HQ H038381

November 17, 2014

OT:RR:CTF:VS H038381

CATEGORY: Valuation

Area Director

U.S. Customs and Border Protection

JFK International Airport

Building #77

Jamaica, New York 11430

RE: Internal Advice Request; Service Fees; Transfer Price; Restrictions on the Disposition or Use of Imported Merchandise; 19 U.S.C. § 1401a(b)(2)

Dear Area Director:

This decision is in response to your request of September 3, 2008, requesting internal advice on the dutiability of service agreement fees paid by the Importer to a related party seller and another related party. You and the importer are seeking internal advice from this office under the provisions of 19 CFR 177.11. Along with your request, this office received a copy of the Pre-Assessment Survey Report Number 261-07-FA1-P1-20832 (hereinafter, Report), dated June 25, 2008. The Report audited imports from the Importer for its calendar year 2005. The Report sets forth the reasons Regulatory Audit believes the fees to be dutiable.

Your port is in agreement with Regulatory Audit. However, the Importer, represented by counsel, disagrees with the conclusion that the service fees are dutiable and in its response to the Report, the Importer requested Internal Advice be sought from this office. In addition, counsel for the Importer requested that this Internal Advice be considered in conjunction with another Internal Advice request filed on behalf of a related importer, in response to a Focused Assessment Follow-up Audit Report, Number 821-04-FA1-F1-18241, dated August 29, 2008. As the Internal Advice requests involve the same or substantially similar issues, this office considered all of the information submitted for both internal advice requests. Our decision herein is based on the information provided in both reports referenced above, including the submissions from counsel for the related importers submitted in response to the Regulatory Audit reports; supplemental submissions made in response to inquiries made by this office; additional material requested by this office from Regulatory Audit which was acquired in the course of the audits; a review of the service agreements at issue; consideration of arguments made at a meeting held with counsel and her clients on June 16, 2009 at our offices; and additional supplemental submissions from counsel. This decision is applicable to both internal advice requests.

By letter dated July 1, 2009, the importer requested confidential treatment be accorded to certain information submitted in connection with this Internal Advice request. In consideration of the request and sufficient justification being presented pursuant to 19 CFR 177.2(b)(7), this office will not identify the parties having any connection to the transactions under review nor any of the financial information provided to CBP which relates to the costs, pricing, profit, expenses and resale related to the imported merchandise.

FACTS:

In this case, the related parties, the Seller and the Importer, promote and sell merchandise under a trademarked brand name. Brand merchandise is promoted and sold globally. The Seller performs the design and development of the brand merchandise and oversees the manufacturing of the products by related and unrelated manufacturers from whom the Seller purchases the products.[1] The Importer is a distributor of the Seller’s merchandise, imported and domestically produced, within the Northern Hemisphere, including the continental United States. The Seller owns all marketing intellectual property, brand names, trade names and trademarks. It owns the designs, models, and all intellectual property rights relating to the merchandise. The type of merchandise imported varies and includes a wide range of goods, including seasonal goods. In addition to buying merchandise from the Seller, the Importer buys merchandise from a U.S. related party.

The Importer provided Customs and Border Protection (CBP) with information regarding its electronic ordering/inventory control system. The Importer states that it monitors and manages the system whereby orders are generated through an auto-replenishment system based on sales activity and inventory levels in the Importer’s stores or inventory levels in the Importer’s warehouse. When the Seller ships the merchandise, whether to a store or to the Importer’s warehouse, the invoice indicates the Importer is the buyer, payment is due in U.S. dollars “30 days – End of month”, the total invoice amount due, and the sales terms, i.e., “ex-works.” It is asserted that based on the terms of sale as indicated on the invoice, title to the merchandise is transferred from the Seller to the Importer at the Seller’s distribution center abroad. The Importer is responsible for all freight, insurance, brokerage, and handling from that point forward.

The Importer declares the invoice price as the value for purposes of appraisement under transaction value. The invoice price is a transfer price which is a percentage of the retail price. This method for determining the transfer price is referred to as the “resale minus method” or “resale price method.” The Seller has used this method worldwide for determining transfer prices since 1993 based on a transfer pricing study of the same year. The transfer pricing study states with regard to the “resale price method”: “. . . [the Seller] must maintain control and coordination over the retail price for its product. . . .”[2] However, the Importer submits that it negotiates prices for the merchandise with the Seller and there is no evidence to support Regulatory Audit’s determination that the Importer must accept the pricing determined by the Seller.[3] Evidence, in the form of printed emails, was submitted to support the argument that the related buyers negotiate with the Seller with regard to prices.

In addition to the invoiced amounts for shipments of merchandise which the Importer pays to the Seller, the Importer pays the Seller for certain services under a “Service Agreement” which the parties claim are unrelated to the imported merchandise and are strictly services related to the retail operation of the Importer. These services, in general terms, include, among other things: establishing worldwide policy for retail prices, improving logistical systems for retail stores, merchandising services, general management services, financial management, electronic data processing (EDP) services, trademark protection, consumer and marketing services, advertising support, and other retail services which the Importer may request which are necessary for the operation of the Importer’s retail business.

In consideration for these services, the Importer pays the Seller quarterly an advance in an amount equal to a set percentage of the external net sales of trademarked brand products (excluding taxes) of the North American territory for the preceding quarter. The North American territory includes the continental United States, Puerto Rico, and other locations in the Northern Hemisphere in which brand retail stores are located and operationally managed by the Importer. In other words, the Importer pays the Seller an advance for services on a quarterly basis, based on its net sales in the United States and Puerto Rico, plus the net sales of brand merchandise which occur outside the United States and its customs territory.[4] However, the service agreement provides that at the beginning of the following year, after accounts have been finalized, the Seller and the Importer will review the services rendered and their related costs and the Seller shall reconcile the payments made by the Importer to the total amount of costs incurred. Based on this reconciliation by the Seller, the parties jointly determine any appropriate adjustment. We note the service agreement also

states that the Importer “agrees to reimburse [the Seller] for [the Seller’s] actual costs directly incurred in connection with the services rendered.”

The reconciliation of the payments was explained by the Importer as based on a combination of net sales by the Importer and a usage analysis. As counsel explained: “The methodology employed to determine the proper allocation was based upon the relative percentage of sales and management’s estimate of how much time and effort were applied to a particular expense, along with the degree to which each company benefited from the expense. The methodology was in accord with local GAAP standards.” The usage calculation was further explained as being determined by the Seller and Importer, in conjunction with one another. It was also explained as corresponding to the time spent/costs allocated by the Seller to provide services.

In addition to the service agreement with the Seller, the Importer has a service agreement with its parent holding company located in the U.S. The parent holding company provides the Importer with services which are referred to by counsel for the Importer as “back office services.” In general terms, these services include, among other things: accounting and treasury services, negotiating and purchasing general services, legal support services, human resource services, tax services, real estate related services, coordinating the centralization of media space-buying, representing the Importer in U.S. public relations activities, and serving as liaison with other U.S. related parties.

In consideration of the services provided, the parent holding company deducts from the Importer’s cash pool, account fees for services provided at the end of each quarter. “The amount of Fees shall be calculated by the Provider [the parent], in its sole discretion, based on a variety of factors including but not limited to [the Importer’s] percentage of net sales, payroll expenditures, the book value of all property held by the Company, etc., in relation to all entities that have entered into similar service agreements.” Based upon its terms, the fees paid under this service agreement are not limited to simply covering the actual costs of the services rendered. The calculation also includes a mark-up to provide a profit to the service provider.

With regard to written agreements between the parties, besides the service agreements described above, we have been provided with a copy of an “Exclusive Distribution Agreement” between the Seller and the Importer, executed on January 1, 2009. It is stated in the Distribution Agreement that “the parties agree that this Agreement is intended to memorialize the compliance with the norms and standards of [the Seller’s] distribution network that has been followed since 1981.” Other than the service agreements and the recently executed Distribution Agreement, we have been informed there are no other written agreements between the parties.

We note the following relevant portions of the Distribution Agreement:

3.4 This Agreement does not transfer or convey to [the Importer] any license or property rights whatsoever in relation with the Trademarks, the models, the distinctive signs, the decorations and/or the presentations which are used by the [Seller] for the Products.

* * *

5.1.2 The [Seller] is free to change the [merchandise] at its own will, including the additions of articles of different types.

The [Importer] declares to have accepted in advance all changes, additions or withdrawals that may have future effect on the [merchandise].

The [Seller] has the right to withdraw from distribution certain Products and require that they not be sold, and the [Seller] shall be obliged to buy back certain products from the [Importer] according to a repurchase price to be determined by the Parties on a case by case basis, taking into account possible damages suffered.

It is understood that the [Seller] shall have the right at any time and in its sole discretion to withdraw existing Products from, to add new Products to, or to modify in any other way the list of Products, without incurring any liability towards the [Importer].

* * *

ARTICLE 8 – ADVERTISING AND PROMOTION

8.1 The [Importer] shall actively and continuously advertise and promote the Products in the Territory. [The Importer] agrees to submit for the [Seller’s] prior written approval any proposed advertising and promotional program before it is implemented.

* * *

8.2 The [Seller] is responsible for advertising outside the Territory. . . ., the Parties agree that the advertising themes and documents shall be in accordance with the [Seller’s] international advertising policy.

Therefore, the [Importer] shall have the obligation to use any publicity tools that may be provided to it by the [Seller].

. . ., such tools shall have to be used according to the [Seller’s] instructions and shall by no means, be modified by the [Importer].

* * *

16.1 If, in the course of the execution of the Agreement, a Party does not require from the other one to comply with a provision or provisions of this Agreement or does not take advantage of a provision, it shall not be considered as an expressed or tacit waiver of the related right of requiring the correct implementation of the other Party’s commitments.

* * *

ARTICLE 17 – MODIFICATIONS:

This Agreement may not be altered, amended or changed, nor may any provision hereof be amended or waived, except by an instrument in writing signed by a duly authorized representative of the Party against whom such amendment, change or waiver is sought to be enforced.

[Bold added.]

In its Report, Regulatory Audit concluded that the Importer is using the appropriate basis for appraisement, i.e., transaction value, but believes that the Importer does not have adequate controls for reporting accurate and complete transaction value information. Specifically, Regulatory Audit finds the service fees being paid by the Importer to the Seller and to its parent holding company to be dutiable indirect payments which have not been declared to Customs and Border Protection (CBP) as part of the price actually paid or payable.[5]

Regulatory Audit believes these service fees are dutiable because of the relationship of the services to the product. The value of the product includes not only the cost of producing the product, but the customer’s perception of the product’s brand name value. This perception is created and controlled by the Seller. The service agreements allow the Seller to maintain the necessary control to ensure a uniform image, marketing strategy, and perceived value for its brand name products on a worldwide basis. Regulatory Audit concluded that the service agreements were intrinsically linked with the imported merchandise and thus dutiable as part of the price actually paid or payable.

Your port agrees with Regulatory Audit that the service fees are dutiable, but you differ on the basis of the dutiability. You believe that the service fees are dutiable as royalty payments and/or proceeds of a subsequent sale. You adopt Regulatory Audit’s

view that these service fees are part of the price actually paid or payable, as opposed to additions thereto, as an alternative argument for their dutiability.

As noted, a Related Importer filed a request for internal advice on substantially similar issues. Regulatory Audit’s San Francisco Field Office took a different approach in determining that the service fees paid by the Related Importer to the same Seller and other related parties were dutiable. In a Focused Assessment Follow-up Audit Report, dated August 29, 2008, Number 821-04-FA1-F1-18241, the San Francisco Field Office determined, after an audit of imports by the Related Importer for the calendar year 2006, that the Related Importer’s transfer payment to its related Seller was insufficient to meet the circumstances of the sale under the all costs plus a profit test. However, when the service payments which the Related Importer paid to the Seller, its parent holding company, and another related party, were added to the transfer price, then the Related Importer met the all costs plus a profit test. Regulatory Audit found the service fees to be related to the merchandise and to be dutiable as part of the price actually paid or payable, or as proceeds from the sale of the imported merchandise after importation.