HQ 545481 - Transaction value inapplicable; deductive value; unit price at which merchandise is sold to unrelated persons at the first commercial level after importation; related persons; 19 U.S.C. ? 1401a(g); meaning of the term "control;" Transfer Pricing Notice; Customs Valuation Code - United States International Trade Commision Rulings

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HQ 545481

September 14, 1994

VAL CO:R:C:V 545481 CRS

CATEGORY: VALUATION

District Director
U.S. Customs Service
300 South Ferry Street
Room 1001
Terminal Island, CA 90731

RE: Transaction value inapplicable; deductive value; unit price at which merchandise is sold to unrelated persons at the first commercial level after importation; related persons; 19 U.S.C. ? 1401a(g); meaning of the term "control;" Transfer Pricing Notice; Customs Valuation Code

Dear Sir:

This is in reply to your request for internal advice (IA), dated November 5, 1993, regarding the appraisement of [***] imported from *********** by ABC, Inc. (ABC), the wholly owned U.S. subsidiary of XYZ Corp. (XYZ), the manufacturer of the merchandise. Two submissions were made by ABC in regard to this matter under cover of letters dated November 5, 1993, and April 1, 1994. ABC has requested that certain information supplied in connection with the IA be treated as confidential pursuant to section 177.2(b)(7), Customs Regulations (19 C.F.R. ? 177.2(b)(3)). Any such information that appears in this decision has been bracketed and will be deleted from any published versions. We regret the delay in responding.

FACTS:

ABC imports [****] from XYZ and sells them to exclusive distributors who in turn are responsible for supplying dealers with the merchandise. One of the distributors, Distributors, Inc., is a subsidiary of ABC; however, two others are independently owned. Based on the information presented, the transfer price is "negotiated" at periodic meetings between ABC and XYZ, which negotiations, ABC contends, are conducted at arm's length. Once the retail price of a particular product is set, the transfer price is derived by deducting from this figure certain

Also included in the adjustments to the retail price is an item identified as a "special fund." The "special fund" was established by the parties in order to adjust ABC's profit and thereby satisfy concerns raised by the Internal Revenue Service (IRS) under section 482 of the Internal Revenue Code. The effect of the fund is to [*************] and correspondingly, to lower the value of the imported merchandise for appraisement purposes. You have therefore questioned the XYZ-ABC transfer price based on the existence of the "special fund." You maintain that unrelated parties would not settle prices in this manner; consequently, you consider transaction value to be unacceptable.

ABC maintains that the imported merchandise should be appraised under transaction value. Nevertheless, in the alternative, assuming that deductive value is determined to be the appropriate basis of appraisement, ABC asserts that the imported merchandise should be appraised based on the price paid to ABC by the two independently owned and operated distributors, Distributors A and Distributor B. According to information provided by the importer, ABC does not directly or indirectly own, control, or hold any voting stock or shares of either Distributor A or Distributor B, nor do Distributor A or Distributor B have any stock ownership, direct or indirect, in ABC.

In regard to alternative bases of appraisement you have advised that there are no sales of identical or similar merchandise to unrelated parties in the U.S. and that, as a result, the imported merchandise cannot be appraised on the basis of the transaction value of identical or similar merchandise. You also contend that deductive value is inapplicable in regard to merchandise imported by ABC since you deem Distributor A and Distributor B to be related to ABC by virtue of the control ABC exercises over these independently-owned distributors.

ISSUES:

The issues presented are: (1) whether transaction value is an acceptable basis of appraisement; (2) if transaction value is inapplicable, whether the deductive value method mandates use of the "first sale" after importation as the only acceptable starting point for appraisement or whether it permits use of the first sale to unrelated parties, even though that sale may not be the first sale in the U.S.; and (3) whether distributors which are independently owned and operated but subject to strict contractual constraints, are considered to be directly or indirectly under the control of the ABC and, therefore, related parties for appraisement purposes. LAW AND ANALYSIS:

Transaction Value

Merchandise imported into the United States is appraised 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. the "price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain enumerated additions. 19 U.S.C. ? 1401a(b)(1).

However, imported merchandise is appraised under transaction value only if the buyer and seller are not related, or if related, the transaction value is deemed to be acceptable. Here the buyer and seller, i.e., ABC and XYZ, are related pursuant to section 402(g)(1)(G) of the TAA. 19 U.S.C. ? 1401a(g)(1)(G). Section 402(b)(2)(B) of the TAA sets forth two conditions under which a transaction value between related parties will be deemed acceptable. The first is where an examination of the circumstances of sale indicates that the relationship between the parties did not influence the price actually paid or payable. The second is where the transaction value closely approximates certain "test" values. 19 U.S.C. ? 1401a(b)(2)(B).

Under the first approach, if the circumstances of sale indicate that while related, the parties buy and sell from one another as if they were unrelated, transaction value will be considered to be acceptable. In this respect, Customs 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. 19 C.F.R. ? 152.103(l)(1)(i)-(ii). In addition, Customs 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 buyer's overall profit realized over a representative period of time. 19 C.F.R. ? 152.103(l)(1)(iii).

ABC asserts that the circumstances of the XYZ-ABC sale support the validity of the transfer price. Specifically, ABC contends that the negotiations it undertakes with XYZ in setting the transfer price satisfy the statutory requirement for finding transaction value to be acceptable. However, the transfer price is determined by deducting certain amounts from the retail price, including a deduction in respect of the "special fund." The "special fund" reflects the IRS's demonstrated that this is the manner in which XYZ settles prices with unrelated buyers, nor that this method of setting prices is consistent with the normal pricing practices of the [***] industry.

ABC also contends that it has satisfied the "all costs plus a profit" test set forth in 19 C.F.R. ? 152.103(l)(1)(iii); but in lieu of cost and profit information, ABC prepared a deductive value calculation which it contends demonstrates that the relationship did not influence the transfer price. However, this information does not show that the transfer price was adequate to recover all XYZ's costs plus a profit representative of its overall profit realized over a representative period. Thus it fails to establish that the relationship did not influence the price.

Alternatively, a transaction value between related parties is acceptable if it closely approximates, inter alia, the deductive or computed value "test values" for identical or similar merchandise. The term "test values" refers to values previously determined pursuant to actual appraisements of imported merchandise. Thus, for example, a deductive value calculation can only serve as a test value if it represents an actual appraisement of imported merchandise determined pursuant to section 402(d) of the TAA. E.g. Headquarters Ruling Letter 543568 dated May 30, 1986. There are no previously determined deductive or computed values with respect to merchandise imported by ABC. Consequently, test values cannot be used to validate transaction value. Since ABC has been unable to demonstrate that the relationship with XYZ did not influence the price actually paid or payable, transaction value is inapplicable.

If imported merchandise cannot be appraised on the basis of transaction value, it will be appraised in accordance with the remaining methods of valuation, applied in sequential order. 19 U.S.C. ? 1401a(a)(1). The first of the alternative bases of appraisement is the transaction value of identical merchandise or the transaction value of similar merchandise (19 U.S.C. ? 1401a(c)). However, you have advised that there is insufficient information respecting the sales of such merchandise. Accordingly, the imported merchandise cannot be appraised under 19 U.S.C. ? 1401a(c).

Deductive Value

The next applicable basis of appraisement is deductive value pursuant to section 402(d) of the TAA, which defines deductive value as being the unit price at which imported merchandise is sold in the greatest aggregate quantity, subject to certain limitations as to when those sales may occur. Section 402(d)(2)(B) of the TAA defines the term "unit price," in pertinent part, as follows:

(B) For purposes of subparagraph (A), the unit price at which merchandise is sold in the greatest aggregate quantity is the unit price at which such merchandise is sold to unrelated persons, at the first commercial level after importation...at which such sales take place.... (Emphasis added).

19 U.S.C. ? 1401a(d)(2)(B). You have asked whether the TAA limits deductive value appraisement to the first sale after importation, or whether sales at another level may be considered if the first level sale is to a related party. It has been asserted that if the first sale in the U.S. is to a related party, the use of deductive value is prohibited. Nevertheless, in our view a number of factors support a contrary conclusion.

First among these is the language of section 402(d)(2)(B) of the TAA and the reference therein to "such sales." The phrase "at which such sales take place" is a prepositional phrase that forms part of the subordinate clause underlined above. The term "such sales" in the subordinate clause must therefore modify sales which are identified in the sentence's main clause, i.e., the sales "at which merchandise is sold to unrelated persons." Thus the expression "such sales" refers to sales made to unrelated persons. Indeed, the entire subordinate clause refers to sales of merchandise to unrelated persons. Accordingly, if there are no sales to unrelated persons at the first level after importation, the statute admits of an inquiry at subsequent levels in order to determine if there exists a basis for deductive value.

Additionally, the Customs regulations support this interpretation. The regulations focus on the need to use prices for sales to unrelated purchasers following importation but make no mention of "commercial level." Instead, the regulations state a unit price will be established for deductive value purposes after a sufficient number of units are sold to unrelated persons. 19 C.F.R. ? 151.105. Since the regulations focus solely on sales to unrelated purchasers rather than on commercial levels, ABC argues that Customs has adopted an interpretation of section 402(d)(2)(B) that implements the intent of Congress.

The legislative history of the TAA also suggests that Congress intended that there should be recourse to subsequent levels of sales in the event that there were no sales to unrelated persons at the first level after importation. In this regard, the report of the House Ways and Means Committee states that the term "unit price" refers to "the unit price at which merchandise is sold to unrelated persons, at the first commercial level after importation at which such sales take place." The H.R. Rep. No. 317, 96th Cong., 1st sess. 93 (1979). Here again, the term "such sales" can only refer to sales to unrelated persons since these are the only sales in the sentence that the term could conceivably modify. Thus the language of the House Report supports the view that "such sales" refers to merchandise sold to unrelated persons.

Furthermore, the report states that although it would constitute a change from pre-TAA law not to consider sales to related parties, the effect of the change was expected to be minimal. Id. ABC argues that the alternative interpretation, i.e., to deny the use of deductive value appraisement to importers who had no first-level sales to unrelated parties, would represent a sweeping change from the pre-TAA legislation which contained no such limitation. By characterizing the change from the old law to the TAA as minor, ABC suggests that Congress intended that deductive value inquiries should continue beyond the first commercial level to the first commercial level at which sales to unrelated customers take place.

Finally, this interpretation is also supported by the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (the "Customs Valuation Code," or the "Code"), which was implemented in U.S. law by the TAA. Article 5 of the Code is the parallel provision to section 402(d) of the TAA. It states that if imported goods are sold in the country of importation in the condition as imported, their customs value "shall be based on the unit price at which the imported goods...are so sold in the greatest aggregate quantity, at or about the time of the importation...to persons who are not related to the persons from whom they buy such goods." There is no mention of commercial levels the Code language. Thus the only criterion is that the sale be made to an unrelated person in the country of importation.

The Code divides the analysis into two prongs. First, it requires that an inquiry be made to determine whether any sales to related parties occur. Second, assuming sales to related parties do occur, the Code states that customs value should be based on the unit value at the first commercial level at which there are sales to unrelated parties. Thus, in a situation where the importer first sells to a related party in the U.S., which party then sells to an unrelated third party in the U.S., the second sale could form the basis of a unit value on which to appraise under deductive value.

Pursuant to the foregoing, it is our position that the term "unit price" for deductive value purposes means the unit price at which the greatest number of units is sold to unrelated persons at the first commercial level at which such sales occur. It therefore follows that the language of the TAA does not prohibit sales to unrelated persons beyond the first level of sale after importation, e.g., sales at secondary or tertiary levels, from being used as a basis for deductive value. Accordingly, deductive value is not limited to the first sale after importation, but can be applied to any unrelated sale after importation, provided aggregate quantity levels are satisfied.

Related persons and the meaning of the term "control"

Section 402(g)(1) of the TAA sets forth the definition of the term "related persons" and provides in relevant part that the following shall be treated as persons who are related:

(F) Any person directly or indirectly owning, controlling, or holding with power to vote, 5 percent or more of the outstanding voting stock or shares of any organization and such organization.

(G) Two or more persons directly or indirectly controlling, controlled by, or under common control with, any person.

Customs recently published a notice in the Federal Register (58 Fed. Reg. 5445, January 21, 1993; 27:4 Cust. B. & Dec. 4) entitled, "Transfer Pricing; Related Party Transactions." The notice focused on the statutory definition of "related parties" set forth in section 402(g) of the TAA. In addition, the notice stated:

In the Statement of Administrative Action ("the SAA"), adopted by Congress, the phrase "two or more persons directly or indirectly controlling, controlled by, or under common control with, any person" is understood to cover the following situations:

(1) where one of them directly or indirectly controls the other;

(2) where both of them are directly or indirectly controlled by a third person; or

(3) where together they directly or indirectly control a third person.

27:4 Cust. B. & Dec. at 4-5. However, the notice recognized that Customs has not had occasion to issue any decisions pertaining to the meaning of the term "control" as set forth in section 402(g)(1)(G) and the SAA.

The transfer pricing notice also referred to the Customs Valuation Code, which provides at Article 15, Paragraph 4(e):

For the purposes of this Agreement, one person shall be deemed to control another when the former is legally or operationally in a position to exercise restraint or direction over the latter.

The notice stated that determinations of what constitutes "control" will be made on a case by case basis within the context of the administrative review procedures available to the importing public under sections 174 and 177 of the Customs Regulations (19 CFR 174 and 19 CFR 177). 27:4 Cust. B. & Dec. 4, at 4-5 (Jan. 27, 1993). The announcement placed the importing public on notice that Customs will look to all provisions of the value statute to make determinations concerning related parties.

As discussed above, under deductive value Customs must determine a starting point for appraisement relative to the sale in the U.S. of imported merchandise. In the instant case ABC sells the imported merchandise to exclusive distributors, some of which are owned by ABC, and others of which are independently owned. ABC asserts that the starting point for deductive value should be based on the price charged to two independently owned and operated distributors, Distributor A and Distributor B. According to information provided by the importer, ABC does not directly or indirectly own, control, or hold any voting stock or shares of either Distributor A or Distributor B, nor do Distributor A or Distributor B have any stock ownership, direct or indirect, in ABC. Thus the only other possible basis for finding that Distributor A and Distributor B are related to ABC is the control provision; however, the TAA and the regulations do not define the term "control," and no decisions interpreting the term "control" have been issued. Consequently, it is necessary to look at the legislative history of the TAA.

The U.S. valuation law was enacted to implement the Customs Valuation Code. 19 U.S.C. ? 2502(1). The Code elaborates on the definition of control and, as noted above, states in the Interpretative Note to Article 15, paragraph 4(e), that "one person shall be deemed to control another when the former is legally or operationally in a position to exercise restraint or direction over the latter." In July, 1987, the Technical Committee on Customs Valuation, established under the Code to operate under the auspices of the Customs Co-operation Council (Technical Committee), published an explanation of its interpretation of the term "control," entitled Explanatory Note 4.1, "Consideration of Relationship Under Article 15.5, Read in Conjunction with Article 15.4," published in Customs Co-operation Council, Customs Valuation: GATT Agreement and Texts of the Technical Committee on Customs Valuation, Amending Supplement No. 5, July, 1987 (Explanatory Note (EN) 4.1). The document begins by noting that Article 15.5 of the Customs Valuation Code specifies that parties will not be deemed related simply because one is the sole agent, distributor, or concessionaire of the other. Rather, to conclude that parties are related it is necessary to determine whether they meet one of the definitions in Article 15.4 of the Code (the related party definitions). EN at ?? 2 and 4.

It should be noted that the international texts discussed here are not U.S. law. As such, they are not necessarily binding on our interpretation. E.g., Campbell Soup Company, Inc. v. U.S., Slip Op. 94-80 (Ct. Int'l Trade, May 16, 1994), wherein the court stated:

Even assuming Congress did not conform United States laws with the GATT, such a problem is immaterial to the Court's resolution of this case. See Suramerica de Aleaciones Laminadas, C.A. v. United States, 10 Fed. Cir. (T)__,__, 966 F.2d 660, 667 (1992) ("While we acknowledge Congress's interest in complying with U.S. responsibilities under the GATT, we are bound not by what we think Congress should or perhaps wanted to do, but by what Congress in fact did. The GATT does not trump domestic legislation; if the statutory provisions at issue here are inconsistent with the GATT, it is a matter for Congress and not this court to decide and remedy.") (citations omitted).

Nevertheless, absent guidance in our own law regarding the interpretation of the term control, we have looked to the international text for guidance.

In their analysis of the term "control," the Technical Committee noted that Customs officials must be careful not to interpret the term so liberally as to produce results that were not intended. As stated by the Technical Committee:

12. Obviously, caution must be exercised...to ensure that unintended results do not occur through improper interpretations of this provision [the "control" definition] when considering the terms and conditions of contracts which have been freely entered into by otherwise unrelated parties. The examples [discussed in paragraphs 6 and 7]) represent situations wherein the terms and conditions of the contracts are heavily weighted in favor of one party over the other and the former would be legally in a position to exercise restraint over the latter. However, in any contract, verbal or written, even of the most simple type, one party is always in a position to legally [sic] exercise restraint or direction over the other in accordance with the terms of the contract and that party will have legal remedies if the terms of the contract are not met.

14. It can be concluded that it is not the intent of [the definition of the term "control"] to create a relationship out of every contract or agreement which of their very nature establish legal rights or obligations enforceable under national laws. Therefore, the wording of the Interpretative Note to Article 15.4(e) wherein a person is legally or operationally in a position to exercise restraint or direction over another must normally be taken to apply to situations other than those wherein two parties, who are otherwise unrelated, freely enter a contract.

15. In other words, if the parties are free to negotiate or not negotiate, if the parties are free to enter or not enter the contract and if the contract can be terminated by either one of the parties upon notice, by action of a type specified in the contract or by means of not acting on a renewal provision then, regardless of the terms or conditions or the degree of control of one party over the other given by these terms or conditions, it would be difficult to envisage circumstances wherein such contracts would cause the parties to fall within the purview of Article 15.4(e) or its Interpretative Note ["control" definition of related parties]. To create such a relationship, the conditions of Article 15.4(e) ["control"] must normally exist independently of the freely entered terminable contract under consideration....

EN 4.1 at ?'s 12-15.

ABC asserts that deductive value should be based on the price at which ABC sells imported merchandise to the independently owned, unrelated distributors, Distributor A and B. Moreover, ABC asserts that it sells identical merchandise to its related distributors at the same prices charged to Distributors and B. Although Customs accepts the fact that ABC has no ownership interest in either Distributor A or Distributor B, a question has arisen about whether the distributors are related to ABC by virtue of the control ABC is able to exercise pursuant to express contractual provisions.

The relationship between ABC and its distributors is governed by a standard distributorship agreement, the provisions of which suggest a substantial degree of influence or control by ABC over Distributor A and Distributor B. The Distributor A/ABC and Distributor B/ABC agreements contain, for the most part, identical language setting forth the rights and obligations of the parties. Specifically, the agreements state:
a. Importer has the right to approve changes in the distributors' ownership and the right of first refusal with respect to sales of distributors' stock.
b. Importer has the right to approve appointment of general managers, dealers and Dealer Agreements by the distributors. Distributor will not appoint any general manager without the prior written approval of importer.
c. Distributor must obtain prior written approval from importer before moving its place of business or establishing a new location, branch office, or place of business with respect to its [***] distributorship operations.
c. Distributors must maintain adequate working capital and ownership equity in amounts satisfactory to importer and maintain a confirmed [line of credit] with a bank or other financial institution or other method of financing acceptable to importer; distributors must submit to importer a summary of their flooring agreements specifying terms and conditions.
d. Distributors must submit to importer, full and complete financial and operations statements for each month in a form and at a time satisfactory to importer; and distributors must submit audited annual financial statements to importer.
e. Importer has right to establish and change prices and terms for its sales to distributors without advance notice; it retains the right to change its price at any time. [In its papers, ABC states that this right was freely negotiated and importer believes this has always been the standard pricing practice in its industry].
f. While importer can change prices to distributors, it has no right to share in the distributors profits, and it cannot do so simply by controlling its sales price to distributors.

Notwithstanding the above provisions, ABC argues that the agreements do not give them the authority to dictate the prices or terms at which the distributors sell their merchandise, nor do the agreements give them the authority to name or appoint the distributors' management. ABC contends that the agreements are the result of bargained-for exchanges between ABC and the distributors during the negotiation process.

ABC claims that the purpose of these clauses is to safeguard ABC's interest in the effective distribution of its products and the goodwill, reputation and trademarks that it has developed over many years. In order to accomplish these objectives, ABC states that it must have access to information relating to its independent distributors' financial condition, first to ensure that they are financially able to distribute [***] products and, second, to warn of an impending bankruptcy if a particular distributor were unable to adhere to the terms of the agreement. In addition, ABC notes that it requires the information for its own purposes, e.g., to monitor unit volumes, inventory levels and inventory mix. In this respect ABC asserts that the contractual provisions are merely an attempt by ABC to protect its own intangible property (trademark, reputation, goodwill, etc.) by the independent distributors and dealers, rather than specifically to control its distributors and dealers. Finally, in regard to the ability to set prices and change sale terms, ABC contends that this right was freely negotiated, is found in model distributorship agreements, is standard in the [***] industry, and therefore does not amount to control.

We do not dispute the fact that there are valid business reasons for the provisions contained in the agreements. Nevertheless, we regard the agreements as giving ABC the ability to exercise substantial control over the unrelated distributors. In disputing the contention that the agreements amount to control, ABC states that provisions of the agreements were freely negotiated and are found in model distributorship agreements. For example, the right to changes prices (article IV of the ABC-Distributor A agreement) derives from section 36 of a model exclusive distributorship contract. 12 Am Jur Legal Forms 2nd ? 178.82. Certain other provisions in the agreements are also standard clauses found in model distributor agreements (the "model agreement"). E.g. 12 Am Jur. Legal Forms 2d ? 178.82; section 5 (Distributor's appointment of dealers is subject to company approval); section 23 (distributor agrees to maintain adequate finances and to provide financial and operating statements to company on a regular basis). However, the provisions of ABC's agreements with Distributor A and Distributor B go well beyond those of the model agreements.

Section 5 of the model agreement gives the company granting the exclusive distributorship the right to appoint dealers. This right is subject to approval by the granting company. A similar but more detailed provision appears in ABC's distributorship agreements, e.g., article VI of the Distributor A agreement. However, in addition to exercising control over the distributors' actions at the dealer level, ABC's authority over its unrelated distributors extends much further than do any of the rights conferred by the model agreements. Thus, for example, Distributor A must obtain ABC's prior written approval for any changes in ownership, and grant ABC the right of first refusal in any stock transfers. Distributor A agreement at 2. Distributor A cannot appoint any general manager without ABC's approval. Distributor A agreement, article V, ? 3 at 13.

Another example of the extent of ABC's control can be found by comparing section 23 of the model agreement with its counterpart in the ABC distributorship agreements. Section 23 of the model agreement states that the distributor will provide certain financial information on a monthly basis. Once again, ABC's agreements go further. In addition to providing financial statements on a monthly and annual basis, Distributor A, for example, must provide ABC with daily and monthly reports of its sales and inventory of [***] merchandise, daily and monthly reports of its sales and inventory of parts, and daily and monthly compilations of its dealer's sales and stock. Distributor A agreement, article V, ? 10 at 16.

In view of the rights granted by the agreements, we consider that ABC is in a position to exercise substantial control over both Distributor A and Distributor B. Moreover, we believe this conclusion to be consistent with section 402 of the TAA, the Code and EN 4.1. In our view, ABC's relationship with Distributor A and Distributor B, is not the type of contractual arrangement to which the Technical Committee's Explanatory Note refers when it states that one should not conclude that it is the intent of the Code "to create a relationship out of every contract or agreement," and that the control provision "normally" does not apply to situations where two parties freely enter a contract. EN 4.1 at ? 14.

Indeed, for the reasons set forth above, we deem the ABC-distributor agreements to be distinguishable from the type of contract "normally" entered into by two parties, as envisaged by EN 4.1. Here the contract resembles not so much one whose terms are the subject of negotiation, but a contract in which the bargaining positions of the parties are unequal. While it may be possible to engage in limited negotiations, there is generally but little scope for bargaining in such situations. Thus the only course of action is to refuse the offer, or to accept the terms offered by the stronger party. In consequence, the resulting contract terms and conditions are so weighted in favor of the stronger party that it is in a position to exercise control. In our view this is precisely the situation of ABC vis � vis Distributor A and Distributor B. ABC, the exclusive importer of the imported merchandise, has a degree of market power that exists outside the terms of the distributorship agreements. Anyone wanting to purchase the imported merchandise must deal with ABC.

In this respect, it can be argued that the control exerted by ABC "exists independently of the freely entered terminable contract[s]" with Distributor A and Distributor B. See EN 4.1 at are much sought after in the markets of the importing country" will be in a stronger position than will the buyer of those goods, and that this strength will be translated into a higher price. EN 4.1 at ? 6. While this portion of the note contemplates a situation in which the buyer is a sole agent, we consider that the distinction drawn between a manufacturer/seller whose goods are sought after, and who in consequence thereof enjoys a strong bargaining position, and an importer who does not enjoy these advantages, is nonetheless applicable to the instant situation. This is not to argue that all forms of market power will lead to a finding of control. For example, market power deriving from patents or trademarks would in all likelihood not lead to a finding of control. See EN 4.1 at ? 13. Nevertheless, in the instant case, the fact that [***] are sought after and, moreover, sell at a scarcity premium (at the retail level), invests ABC with control that also exists independently of the agreements.

Accordingly, it is our position that ABC is related to Distributor A and Distributor B by virtue of the control it exercises pursuant to the distributorship agreements, and by virtue of the market control it enjoys as the exclusive importer of the imported merchandise. Consequently, sales between ABC and Distributor A and Distributor B cannot be used as the basis of deductive value. Instead, the deductive value of the imported merchandise should be calculated with reference to the unit price at which they are sold to unrelated parties by the distributors.

As stated above, however, the identification of the level at which sales to unrelated persons occur is merely the starting point of the deductive value inquiry. Once this has been established, there remains the question of the deductions from the unit price provided for under section 402(d)(3)(A) of the TAA. Besides duties and taxes, and certain transportation costs, the deductions include "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." (Emphasis added). 19 U.S.C. ? 1401a(d)(3)(A)(i). Thus a clear reading of the TAA demonstrates that the deduction for profit and general expenses would include profit and general expenses in all sales in the U.S. at which imported merchandise of the same class or kind is sold to unrelated persons at the first commercial level after importation.

Furthermore, the TAA states that the deduction for profit and general expenses should be based on the importer's profit and general expenses unless this figure is inconsistent with the figure for profit and general expenses reflected in sales in the United States of imported merchandise of the same class and kind. In such a case, the deduction should be based on the usual profit and general expenses in U.S. sales as determined from sufficient information. 19 U.S.C. ? 1401a(d)(3)(B)(i). Merchandise of the same class or kind is defined by the Regulations as "merchandise (including, but not limited to, identical and similar merchandise) within a group or range of merchandise produced by a particular industry or industry sector." 19 C.F.R. ? 152.102(h). In addition, the Regulations contain a provision, specifically for purposes of deductive value, which states that the term "merchandise of the same class or kind" includes: (1) merchandise imported from the same country as that from which the merchandise being appraised was imported; and (2) merchandise imported from countries other than that from which the merchandise being appraised was imported. 19 C.F.R. ? 152.105(b). Thus, Customs may compare the figure for the importer's profits and general expenses to the "usual" profit and general expenses with regard to all sales of same class or kind merchandise, regardless of the country from which that merchandise was imported.

In applying these principles to the facts we note that ABC sells its merchandise through related distributors. In contrast, we understand that other importers, for example, *** and ***, sell directly to dealers (We have no information in regard to ****** importers, e.g., **********). Thus were only ABC's profit and general expenses taken into account, the adjustment would not be comparable with "the addition for profit and general expenses, in...sales in the United States of imported merchandise...of the same class or kind," since at a minimum, it would not include costs incurred at the distribution level. These costs primarily reflect the expense of transporting the merchandise to dealers and presumably would be included in the profit and general expenses of importers who do not use distributors but perform this function themselves, i.e., who internalize this cost. Accordingly, in determining the addition for profit and general expenses, Customs should look to the profit and general expenses of both ABC and its related distributors, including Distributor A and Distributor B.

Thus, to summarize, Customs must consider the importer's figures in making the adjustment for profit and general expenses; but it may also reject these figures and base the deduction on the usual profit and general expenses reflected in sales in the U.S. of all imported merchandise of the same class or kind, regardless from whence produced and imported. Should it prove necessary to look beyond ABC' and the distributors' figures in order to make a determination in respect of profit and general expenses, Customs should confine its examination to sales of the narrowest group or range of imported merchandise, of the same class or kind as that being appraised, for which sufficient information can be obtained. 19 C.F.R. ? 152.105(e)(2). Nevertheless, the narrowest group or range in this instance arguably includes all imported merchandise of the same class or kind as those imported by ABC.

HOLDING:

The relationship between ABC and XYZ influences the price actually paid or payable such that the transaction value of the imported merchandise cannot be determined.

For purposes of deductive value, the term "unit price" means the unit price at which the greatest number of units is sold after importation to unrelated persons. If there are no sales to unrelated persons at the first commercial level after importation, deductive value should be based on the unit price at which the greatest number of units is sold after importation at the first commercial level at which sales to unrelated persons occur.

ABC is related to Distributor A and Distributor B by virtue of the control it exercises under the terms of the distributorship agreements. In the instant case deductive value should be determined with reference to the unit price at which the imported merchandise is sold by the distributors to unrelated parties.

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

Sincerely,

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