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HQ 547155

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March 22, 2001

RR:IT:VA 547155 MMC

CATEGORY: VALUATION

Port Director
U.S. Customs Service
6 World Trade Center, RM 761
New York, New York 10048

RE: Sale for Export; Multi-Tiered Transaction; Related Parties; Royalties

Dear Port Director:

This is in response to an August 17, 1998, ruling request filed by counsel on behalf of the [ ] Group, Inc., concerning the appraisement of garment and shoe imports from Italy. Importations of the merchandise had already occurred at the time of this request and counsel is engaged in on-going discussions regarding the issue with your office. As such, we have decided to treat the request as an Internal Advice (IA). This IA will apply to both pending and future transactions covering the facts described.

On April 21, 1999, attorneys from our office met with counsel. Subsequently, counsel provided additional requested information. Information provided in the meeting and additional submissions of July 22, 1999 and September 19, 2000, has also been taken into consideration in reaching this decision. We regret the delay in responding.

Counsel requests that the ruling cover only merchandise which has been pre-ordered by US customers. The request does not cover [ ] production for stock. Production for stock results from the over-production of specific orders in anticipation of additional customer orders. Additionally, this response does not cover instances where the middleman has purchased from a related factory.

FACTS:

The [ ] Group consists of 5 companies [ ]. All are related and, according to counsel, are, with the exception of [ ,] “titleholders” in the chain of sale. [ ], located in Milan, Italy is a service company that provides showroom and sales services for the [ ] Group. Such services include filling out purchase orders for US retailers and forwarding them to the other companies in the group. It is not clear whether [ ] also sends and/or provides a
confirmation of the purchase order to the initial US retailer. [ ] located in the U.S., is the exclusive US distributor of [ ] merchandise. A copy of this distribution agreement was not provided. According to counsel, the U.S. distributor has full authority to negotiate prices and accept orders from US customers. The U.S. distributor maintains its own accounting records.

[ ] located in Florence, Italy is the middleman that oversees manufacturing. The middleman’s tasks include product design, production costing computation including preparation of the bill of materials and estimated costs for cut & make operations, direct negotiation and contracting with factories, sourcing and furnishing of raw material to the factories, quality control, and tracking and consolidation of the various products for shipping. Counsel notes that the middleman retains title to the raw materials when turned over to the factories.

[ ], located in Switzerland, is the parent company of both the middleman and U.S. distributor, is the importer of record for this request. According to counsel, the parent company buys merchandise from the middleman and sells it to the U.S. distributor and other related entities “for its own account and risk.” Additionally, counsel claims the parent company oversees the business function included in the worldwide marketing and product mix for [ ] merchandise. Finally, [ ] of Luxembourg owns the trademark [ ] and is the licensor of its use.

Counsel indicates in his August 17, 1998, submission that the transaction begins when a US retailer issues a purchase order to the US distributor “through” the Italian service company. The Italian service company staffer takes the purchase order from a US retailer at the service company’s offices in Italy. Confirmation of that purchase order is forwarded to the other companies in the [ ] Group, including the middleman.

Upon receipt of the purchase order, the middleman enters into contracts with various unrelated factories to produce the ordered merchandise. According to counsel, raw material for both apparel and handbags is provided and considered an assist for valuation purposes. The apparel is purchased on a cut and make basis. In the case of footwear, the middleman sells the necessary raw materials to the factory. Counsel states that the factory sells cut & make merchandise to the middleman based upon a previously agreed to price list which is calculated on a style-by-style basis. The middleman then sells the finished merchandise to the importer (parent company) who then sells it to the US distributor to sell to the US retailer.

In its July 22, 1999 and September 19, 2000 submissions, counsel indicates that the middleman purchases the merchandise on an ex-factory basis. The merchandise is tagged at the factory to indicate, according to counsel, the ultimate US purchaser. Additionally, this tagging facilitates the sorting and consolidation of the garments at the middleman’s warehouse once it is moved from the factory to the Florentine warehouse by the middleman. When the goods arrive at the warehouse, they are unladed and sorted and the tags are electronically scanned. Counsel claims that this scanning “results” in the printing of a shipping label setting forth the U.S. destination. Once sorted according to country destination, the merchandise is consolidated with other orders of merchandise being shipped to that particular country, and packed ready for export. No indication of how long the merchandise remains in the warehouse was provided. Though in-line quality inspections are performed at the factory, the middleman also performs a quality control inspection at the warehouse. When defective merchandise is discovered during the warehouse quality control inspection, the middleman returns the defective goods to the factory for repair or replacement. According to counsel, “second quality merchandise (defective merchandise) is not diverted to any other marketplace because of the high quality associated with the [ ] name.

As proof of the transactions’ structure, counsel has submitted several exhibits that he asserts form the paper trail of a typical transaction. The paper trail is for 8 units of men’s trouser style #[ ] ordered by and sold to the US retailer [ ] whose client number is [ ]. All submitted example documents, with the exception of the parent company’s invoice, are in Italian with no English translation. The documents submitted include:

1. U.S. retailer’s purchase order: The purchase order includes an order for, among other things, the 8 units of men’s pants. It is represented as a copy of the original U.S. retailer’s purchase order but contains no header identifying to whom the purchase order is sent. The purchase order number for the merchandise appears to be [ ]. It is difficult to read and appears to have been altered. Counsel indicates in his September 19, 2000, submission that “because the original handwritten order with the [ ] number was highlighted with non-opaque marker, we (counsel) had to rewrite, by hand, the number atop the highlight. Counsel asserts that the resulting lack of clarity does not occur “anywhere else”. Additionally, the client number on the submitted document is illegible. The document is dated July 17, 1997, and is identified as a purchase for [ ]. The subject merchandise is identified on this sheet as [ ] then 8 pairs at $ [ ]. The order column for price indicates per unit. In the center of the document the phrase “order sheet see conditions written on the back page” appears. The page containing the conditions was not provided.

2. Electronic copy of the purchase order: No header identifying to whom this document is directed appears on the paper. A date of April 20, 1998 appears in the uppermost left corner. According to counsel, this document is an “electronic version” of the retail purchase order that was electronically transferred to all other companies in the [ ] Group. The term “FREE ON BOARD” appears on this document but no indication of a port or place accompanies it.

3. Middleman’s purchase order to a particular factory: The middleman’s purchase order number to the factory appears on the first page of the document in a pen version written over whatever was originally on the document. It appears that in the copying process, whatever was on the original document was cut off. This cutting off occurs on both pages of the document. A line item for 8 pairs of men’s pants appears, is dated December 17, 1997, identifies the U.S. retailer by client number and name.

4. Price list: According to counsel, the price list represents the negotiated price between the middleman and the factory for the 8 units of men’s pants. Unofficial translation of the document indicates that the price list is for women’s slacks, not men’s. No indication of factory acceptance of the price list, signature or otherwise, appears on the document.

5. Factory invoice: The invoice dated December 4, 1997, is from the factory to the middleman. The invoice includes an order for 49 of the subject style pants with the middleman’s purchase order number in the description, as well as two other styles of pants from different purchase orders. The price per unit is expressed in Lira. Counsel asserts that 8 of the 49 slacks on this invoice are the men’s slacks. No reference to [ ] the US retailer’s original purchase order number for the 8 pairs of slacks appears on this factory invoice. According to the September 19, 2000, submission, this invoice number [ ] was submitted in error.

6.Second submitted factory invoice: In counsel’s September 19, 2000, submission a new invoice number [ ] was submitted. That invoice is dated November 30, 1997 and includes an order for 30 of the subject style pants with the middleman’s purchase order number in the description, as well as one other style of pants which is from a different purchase order. The price per unit is expressed in Lira. Counsel asserts that 8 of the 30 slacks on this invoice are the men’s slacks. No reference to [ ] the US retailer’s original purchase order number for the 8 pairs of slacks appears on this factory invoice.

7.Proof of payment to the factory: A January 8, 1998, [ ] debit advice against the middleman’s account and in favor of the factory for the total price on the factory invoice.

8.Transportation document: The document is, according to counsel for movement of the goods from the factory to the middleman’s warehouse. It identifies 30 of the subject style pants with the middleman’s purchase order number in the description.

9.Factory Tags: A copy of a sample tag was submitted. The paper tag indicates the purchase order and client number which appear on the original U.S. retailer’s purchase order. The merchandise is specifically described by style number, material and color. The middleman’s purchase order number to the factory also appears on the tag.

10. Inventory tracking report: According to counsel, this document is the “inventory receiving” document for the middleman’s warehouse facility. It is in Italian with no English translation. Counsel states that as the merchandise is received in the warehouse the manufacturing tickets are compared to particular vendor transportation documents, then the bar code on the manufacturing tickets affixed to the garments are scanned to create this inventory tracking report. According to counsel, this document creates a “direct link” between the factory invoice and the purchase order to the factory, but also to the factory invoice and the specific goods destined for the United States. It does so because, according to counsel, it sets forth the factory order and factory code name, the transportation document number and the style number, quantity, showroom order and customer name.

11. Middleman’s invoice to the importer (parent company): This invoice dated December 11, 1997 indicates that the merchandise is sold ex-works from the middleman to the parent company. A separate descriptive line item for the 8 pairs of pants appears as one of several line items. Amounts paid are expressed in Lira.

12. Importer’s invoice to the U.S. distributor: This invoice also dated December 11, 1997. A separate descriptive line item for the 8 pairs of pants appears as one of several line items. Amounts paid are expressed in US dollars. Merchandise subject to this invoice is sold on a free on board basis. No port or place was indicated.

13. Proof of payments: Bank documents known as “debit and credit advices” between middleman and importer and the importer and distributor were submitted as proof of payment. Total paid is in large excess to that which is billed on the invoice, although itemization with these two transactions being identified was provided.

All documents in the various submissions as well as any garment tags indicate the size of the garment using the European sizing system. Additionally, the July 22, 1999, submission includes copies of what appear to be U.S. marking labels to be placed in the garments.

According to counsel, in future transactions the importer (parent company) is to act as the non-resident importer into the US. Counsel states that “future transactions between the importer and middleman will be on C&F Duty Paid basis, to reflect the importer’s obligation to act as importer of record and pay duty.” As this term would obligate the middleman to pay the duty, we assume for this ruling the importer will use the Incoterm “C&F” (cost and freight). Under the term C&F the seller must pay the costs and freight necessary to bring the goods to the named port of destination but the risk of loss of or damage to the goods, as well as any additional costs due to events occurring after the time of delivery, are transferred from the seller to the buyer.

Finally, a royalty for the use of the trademark [ ] is paid by the importer parent company to [ ] a party related to the importer, middleman and U.S. distributor. The royalty is based upon the importer’s resale price to the US distributor. A copy of the royalty agreement has been provided.

ISSUE:

1) Whether transaction value should be based upon the price paid by the middleman to an unrelated factory.

2) If not, is there another sale in the transaction acceptable for the transaction value method of appraisement?

LAW AND ANALYSIS:

Merchandise imported into the U.S. 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 basis 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. Thus, for imported merchandise to be appraised under transaction value, it must be the subject of a bona fide sale between the buyer and seller and it must be a sale for exportation to the U.S.

In Nissho Iwai American Corp. v. United States, 16 CIT 86, 786 F. Supp. 1002 (1992), rev'd in part, 982 F.2d 505 (Fed. Cir. 1992) [Nissho Iwai] and Synergy Sport International, Ltd. v. United States, 17 CIT 18 (1993), [Synergy], the U.S. Court of Appeals for the Federal Circuit and the Court of International Trade, respectively, addressed which sale may be used as the basis of transaction value for merchandise imported into the U.S. pursuant to a three-tiered distribution arrangement involving a foreign manufacturer, a middleman and a U.S. purchaser. In both cases the middleman was the importer of record. In each case the court held that the price paid by the middleman/importer was the proper basis for transaction value. Each court further stated that in order for a transaction to be viable under the valuation statute, it must be a sale negotiated at arm’s length, free from any non-market influence and involving goods clearly destined for the U.S.

Likewise, in the context of filing an entry, Customs Form (“CF”) 7501, an importer is required to make a value declaration. As indicated by the language of CF 7501, the language of the valuation statute, and in accordance with the Nissho and Synergy decisions and our own precedent, we presume that transaction value is based on the price paid by the importer. See, HRL 545114 dated May 31, 1994 and HRL 545648 dated August 31, 1994.

In situations where an importer requests appraisement on the basis of a sale from the foreign manufacturer to the middleman, the importer must submit sufficient evidence to show that the price is acceptable under the criteria set forth in Nissho Iwai and Synergy. That is, the importer must establish that it was an “arm’s length sale,” and that the goods were “clearly destined for the U.S.” at the time they were sold or contracted to be sold. For purposes of this discussion, it is assumed that the transaction between the unrelated factories and middleman were conducted at arm’s length.

To that end, in Treasury Decision (T.D.) 96-87, Cust. Bull 52/1, January 2, 1997, entitled Determining Transaction Value in Multi-Tiered Transactions, Customs set forth the documentation and information a claimant needed to supply to support a claim that transaction value should be based on a sale involving a middleman and the manufacturer or other seller. It states, in pertinent part, that:

In order for an importer to rebut the presumption discussed above, certain information and documentation must be provided. Specifically, the requestor must describe in detail the roles of all the various parties and furnish relevant documents pertaining to each transaction that was involved in the exportation of the merchandise to the United States. If there is more than one possible sale for exportation, information and documentation about each of them should be provided. Relevant documents include, purchase orders, invoices, proof of payment, contracts and any additional documents (e.g. correspondence) which demonstrate how the parties dealt with one another and which support the claim that the merchandise was clearly destined to the United States. If any of these documents do not exist, or exist but are not available, the importer should so indicate. What we are looking for is a complete paper trail of the imported merchandise showing the structure of the entire transaction.

Counsel has submitted a variety of documentation, including purchase orders, invoices, proof of payment, tags and labels. However, analysis of the information contained in these documents is not possible due to the irregularities as detailed in the FACTS section above and the lack of an official English translation. As such, it is not possible to determine whether a bona fide sale in the context of transaction value occurred between the manufacturer and middleman.

Even if the submitted documentation was perfected and the sale between the factory and middleman were considered a bona fide sale for transaction value purposes, the sale between the factory and middleman still could not be used as the basis for transaction value. The goods, when sold to the middleman, are not clearly destined for the U.S. The submitted documents concerning the transaction between the factory and middleman indicate that the transaction between the middleman and factory include the cutting and making of garments far in excess of those exported to the U.S.. In fact, not only is the subject garment style ordered far in excess of the example, other styles are also billed on the factory invoice. Furthermore, the retailer’s purchase order or client number does not appear on the factory invoice. In essence, nothing on the factory invoice indicates that some or any of the billed items are destined for the United States.

Even if the garments were identified on the factory invoice, their subsequent warehousing together with its potential quality control inspection creates a possibility of diversion such that the goods cannot be considered clearly destined for the U.S. In HRL 547349, dated May 5, 2000 a U.S. retailer, a non-resident importer, and factories not related to either of the other two parties were importing apparel. The transaction was structured such that the U.S. retailer ordered the apparel from the designer/importer who then consolidated that order with other orders from both U.S. and non-U.S. companies onto a master purchase order or “docket”. This docket was sent to the factory as a purchase order. Among other things, the docket stated that the garments must be marked and labeled pursuant to U.S. country of origin and labeling laws & regulations.

The factories manufactured the apparel and fastened labels containing sizing and country of origin requirements and hang tags indicating the U.S. destination. The factories delivered the finished garments to the importer on hangers covered with plastic bags. A consolidated factory invoice, based upon the dockets, was issued to the importer. The invoices indicated that the garments met all U.S. labeling and country of origin requirements.

The finished apparel was shipped from the factory to the importer FOB destination. The importer then consolidated the apparel from 5 factories. To facilitate shipment schedules and consolidation, the importer temporarily warehoused the apparel intended for the U.S. or other countries for 3-5 days. Once the customer’s order was available, the importer allocated and picked the garments that were then consolidated into one shipment for export to the U.S. retailers delivery duty paid.

Prior to warehousing, the garments were subjected to a quality control inspection by the importer in addition to the quality control procedure performed by the factories. At this point any failures were rejected and may have caused retailers to receive short shipments. Failures were either destroyed or used as samples. Finally, the garments were not sized separately with U.S., European, or British sizes and all labels, regardless of destination, were printed in English. Based on these facts we held that there existed a possibility of diversion such that the merchandise was not clearly destined to the U.S. at the time the importer purchased the garments from the factory. As such, transaction value could not be based upon that transaction.

The subject transaction, like the one in HRL 547349, exhibits a possibility of diversion such that the apparel at the time the merchandise is purchased by the middleman from the factory it is not clearly destined for the U.S. The subject middleman warehouses the apparel for an undisclosed period of time. All documents as well as tags indicate the size of the garment using the European sizing system. All of these factors create a viable contingency of diversion.

In this case, counsel asserts that any contingency for diversion is eliminated by the use of a “tracking system” and cites HRL 546233 dated November 25,1996, in support of the claim. In HRL 546233, we held that the middleman’s extensive tracking system for merchandise was one of the factors indicating that the articles were clearly destined to the United States. During the production, the articles of HRL 546233 were marked with tracking codes to ensure they arrived at the intended destination and were not diverted to alternative purchasers and locations. The code also appeared on all control system generated documents. Customs accepted the tracking system as evidence that the articles were clearly destined to the United States because the manufacturers were required to abide by the system. No such requirement was indicated for the present merchandise.

In addition to the “tracking system factor”, in HRL 546233 we indicated that another factor which would support a finding that the goods are clearly destined to the U.S. at the time of sale, was that a factory produces garments to fulfill a pre-existing purchase order issued by a U.S. retailer. However, to fulfill this requirement, the merchandise had to be sized and labeled to meet United States standards. In this case it is our understanding that this merchandise is, at a minimum, sized for both the European and American markets.

Accordingly, we find that at the time of the alleged sale from the factory to the middleman the goods are not clearly destined for the United States. Under these circumstances, even if the submitted documentation was perfected, the transaction between the factory and middleman may not be used as the basis for transaction value, as when the goods are purchased from the factory they are not clearly destined for the U.S. As such we presume that transaction value is based on the price paid by the importer.

Counsel indicates that the middleman and importer are related parties pursuant to §402(g)(1) of the TAA. 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. Section 402(b)(2)(B) of the TAA provides that transaction value between related parties is acceptable only if an examination of the circumstances of the sale indicates that the relationship between the parties does not influence the price actually paid or payable or, if the transaction value of imported merchandise closely approximates the transaction value of identical or similar merchandise in sales to unrelated buyers in the U.S. or the deductive or computed value for identical or similar merchandise.

In the context of their ruling request counsel did not provide information concerning the relationship between the middleman and the importer. If a review of the circumstances and information available to you indicates that the relationship of the parties did not influence the importer’s price, then transaction value using the importer’s price should be permitted.

Finally we note that if the transaction value between the middleman and importer is determined to be acceptable, the royalty fee paid would be part of the price actually paid or payable. The importer/buyer is the party directly paying the royalty fee to a party related to the middleman/seller. As such, unless counsel could clearly establish that the payments are completely unrelated to the imported merchandise they are considered payments included in the transaction value.

HOLDING:

The submitted documentation is insufficient to support the claim that a bona fide sale occurred between the manufacturer and middleman and that imported merchandise was clearly destined for the United States at the time of the alleged sale.

If the transaction value between the middleman and importer is determined to be acceptable, the royalty fee paid would be part of the transaction value. The importer/buyer is the party directly paying the royalty fee to a party related to the middleman/seller. As such, unless counsel could clearly establish that the payments are completely unrelated to the imported merchandise they are considered payments included in the transaction value.

Sincerely,

Virginia L. Brown, Chief
Value Branch

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