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HQ 546946

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September 30, 1999

RR:IT:VA 546946 er
CATEGORY: VALUATION

Joseph P. Cox, Esq.
Stein, Shostak, Shostak & O’Hara
Suite 1200
515 South Figueroa Street
Los Angeles, California 90071-3329

RE: Request for Ruling; Sale; Sale for Exportation; Related Parties; Nissho Iwai; Clearly Destined; Arm’s Length.

Dear Mr. Cox:

This is in response to your submissions dated December 10, 1997, September 10, 1998, May 25 and June 24, 1999, in which you request a ruling on behalf of your client, Linear Corporation ("Linear"), concerning the proper basis of appraisement of imported security system equipment. This office met with you and your client on April 27, 1999, to discuss the issues raised in your ruling request.

FACTS:

Linear, a California corporation, is wholly owned by Nortek, Inc., a publicly traded Delaware corporation headquartered in Rhode Island. Linear has several wholly owned subsidiaries, two of which are Moore-O-Matic Inc. ("MOM"), a Wisconsin corporation, and We Monitor America, Inc. ("WMA"), an Arizona corporation. The total shares outstanding for Linear Hong Kong Manufacturing Ltd., ("LHK"), a Hong Kong corporation, are owned by Linear and WMA.

You state that the imported merchandise, security system equipment, is manufactured by Chinakong Ltd. ("Chinakong") and is sold to LHK, who then resells the products to Linear. Chinakong is owned by Linear. Linear, LHK and Chinakong are related parties.

In exhibit 1 to your December 10, 1997 submission you provided us with a "Summary of Business Functions" that was prepared for the Hong Kong Government to explain the function of LHK in the transactions with Linear and MOM. In your September 10, 1998 submission you informed us that the summary remains in effect and still accurately describes the functions of the various parties to the transactions. In this summary LHK is described as a "Far East Buying Office" generating no sales to outside (unrelated) companies, with all product produced by Chinakong in the People’s Republic of China ("PRC") invoiced by LHK to either Linear or MOM. All Linear merchandise will be invoiced to and title passed to Linear. The great majority of Linear’s product (90 to 95 percent) will be shipped to their warehouse in California, with the balance drop-shipped to international customers. All MOM merchandise will be shipped and invoiced to MOM. All finished goods which are completed by Chinakong are transported by them to LHK’s freight forwarder in Hong Kong. The freight forwarder is instructed by LHK as to the shipping destination of the merchandise.

The summary statement in the "Summary of Business Functions" provides the following with regard to the role of LHK’s business activities:

In summary, the above description of LHK’s business activities as it relates to the two companies it supports, supports our contention that: 1. LHK does not carry on a trade or profession in Hong Kong. Linear and MOM consider the LHK operation as a Far East Buying Office with ancillary functions which are in support thereof. Linear and MOM in the US carry on a trade as defined by Webster. LHK performs a departmental function in support of that trade, but is located in Hong Kong so as to be close to the primary sources for components and sub-contract manufacturing. 2. The incomes which your office seeks to assess, were not profits derived from a trade or profession carried on in Hong Kong. If LHK does not carry on a trade or profession in Hong Kong, as we have shown above, the reported income is not subject to tax assessment. 3. LHK’s sub-contracted manufacturing process is done outside Hong Kong. LHK has a contractual agreement with Chinakong to manufacture product for both Linear and MOM in the PRC. 4. The distribution of goods is outside Hong Kong. All products produced by Chinakong are sold to either MOM or Linear and title is transferred to them upon receipt as completed product into Hong Kong.

We were not provided with a copy of the contractual agreement between LHK and Chinakong which is referenced in item three above.

We were provided with an English translation of an "Understanding Memorandum About Some Aspects of the Subcontract" ("LHK/Chinakong memorandum") as exhibit 2 to the December 10, 1997 submission. The translation provides that the memorandum is effective as of the first day of January 1992 but it is undated and unsigned. The Chinese version appears to be signed but we cannot discern whether it is dated. The LHK/Chinakong memorandum does make reference in part I section 1.2 to the aforementioned LHK and Chinakong contract which was not provided to us.

Under section 3 of the LHK/Chinakong memorandum, LHK’s exercises considerable control over the day to day operations at Chinakong. In the event there is a disagreement between Chinakong and LHK over such operations, LHK is the final decision-maker. Per section 7, LHK pays the salaries of the various personnel involved in manufacturing the subject merchandise, including: supervisory personnel, quality control inspectors, repairmen, touch-up operators, and aligners/final test operators. Section 16 further provides that almost all of the expensive equipment is provided by LHK and that such equipment shall be used for the production of LHK products only. While in Chinakong’s custody, the equipment is insured by Chinakong against damage or loss at the full replacement value. Section 18 provides that materials provided by LHK which are inventoried by Chinakong and are then reported as missing shall be replaced at Chinakong’s expense. Section 21 provides that while all direct materials are provided by LHK, the remaining "indirect" materials including solder bars and wires, cleaning agents, adhesive tapes, hot melt, loctile adhesive, and carton sealing materials are provided at Chinakong’s expense. Section 22 provides that LHK will provide Chinakong with all drawings, specifications, BOMs, manufacturing instructions, ECNs and all other documents necessary for the production of the merchandise.

Exhibit 3 to your December 10, 1997 submission allegedly shows the material transaction flow used and maintained by Chinakong to undertake the manufacturing process. You claim that the documents provided track the manufacture, shipping, and sale of Part Number SNR00149/DXR702, which involves the use of Part Number 210187 Printed Circuit Board. To this end you provided copies of various documents including purchase orders from LHK to Taiton Printing Circuit Board Co., Ltd. in Hong Kong, invoices from Taiton to LHK and various records of shipping documents. While the invoices do track the purchase order reference number, the quantities and prices on the invoice do not correspond to those on the purchase order.

In your September 10, 1998 submission you state that products manufactured by Chinakong are paid for on a monthly basis by Linear and MOM, not LHK. These prices are determined on the basis of a computed cost determination. You state that the factory price is computed by figuring the cost of materials, labor, inland freight, overhead, administrative costs, and profit.

In your May 25, 1999 submission you provided, as exhibit B, a translated copy of an agreement between: (1) LHK, (2) the Trading Unit, Shenzhen Bao An District Foreign Trade Development Company ("Shenzhen"), and (3) Bao An District Xixiang Town Hourei Linear Electronics Plant ("Bao") for the operation of the electronics assembly and manufacturing plant in the People’s Republic of China ("LHK/Shenzhen/Bao Agreement"). The name of the products is redacted from the translated copy. The translation has no date on it. A copy was also provided of the original in Chinese but we cannot determine whether the original is dated. Nowhere in your submission is either Bao or Shenzhen mentioned and we are therefore unsure of their individual roles in the transactions at issue. While we believe that Chinakong and Bao may be the same entity we are not entirely sure. Some of the terms in the LHK/Shenzhen/Bao agreement correspond to those in the LHK/Chinakong memorandum, described above, which describe the responsibilities of LHK and Chinakong in the manufacturing process.

In your June 24, 1999 submission you enclosed various shipping documents including a bill of lading, terminal receipt, manifest and import/export papers. The documents identify the container number, a Los Angeles port of discharge and place of delivery, and Linear as the consignee.

As described in the LHK/Shenzhen/Bao Agreement between these three parties, Bao must provide the factory buildings, electricity and water supply equipment needed for the production of the merchandise and assist LHK in import and export procedures. Additionally Bao is responsible for appointing the factory director, accounting and warehouse personnel to handle the management and financial control of the factory. LHK remits a monthly processing fee to Bao for the use of the factory buildings and production space.

LHK must provide all the necessary equipment and raw materials for processing the merchandise. The agreement references a specific list of equipment to be provided by LHK, but a copy of the list was not provided with the English translation of the agreement. LHK retains ownership of the equipment.

The LHK/Shenzhen/Bao agreement also sets the anticipated commission processing volume and approximate payment for the first year. The agreement further specifies that volume and payment amounts for subsequent years will be specified in a production contract, copies of which were not provided to us. The agreement does provide that LHK will reimburse Bao a certain amount for wastage in production.

Attached as exhibit "C" in your May 25, 1999 submission you included a narrative and supporting documents to illustrate how merchandise ordered by Linear for its foreign clients is ordered and shipped directly to those foreign clients.

ISSUE:

Whether the imported merchandise may be appraised under transaction value based on the transaction between Chinakong and LHK?

LAW AND ANALYSIS:

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 to the United States," plus certain enumerated additions. For purposes of determining transaction value in appraising imported merchandise, a sale for exportation to the United States must take place at some unspecified time prior to the exportation of the goods HRL 545434, dated May 31, 1994.

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 influences that affect the legitimacy of the sale price.

Id. at 509. See also, Synergy Sport International, Ltd. v. United States, 17 CIT 18 (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 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 this case, you contend that based on Nissho, the transaction value for the imported merchandise should be based on the transactions between the manufacturer (Chinakong) and the middleman in Hong Kong (LHK). In determining if this claim is valid, the first question to be addressed is whether there is a bona fide sale between Chinakong and LHK.

For Customs purposes, a "sale" generally is defined as a transfer of ownership in property from one party to another for consideration. J.L. Wood v. United States, 62 CCPA 25, 33; C.A.D. 1139, 505 F.2d 1400, 1406 (1974). Although J.L. Wood was decided under the prior appraisement statute, Customs recognizes this definition under the TAA. In determining whether a bona fide sale has taken place between a potential buyer and seller of the imported merchandise, no single factor is determinative. Rather, the relationship is to be ascertained by an overall view of the entire situation, with the result in each governed by the facts and circumstances of the case itself. Dorf International, Inc. v. United States, 61 Cust. Ct. 604, A.R.D. 245 (1968).

In determining whether the relationship of the parties to the transaction in question is that of a buyer-seller, where the parties maintain an independence in their dealings, as opposed to that of a principal-agent, where the former controls the actions of the latter, Customs will consider whether the potential buyer:
a. Provided (or could provide) instructions to the seller:
b. Was free to sell the items at any price he or she desired:
c. Selected (or could select) his or her own customers without consulting the seller; and
d. Could order the imported merchandise and have it delivered for his or her own inventory.

Other factors may also 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, dated January 27, 1995.

In the instant case it is unclear whether the three related parties to the transaction, LHK, Linear and Chinakong, are operating independently from each other. You have asked for appraisement based on the transaction between LHK and Chinakong. However, based on the information you have submitted in the LHK/Chinakong memorandum, we have determined that LHK not only provides instructions to Chinakong but is so involved in Chinakong’s day-to-day manufacturing operations as to call into question the distinctness of the parties’ identities from each other. Based on the description of the roles of the two parties, LHK does more than provide instructions to Chinakong, LHK is the final decision-maker in the event of a disagreement between the two parties regarding the day-to-day operations. LHK also pays for a number of the personnel involved in the production of the subject merchandise, bases one of its own representatives at Chinakong to oversee matters, and furnishes most of the production equipment and manufacturing materials.

It is also unclear whether title to the merchandise is ever transferred from Chinakong to LHK. Without transfer of title to LHK, LHK cannot set prices and resell the merchandise. Nor can LHK select its own customers. Instead, the information submitted concerning the subject transactions indicates that the transfer of title may have occurred directly between Chinakong and either Linear or MOM. In your September 10, 1998 submission you state that Chinakong is paid on a monthly basis by Linear and MOM, not by LHK.

While the facts in your September 10, 1998 submission stipulate that Chinakong is paid by Linear and MOM, the facts in your December 10, 1997 submission stipulate that Chinakong is paid on a monthly basis by LHK. For purposes of this decision we assume the facts provided in the more recent submission are correct. Moreover, according to your September 10th submission, MOM and presumably also Linear, don’t conduct business exclusively through LHK, but can and do also transact directly with Chinakong. Additionally, the description of LHK’s business activities in the Summary of Business of Functions, reproduced in part above, indicates that LHK is not operating as an independent buyer/reseller of the merchandise.

We note that we have not been provided with a copy of the contract between Chinakong and LHK referenced in the Summary Statement of the Summary of Business Functions of Linear and MOM. A copy of this contract may have explained the nature of the transactions at issue, including the determination of pricing between the parties to the transactions. As Customs pointed out in an Informed Compliance publication, such documents are relevant to resolving appraisement issues in multi-tiered transactions and "if any of these documents do not exist, or exist but are not available, the ruling request should so provide." See, "Determination of Transaction Value in Multi-Tiered Transactions", T.D. 96-87, 30/31 Cust. Bull 52/1, January 2, 1997. Rather the summary states that LHK does not carry on a trade or profession in Hong Kong and that Linear and MOM consider LHK as a Far East Buying Office "with ancillary functions which are in support thereof... LHK performs a departmental function in support of [Linear and MOM’s trade in the U.S.], but is located in Hong Kong so as to be close to the primary sources for components and sub-contract manufacturing." Furthermore, the summary concludes that "[a]ll products produced by Chinakong are sold to either MOM or Linear [not LHK] and title is transferred to" MOM and Linear, not LHK. As far as we know, LHK does not order the merchandise and have it delivered for its own inventory. Under the circumstances we cannot conclude that bona fide sales occur between LHK and Chinakong.

Even if the transactions between LHK and China were bona fide sales, your request does not satisfy the evidentiary and documentary requirements necessary for us to make a determination that the transactions between LHK and Chinakong involve sales for exportation to the U.S. Namely, we are lacking a complete set of transaction documents which would establish that at the time LHK issued a purchase order to the manufacturer, specific merchandise was clearly destined for the U.S. and is readily distinguishable from the merchandise intended for foreign markets. The great majority of Linear’s product (90 to 95 percent) will be shipped to their warehouse in California, with the balance drop-shipped to international customers. The merchandise intended for international customers is never exported to the U.S. In "Determination of Transaction Value in Multi-Tiered Transactions", T.D. 96-87, 30/31 Cust. Bull 52/1, January 2, 1997, Customs described the information and documentation which must be provided to overcome the presumption that the price paid by the importer is the basis of transaction value. Specifically, Customs stated that 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.

The documents included in your submissions including the shipping documents, purchase orders from LHK to Taiton and invoices from Taiton to LHK do not demonstrate that at the time LHK places an order with Chinakong, the merchandise intended for both importation and sale to Linear is distinguishable from the merchandise which is first sold to Linear but is never imported into the U.S. and is instead directly drop-shipped to Linear’s foreign clients. The merchandise drop-shipped to foreign markets, while purportedly first sold to Linear, is never imported into the U.S. and hence cannot be said to have been sold for exportation to the U.S. Under the circumstances, the imported merchandise does not meet the "clearly destined" prong of the Nissho Iwai test, described above, and accordingly may not be appraised based on the transaction between LHK and Chinakong.

Attached as exhibit "C" to your May 25, 1999 submission you included a narrative and various supporting documents to depict the flow of the foreign orders and how the foreign orders are tracked through both the Linear and LHK systems and are shipped in response to the foreign customers’ orders. While this description of the foreign ordering process is helpful in understanding how the foreign orders are initially received and placed, the narrative and supporting documents do not trace the ordering process in such a way that we can distinguish which merchandise is destined for the U.S. versus which merchandise is destined for drop-shipment to Linear’s foreign customers, at the time LHK places the order with the manufacturer. Accordingly, we remain unconvinced that the "clearly destined" prong of the Nissho Iwai test has been met.

The second prong of the Nissho Iwai test is the whether the transaction at issue is "at arm’s length". In general, Customs will consider a sale between unrelated parties to have been conducted at "arm’s length." If the parties to the requested transaction are related, then it is necessary to provide Customs with information which demonstrates that transaction value may be based on the related party sale as provided in 19 U.S.C. 1401a(b)(2)(B) (i.e., that the circumstances of sale indicate that the relationship did not influence the price or that the transaction value closely approximates certain test values.) For further information regarding related party transaction see Transfer Pricing; Related Party Transactions, 58 Fed. Reg. 5445, January 21, 1993. In the instant matter, Linear, LHK and Chinakong are related parties. Based on the information submitted, we doubt whether the transaction between LHK and Chinakong (if considered a "sale") would satisfy the arm’s length criteria. However, because we have already established why the merchandise may not be appraised under transaction value based on the transaction between LHK and Chinakong because the "clearly destined" prong of the Nissho Iwai test is not satisfied, we will not address whether it also definitively fails to satisfy the second prong of the Nissho Iwai test, namely the "arm’s length" part of the test.

HOLDING:

For the reasons described above, the subject merchandise may not be appraised under transaction value based on the transactions between LHK and Chinakong.

Sincerely,

Thomas L. Lobred
Chief, Value Branch

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