The First Sale Rule: Where We ve Been and Where We re Going Tuesday, July 27, 2010 USA-ITA Speaker: Alan R. Klestadt, Esq. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 1
Overview What is the First Sale? Maximizing the Opportunity Vendor Issues Protecting the Benefit CBP and the First Sale Rule The Future? Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 2
The First Sale Rule Where there are back-to to-back sales (e.g.( g.,, a sale from a manufacturer to a middleman followed by a sale from the middleman to a U.S. purchaser) duty may be paid on the so-called first sale (i.e., the manufacturer s s price) provided the following two conditions are met: 1. the sale between the middleman and manufacturer must be negotiated at arm s s length and free from non-market influences that affect the legitimacy of the sales price; and 2. the sale must involve goods clearly destined for export to the United States. Recognizes that in certain instances there can be more than one sale for export to the United States. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 3
Valuation Basics First sale is a duty savings concept which is available to importers utilizing the transaction value method of appraisement. Transaction Value is the preferred method of appraisement for most imported merchandise. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 4
Valuation Basics Transaction Value definition: The price actually paid or payable by the buyer to the seller for the goods when sold for exportation to the United States,, plus certain statutory enumerated additions. Must be the sale that causes the goods to be exported to the United States. There must be an arm s s length transaction. If the parties are related, the importer must be able to demonstrate that the relationship did not influence the price. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 5
Single Tier Transaction US Buyer orders goods from the Seller. The Buyer pays the Seller the negotiated price. The price paid to Seller is used as the entered value of the goods. This transaction is not eligible for first sale benefits! 200 bottles Shampoo at $1.00 each $200.00 Entered Value Buyer/Importer Places Order Seller Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 6
First Sale Exists in a Multi-Tiered Transaction The first sale is the sale from the Manufacturer to the Seller. The first sale does not include the Seller/Middleman s s profit and overhead. Typically, the Seller will place the order to the Manufacturer after the Buyer places the order. Buyer/Importer Place Order Second Sale Seller Sales order First Sale Manufacturer Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 7
Basic Documentary Requirements 1. PO from Importer/Buyer to Middleman/Seller 2. PO from Middleman to Factory 3. Invoice from factory to Middleman 4. Invoice from Middleman to Importer 5. Export Bill of Lading 6. Proofs of Payment Between the Parties 7. If the Middleman or the Importer provides an assist or pays a dutiable royalty, a Value Breakdown or Cost Sheet may also be required. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 8
Maximizing the Benefits The goal of the first sale is to avoid paying duty on non-production related expenses. Most vendors are not set up to maximize the first sale benefit. Seek to maximize the middleman s s gross margin. Gross margin includes the costs of running the business plus profit Shift non-production related expenses from the factory to the middleman. Travel Entertainment Legal and consulting fees What does it cost the vendor to run his business? Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 9
One Size Does Not Fit All Ownership structures can significantly complicate the transaction. Logistical considerations such as quality control, warehousing, consolidation, ticketing, etc. must be considered. Varying terms of sale can have a significant legal impact. Factories in different countries face varying obstacles (e.g., VAT, taxation). Results will vary! Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 10
Related Parties A sale between unrelated parties is presumed to be at arm s s length. A related party sale may be accepted if the circumstances of the sale indicate that the relationship did not influence the price OR the transaction value between related parties 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 of identical or similar merchandise that was exported to the U.S. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 11
Circumstances of the Sale Customs may examine relevant aspects of the transaction including the way the buyer and seller organize their commercial relations and how the price was derived; OR Demonstrate the parties organize their commercial relationship and negotiate price as if they were not related and that the price was settled consistent with normal industry practices; OR Demonstrate that the price is adequate to ensure recovery of all costs plus a profit which is equivalent to the firm s overall profit realized over a representative period (e.g., on an annual basis) in sales of merchandise of the same class or kind; OR Test values sales of identical/similar merchandise, deductive or computed value Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 12
Vendors and the First Sale First, the good news: Much less reluctant to participate. Recognize that they can leverage the program to make their merchandise less expensive to the buyer. Less concerned about providing access to costing information and financial results Now, the bad news: Developing structures to avoid related party pricing issues. Resist documentation requirements. Continue to limit the benefit. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 13
Vendor Issues Verification of relationships Confirmation of payment Document retention and production Restructurings or changes to their corporate structures Recordkeeping Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 14
Periodic review? Validation frequency and diversity corrective action third party audit? Most common issues: Terms of sale Related party pricing Complete & consistent documentation Proof of payment Support for assists and cost reconciliation Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 15
Related Party Pricing How was the pricing validated when the program was initiated? Was the testing subjective or empirical? Did the testing follow one of the standards enunciated by CBP? Has anything changed? What happens if the factory is no longer profitable? All costs plus profit test contemplates a profit!! Can the factory show sales to unrelated parties? Are there viable test values? Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 16
Proof of Payment A sale requires transfer of title and risk of loss for consideration. Middlemen must pay the factory for the goods in accordance with the terms of sale. Bulk payments must be reconcilable. Payments for assists must be documented. if made in local currency, what exchange rate are they using? Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 17
Assists Many middlemen work with factories on a cut & make basis and provide the factories with the fabric and trim. Fabric, trim, accessories, etc. are assists which must be added to the price paid to the factory for duty purposes CBP wants to know who paid for what so that they can confirm that the price paid or payable has been properly declared. Cost sheets/value statements must be supported by assist purchase documentation. How were the costs allocated? Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 18
Recordkeeping Burden of proof is on the importer! Importer is required to substantiate the claim for duty allowance in accordance with T.D. 96-87 CBP requires that records be kept for 5 years. Will you still have a commercial relationship with the vendor in 5 years? Records which are important to the first sale program are not necessarily important to the vendor! Partial record production is viewed by CBP as a failure of proof and a reason to disallow the claim. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 19
The Future of the First Sale Program CBP Attempt to Eliminate First Sale Developments in the WCO & European Union CBP Headquarters Position Review at the Port Level Regulatory Audit Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 20
CBP Attempt to Eliminate the First Sale In a 2008 Federal Register Notice, CBP issued a proposed interpretation of the term sold for exportation to the United States which would have eliminated the first sale rule of appraisement. In response to broad industry opposition, CBP withdrew its proposal. Congress passed legislation which required the ITC to study the impact of the first sale rule. As a result, CBP imposed a first sale reporting requirement which has since expired. CBP has advised that it has no current plans to revisit this issue and plans to issue a NPRM in the near future formally withdrawing the 2008 proposal. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 21
World Customs Organization WCO Technical Committee on Customs Valuation Commentary 22.1 adopted April 2007 Price paid or payable when sold for export to the country of importation is the last sale occurring prior to introduction of the goods into the country of importation. Rationale: No definition of sold for export in Article 1 Impact on additions to price (e.g., assists, royalties) Difficult to verify records of foreign buyer Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 22
EU Consideration of Last Sale Rule A coalition of member states has advocated amending the EU value code to adopt a last sale rule. Issue has been debated for many months. Broad industry opposition has been successful in forcing further debate Additional government-industry workshop discussions to be held in October 2010. Recommendation of the Customs Code Committee will then be considered by the full EU Commission. A change in the EU is likely to cause the issue to be reconsidered by the WTO. If the WTO votes to change the value code, the U.S. will... Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 23
CBP Headquarters & The First Sale CBP has resisted the first sale rule since its inception. From 1992 to 2003, CBP issued numerous restrictive rulings which established legal requirements not found in any judicial decision. Recent rulings evidence a strict constructionist approach with heavy emphasis on T.D. 96-87. Existing rulings on transfer pricing and related party sales are very limited and do not provide specific guidance on many issues. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 24
Local Port Reaction Many ports have benignly accepted first sale transactions for many years. Increased CF 28 activity suggests this practice may be changing. Questions raised about prior notification/disclosure. Requests for refunds via protest or post entry adjustments are often met with intense scrutiny. Local import specialists are not well versed in first sale documentation requirements or transfer pricing issues Heavy reliance on Informed Compliance Publications and literal wording of the valuation regulations Few rulings offer specific guidance Frequent referral to CBP Headquarters for guidance via Internal Advice or Applications for Further Review Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 25
Regulatory Audit Auditors are strict constructionists it s s right or it s s wrong! Unwilling to overlook documentation lapses. Concerned about validating price paid or payable. Have suggested that they will require access to the general ledgers for both the middleman and the factory! Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 26
What to Do? Control the records which support the first sale declarations. Initiate regular reviews of first sale transactions to verify the correctness and completeness of the documents. Re-examine examine the validity of transfer pricing arrangements. Consider whether you have taken appropriate steps to minimize program risks. Is it possible to increase the duty savings benefit? Monitor developments in the WTO, EU and other first sale friendly jurisdictions. Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 27
Get More Information Alan R. Klestadt Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP AKlestadt@GDLSK.com (212) 557-4000 Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP 28