HQ 546091 - Application for Further Review of Protest Number 2704-93-101989; sale for exportation in an alleged three tiered sales transaction; Nissho Iwai American Corporation v. United States ; related parties - United States International Trade Commision Rulings

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HQ 546091

January 3, 1996
RR:IT:VA 546091 RSD

CATEGORY: VALUATION

Port Director
United States Customs Service
300 S. Ferry Street
Terminal Island, California 90731

RE: Application for Further Review of Protest Number 2704-93-101989; sale for exportation in an alleged three tiered sales transaction; Nissho Iwai American Corporation v. United States ; related parties

Dear Director:

This is in response to the memorandum from the former District Director for the Los Angeles District dated August 3, 1995, forwarding the application for further review of Protest No. 2704-93-101989, filed by the importer, Playmate Toys USA, Inc., (hereinafter PTI-US) on June 3, 1994. On November 13, 1995, your office forwarded additional information submitted by the protestant. We are aware that the Regulatory Audit Division has conducted an audit on various aspects of the import operations of PTI-US. We have been in contact with the Regulatory Audit Division to discuss to this matter and they have sent us additional material related to this case.

FACTS:

PTI-US is an importer and wholesaler of toys in the United States. It operates out of a warehouse-office in La Mirada, California. Its only supplier of merchandise has been a related company, Playmates Toys (Hong Kong) (hereinafter PTI-HK). Both companies are subsidiaries of a Hong Kong based holding company, Playmates International Holding Ltd. (hereinafter PIHL). In addition to sales and distribution functions, PTI-US performs significant administrative functions related to the identification and development of toy ideas. It relies heavily on subcontractors for this creative work, and its customers include some of the largest retailers in the United States.

The Playmates family of companies has a complex organizational structure involving 34 companies located in 8 countries. The parent of this family of companies is PIHL, a Bermuda company, whose managing office is in Hong Kong. PIHL was founded in 1966 as a manufacturer of dolls for major U.S. and European retailers and toy companies. Over the years the company has divested itself of its own manufacturing operations, while retaining equity interest in other manufacturers in Hong Kong, China, and Macau. Prior to this divesture, PTI-US was buying its
toys from PIHL, and PTI-HK acted largely as a selling agent. In July 1988, PIHL modified its agreement with PTI-HK and after divesting itself of manufacturing facilities, it became a corporate shell. PTI-HK became responsible for the management of all PIHL's toy business and began purchasing toys from related and non-related manufacturers. In addition, a second channel of distributing products to U.S. was set up. This method of distribution bypassed PTI-US by selling toys directly to U.S. retailers.

Despite PTI-HK's direct sales to the retailers in the U.S., PTI-US continued to order all of its products from PTI-HK. PTI-US supplied PTI-HK with tooling and other assists related to its U.S. imports. In turn, PTI-HK reimbursed PTI-US for all its toy development related costs. PTI-HK relied on contract manufacturers to produce its toys. Based on the analysis of the Regulatory Audit Division, it appears that more than 90% of toys imported by PTI-US were produced by three manufacturers, Acefield Limited, Macau International Toys Limited, and Coronet Garment Manufacturers Limited. These companies are part of the Harbour Ring Group. In 1993, PTI-HK owned 16.75% of Harbor Ring through a holding company called Reading Investment.

PTI-US seeks to have the imported merchandise appraised based upon the alleged sales between PTI-HK and the contract toy manufacturers. PTI-US contends that these transactions were sales for exportation to the United States. In an effort to show that the sales between PTI-HK and the toy contract manufacturers were arms-length transactions, PTI-US has furnished price quotes from unrelated toy manufacturers during 1992 and 1993, for identical Playmates items. A comparison of the prices from the Harbour Ring group companies to the price quotes from the completely unrelated manufacturers shows that Harbour Ring group companies' prices are slightly higher. Nevertheless, PTI-HK claims that it is willing to pay a slightly higher price for the merchandise for several reasons including Harbour Ring's large production capacity, high quality standards, and a track record of working efficiently and effectively with PTI-HK's engineering and quality control.

PTI-US has also presented documents to demonstrate how the transactions supposedly work. Included in this package of documents are invoices from PTI-HK to PTI-US, packing lists, order releases from PTI-US, order confirmations, purchase orders from PTI-HK to the contract manufacturers, and pro-forma invoices. We have been informed by the Regulatory Audit Division that PTI-US does not use formal purchase orders with due dates and related performance penalties. Instead, PTI-US provides PTI-HK with order releases against product requirements forecasts. Apparently, PTI-HK has a great deal of flexibility as to when merchandise is shipped to PTI-US.

As noted above, Regulatory Audit Division has conducted an audit on various aspects of the import operations of PTI-US. However, this decision will deal solely with the issue raised by the importer's protest that of whether the imported merchandise should be appraised based on the alleged sale between the middleman, PTI-HK, and the toy manufacturers.

ISSUE:

Whether the imported merchandise should have been appraised based upon the transactions between the manufacturers and PTI-HK?

LAW AND ANALYSIS:

As you know 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. ? 1401a). The preferred method of appraisement is transaction value, which is defined as the "price actually paid or payable for merchandise when sold for exportation for the United States," plus certain enumerated additions.

In Nissho Iwai American Corp. v. United States, 982 F.2d 505 (Fed. Cir. 1992), the Court reaffirmed the principle of E.C. McAfee Co. v. United States, 842 F.2d 314 (Fed. Cir. 1988), that a manufacturer's price, for establishing transaction value, is valid so long as the transaction between the manufacturer and the middleman falls within the statutory provision for valuation. In reaffirming the McAfee standard the court stated that in a three-tiered distribution system:

The manufacturer's price constitutes a viable transaction value when the goods are clearly destined for export to the United States and when the manufacturer and the middleman deal with each other at arm's length, in the absence of any non-market influence that affect the legitimacy of the sale price...[T]hat determination can only be made on a case-by-case basis.

Id. at 509. See also, Synergy Sport International, Ltd. v. United States, 17 C.I.T.___, Slip Op. 93-5 (CT. Int'l Trade January 12, 1993).

As a general matter in situations of this type, Customs presumes that the price paid by the importer is the basis of transaction value. However, in order to rebut this presumption, the importer must in accordance with the court's standard in Nissho, provide evidence that establishes that at the time the middleman purchased, or contracted to purchase, the imported merchandise the goods were "clearly destined for export to the United States" and that the manufacturer and middleman dealt with each other at "arm's length."

In the instant case, the importer, PTI-US, is claiming that in accordance with Nissho, the transaction value for the imported merchandise should be based on the sale between PTI-HK and the toy manufacturers. In determining if this claim is valid, the first question to be considered is whether there was a bona fide sale between PTI-HK and the toy manufacturers.

For Customs purposes, a "sale" generally is defined as a transfer of ownership in property from one party to another for a consideration. J.L. Wood v. United States, 62 CCPA 25, 33; C.A.D. 1139 (1974). Although J.L. Wood was decided under the prior appraisement statute, Customs recognizes this definition under the TAA. Several factors may indicate whether a bona fide sale exists between potential seller and buyer. In determining whether property or ownership has been transferred, Customs considers whether the alleged buyer has assumed the risk of loss and acquired title to the imported merchandise. In addition, Customs may examine whether the alleged buyer paid for the goods, whether such payments are linked to specific importations of merchandise, and whether, in general, the roles of the parties and circumstances of the transaction indicate that the parties are functioning as buyer and seller. See HRL 545705, January 27, 1995.

The evidence in this case does not establish that there were sales between the manufacturers and PTI-HK. The transaction documents presented by the protestant concerning alleged sales between PTI-HK and contract manufacturers, such as proforma invoices and purchase orders do not indicate the shipping terms, so we are unable to ascertain when or if PTI-HK acquired title to the goods and if it bore the risk of loss. We also note that protestant has not presented any other indication of a sale such as a supply contract between PTI-HK and the manufacturers.

Even if it is assumed that there was a sale between PTI-HK and the contract manufacturers, the protestant has not established that the two criteria laid out by the court in Nissho have been satisfied. First, there is no evidence that the merchandise was clearly destined to the United States at the time of the alleged sale with PTI-HK. We note that PTI-HK sells its products to many counties. The Regulatory Audit Division has indicated that PTI-HK has the capability of diverting the shipments to other markets after the transactions occur. Significantly, PTI-HK is under no contractual obligation to deliver specific merchandise to PTI-US at a certain time. Playmates organization apparently does not use formal purchase orders with due dates and related performance penalties as is typical with unrelated parties. Instead, PTI-US just provides PTI-HK with order releases against product requirement forecasts. Accordingly, it appears that PTI-HK buys the merchandise and determines the shipping dates and quantities that will be shipped. Therefore, there is no evidence that the merchandise was clearly destined to the U.S. at the time it was supposedly purchased from the manufacturers.

The protestant has also failed to establish that the transactions between the contract toy manufacturers and PTI-HK were arm's length. The vast majority of the imported merchandise was procured from manufacturers which were part of the Harbour Ring Group. PTI-HK through a holding company owned more than 5% of the stock of the contract manufacturers in the Harbor Ring Group. Under 19 U.S.C. 1401a(g)(1)(F) and section 152.102(g)(6) of the Customs Regulations, 19 CFR 152.102(g)(6), the contract manufacturers in the Harbor Ring Group and PTI-HK are considered related parties. Consequently, the transactions between the contract manufacturers and PTI-HK were not arm's length and could not serve as the basis of transaction value unless they are deemed to be acceptable transaction values. 19 U.S.C. 1401a (b)(2)(B) 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. See 19 U.S.C. 1401a(b)(2)(B). In order for a sale between related parties to be acceptable as an "arm's length" sale under Nissho, it must satisfy the statutory requirements noted above. See HRL 544579 and memorandum dated March 8, 1993, from Director, Office of Trade Operations, Regarding Effect of Nissho Iwai and Related Cases on Field Operations.

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 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 CFR 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 firm's overall profit realized over a representative period of time. 19 C.F.R. 153.103(l)(1)(iii).

Alternatively, a transaction value between related parties is acceptable if it closely approximates, the transaction, deductive or computed "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 computed value calculation can only serve as a test value if it represents an actual appraisement of imported merchandise pursuant to 19 U.S.C. 1401a(e). E.g. HRL 543568 dated May 30, 1986. There are no previously determined transaction, deductive or computed values with respect to the merchandise imported by PTI-US. Consequently, test values cannot be used to validate transaction value.

Instead, to support its position that the transaction between PTI-HK and the Harbour Ring manufacturers should be considered acceptable, the protestant has furnished price quotations from other unrelated toy manufacturers. Although these price quotations are very close to the prices charged by the Harbour Ring manufacturers, they are slightly lower. Moreover, we believe that these price quotations without any other substantiation of the prices are inadequate to show that the transactions between PTI-HK and the Harbor Ring manufacturers were conducted at arms length. First, we note that PTI selected the manufacturers and the quotes, and a price quotation is not necessarily the same as an actual price charged by a supplier when a purchase is made. As such, it is not clear whether the price quotations were firm and binding on these companies, or if the prices could change when actual purchases were made. Furthermore, there is no indication of the terms and conditions of these price quotations. For example, certain elements which generally impact prices such as the size of the orders and the time period for delivering the merchandise were not specified in the price quotes. Under such circumstances, the price comparisons are not especially meaningful.

In addition, it appears that transactions between PTI-HK and toy manufacturers are more informal than would be expected in most arm's length transactions. You point out that it is unclear if the manufacturers actually issued formal invoices to PTI-HK for the merchandise. You have also indicated that PTI-HK provided research and development to the suppliers, and it is not clear whether these costs are included in the price. Accordingly, we find that the protestant has failed to establish that the transactions between PTI-HK and the manufacturers were arm's length transactions. Since neither requirement of Nissho has been satisfied, the imported merchandise should not be appraised based on the transaction between PTI-HK and contract toy manufacturers.

HOLDING:

For the reasons explained above, the imported merchandise should not have been appraised based upon the transactions between PTI-HK and the contract toy manufacturers.

You are directed to deny the protest. A copy of this decision with the Form 19 should be sent to the protestant. In accordance with Section 3A(11)(b) of Customs Directive 099 3550-065, dated August 4, 1993, Subject: Revised Protest Directive, this decision should be mailed by your office to the protestant no later than 60 days from the date of this letter. Any reliquidation of the entry in accordance with the decision must be accomplished prior to mailing of the decision. Sixty days from the date of the decision, 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,

Acting Director
International Trade Compliance

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