling merchandise of the same class or kind to unrelated buyers, citing Headquarters Ruling Letter (HRL) 546998 dated January 19, 2000. Counsel also refers to HRL 546979 dated August 30, 2000, in which Customs accepted a transfer price that was developed through, use of the CPM. In that case the importer provided an Advanced Pricing Agreement with the Internal Revenue Service IRS), as evidence that a price between related parties has not been influenced by the relationship.

As stated in HRL 546979 "while the goal of both the TAA and section 482 of the Tax Code is to ensure that the transactions between related parties are at arm's length, the method of making that determination is different under each law." For example, the ruling notes that the IRS CPM method used in that case reviews profitability on an aggregate basis, not a product-by-product basis as does Customs. Accordingly, HRL 546979 concluded that the existence of a transfer pricing study does not obviate the need for Customs to examine either test values or the circumstances of sale in order to determine whether a related party price is acceptable.

Although information contained in a transfer pricing study may be relevant to the application of the circumstances of sale test, the weight to be given to this information varies depending on the facts presented. For example, a key consideration is whether the transfer pricing study has been considered and approved by the IRS. See HRL 546979, supra. Another important consideration is whether the products covered by the study are comparable to the imported products at issue. See HRL 547672 dated May 21, 2002. The methodology used in the study and the specific details provided are also relevant.

Although Customs did give weight to the transfer pricing methodology based on the CPM in HRL 546979, the following special circumstances were presented in that case: 1) the transfer pricing methodology had been approved by the IRS through the Advance Pricing Agreement (APA) program; 2) Customs participated in the APA pre-filing conference between the importer and the IRS, and had access to the information provided to the IRS throughout the APA process; 3) the importer provided a waiver to Customs to enable access to the documents that were submitted to the IRS in the APA process; 4) all of the importer's imported products were covered by the APA; and 5) the transfer pricing agreement was a bilateral agreement in which both taxing authorities (U.S. and Japan) had examined the relevant aspects of the transactions. Based on these special circumstances, Customs determined that the circumstances of sale test had been met.

In HRL 546998, the other ruling cited by counsel, Customs also took into consideration a transfer pricing study submitted by the importer in determining that the related party price was an arm's length price. However, there are material differences between the facts presented there and in the instant case.

First, in HRL 546998, the Comparable Industry Set consisted only of companies which were engaged in the sale of merchandise of the same class or kind as the importer's (timepieces and clocks). In the instant case, the imported merchandise consists of high fashion and /or designer merchandise. It does not appear that the "comparable companies" referenced in the study are engaged in the sale of high fashion and/or designer merchandise. We note that none of these companies was identified by counsel as a competitor of VUSA or VSpA. Thus, it is not clear whether the comparable companies engage in the sale of merchandise of the same kind or class. Also, it is not clear whether these comparable companies are engaged in the sale of the full range of products sold by VUSA and VSpA, i.e. perfume, cosmetics, watches, optical wear and shoes.

Thus, while HRL 546998 did take into account the company to industry comparisons in determining that the related party price was an arm's length price, this conclusion was based primarily on the fact the manufacturer's price adequately ensured its recovery of all costs plus profit equivalent to SCJ's, or the firm's overall profit, over an appropriate time period, for sales in timepieces and clocks, merchandise that is of the same class or kind. In this instance we do not have the group's overall profit.

Counsel asserts that its submitted information concerning VSpA's costs that indicates the related party pricing is adequate to ensure recovery of all costs plus a profit that is equivalent to the company's overall profit realized over a representative period of time in sales of merchandise of the same class or kind. We disagree.

In HRL 548098 dated May 20, 2002, the importer purchased high value women’s formal wear, lingerie, sleepwear, swimwear, men’s underwear and accessories, from a related seller. In an effort to illustrate the seller’s pricing practices, counsel provided detailed price calculations for three products selected by Customs. For each of these products, the seller provided worksheets calculating the cost of materials and labor, including costs per unit. Furthermore the seller provided audited financial statements, and information regarding the seller’s costs for the subject items and the actual profit for them. A review of this detailed accounting information allowed Customs to find that the seller’s price was adequate to allow the seller to recover all costs and the requisite profit.

In this instance, while counsel stated a list of costs and identified the mark-up with an amount assigned, counsel did not provide detailed information or documentation regarding VSpA's costs, e.g. accounting records. More importantly however, the distribution agreement indicates that the price between VUSA and VSpA doesn’t necessarily have to include a profit, only that VUSA's price to domestic retailers must include a 4% annual profit. Section 3 (a) allows for the price for the wholesale goods between VSpA and VUSA to vary from the "recommended price list" when it is necessary so that any variation can ensure that VUSA earns at least a 4% profit. Section 3(b) indicates that when VSpA sells goods to VUSA for their retail stores the price must cover at least the cost of production and only that. Furthermore, for profit figures to be relevant they must pertain to the firm's overall profit realized in sales of merchandise of the same class or kind. As indicated above, this information was provided by HRL 546998. Here, neither information concerning the Valentino Group's firm-wide profit on sales of the same class or kind was submitted nor was information on HdP SpA's profit. Without this information we cannot determine whether the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind.

Finally, in HRL 546998 Customs held that the mark-up comparison between SLHK to SCJ, as well as to the other companies selling merchandise of the same class or kind, indicated that SLHK's cost and profit figures were consistent with the market as a whole. We stated that such consistency demonstrated that the price between SLHK to SCJ had also has been settled in a manner consistent with the normal pricing practices of the industry.

In asserting that a similar conclusion should be drawn in this case, counsel relies on the transfer pricing study to claim that the operating margins earned by VUSA (net profit as a percentage of net sales) are "comparable" to those earned by "other companies in the apparel industry who purchase from unrelated suppliers under similar circumstances."

In HRL 547672 supra, Customs specifically determined that a submitted transfer pricing study was not sufficient to establish that the transfer prices at issue were set in accordance with the normal pricing practices in the industry. Customs noted that the study did not provide any objective criteria regarding how the industry sets its prices, nor was it clear that the data presented actually pertained to the pricing practices of the pertinent industry. In order to establish a normal pricing practice in the industry, objective evidence is needed regarding how prices are set in the industry in question. For example, in HRL 542261, March 11, 1981 (TAA No. 19), Customs determined that where the transfer price was defined with reference to prices published in a trade journal (the posted price) and the posted price was commonly used by other buyers and sellers as the basis of contract price, the transfer price was acceptable. In such case, a determination could be made that the transfer price was settled in a manner consistent with normal pricing practice in the industry.

With regard to the apparel industry, in HRL 545800, June 28, 1996, a pricing formula was utilized to determine the transfer price; i.e., the transfer price shall equal a specified percentage of the buyer's resale price. In order to show that transaction value was acceptable, the importer submitted information regarding its gross profit realized along with information about the normal profit in the men's and boys' apparel industry which was the Standard Industrial Code classification into which the seller's business activities fell. Even though the gross profit realized by the importer through the application of the pricing formula was similar to the normal gross profit in the men's and boy's industry, Customs concluded that the information provided did not establish that the price was settled in a manner consistent with the normal pricing practices in the industry. The ruling states in pertinent part that:

[n]o evidence has been presented to establish that the pricing formula employed by the parties is a normal practice among unrelated parties in the industry in question, presumably the men's and boys' sweater industry. The information provided on the gross profit of the men's and boys' apparel industry also fails to show that the circumstances of sale between the parties indicate that the price actually paid or payable for the imported merchandise was not influenced by the relationship of the parties. Even if the general expenses and profit realized by (the seller) are within the range of what constitutes the usual general expenses and profits of the relevant industry, this would not show that price between (the buyer and the seller) was settled in a manner consistent with normal pricing practice in the industry.

As was the case in HRL 545800, the present submission lacks objective evidence detailing the normal pricing practice in the industry in question, assuming such a practice even exists for the designer industry. As such the importer has not established an acceptable related party price by establishing that the price was settled in a manner consistent with normal pricing practices in the industry. Also, as discussed above it is not sufficient to demonstrate that the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit realized over a representative period of time in sales of merchandise of the same class or kind.

Accordingly, the information submitted is insufficient to conclude that the relationship between the parties did not affect the price paid by the VUSA. Therefore, transaction value is not an acceptable basis for appraisement.

HOLDING:

The sale between VSpA and VUSA constitutes a bona fide sale. However, based upon the information submitted we find that the related party price is not acceptable for purposes of transaction value. The merchandise should be appraised according to the next applicable method of valuation under the hierarchy of methods set forth in 19 U.S.C. 1401a, beginning with transaction value of identical or similar merchandise.

This decision should be mailed by your office to the party requesting internal advice no later than sixty days from the date of this letter. On that date the Office of Regulations & Rulings will take steps to make the decision available to Customs personnel via the Customs Rulings Module in ACS and the public via the Diskette Subscription Service, Freedom of Information Act, and other public access channels.

Sincerely,

Virginia L. Brown

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