Duest

Here's a question. Assume pots and pans from Thailand individually qualify for duty-free entry into the United States under the Generalized System of Preferences ("GSP"). That means they have 35% of their value derived from Thai-origin materials or costs and are shipped directly from Thailand to the U.S. So far, so good. Now assume that glass lids for the pots and pans are added to the imported goods and those lids are from China, which is not a GSP-eligible country. Do the pots and pans continue to qualify for duty-free entry under GSP or is the entire set disqualified due to the presence of the lids from China?

That is the question presented in Meyer Corporation US v. United States. The tricky thing about this situation is keeping separate tariff classification rules, entry documentation, and GSP eligibility. The classification of the pots and pans plus the lids is controlled by General Rule of Interpretation 3(b), under which the retail set is assigned a single classification based on the one item in the set that imparts the essential character. In this case, that was the pots and pans. As a result of this rule, the entire retail set is usually assigned a single rate of duty.

Following a 1991 Treasury Decision (T.D. 91-7), Customs argued that the 35% value added test must be applied to the entire set, including the lids. According to Customs, the mere packaging of the lids with the pots and pans was not sufficient to substantially transform them into articles of Thailand, making them count against the 35% requirement.

Rather than focus on the Treasury Decision, the Court of International Trade looked at the GSP statute. In 19 U.S.C. 2463, Congress extended GSP benefits to "any eligible article which is the growth, product, or manufacture of a beneficiary developing country" if that article satisfies the other statutory requirements. The pots and pans, individually, are eligible articles. The set, as a whole, is not.

According to the Court, the GSP statute extends to the individual articles that make up the contents of the set, not the set itself. The fact that GRI 3(b) produces a single rate of duty applicable to the retail set does not collapse the contents of the set into a single article for GSP purposes. Thus, the pots and pans arguably retain their individual GSP status. That is the legal conclusion. Whether the facts establish that to be true or not, is not decided in this preliminary decision.

There are other related issues to be settled. For example, if the pots and pans get duty-free status under GSP, does that mean that the lids are dutiable as products of China? If so, at what rate, the rate applicable to the pots and pans, which provide the essential character or at the rate applicable to glass lids from China? The Court did not resolve that and noted that further briefing is necessary to do so.

Next, the plaintiff asserted that the proper valuation for purposes of entry and, therefore, the GSP calculation should be the sale price of the lids from the Chinese manufacturer to the company in Thailand. This is first-sale valuation under Nissho Iwai (Fed. Cir. 1992). To determine whether the first sale is a bona fide sale for purposes of appraisal, Customs looks to the level of profitability of the "firm." In this case, CBP treated the firm as the parent of the importer. There is a debatable question of whether that is a reasonable data point for comparison. The Court also noted that the first sale might be influenced by China's status as a non-market economy. In the end, the Court determined that there are not sufficient facts available to make a decision on this point.

As a result, the Court ordered the parties to confer and propose how to proceed.

The legal decision here should not be lost in the details. This case holds that combining GSP-eligible and non-GSP-eligible items in a retail set does not strip the benefit of the GSP from the eligible articles in the set. That is the takeaway and is big, if it holds up on appeal.

There is a practical question of how entry will be made. A footnote in the decision discusses the possibility of separate line items or even separate entries of the items within the set. The resolution of that also remains to be seen. But, keep in mind that the contents of retail sets must be itemized on the entry anyway. This is the X/V reporting requirement contained in the instructions (see page 14) for completing the 7501. One would assume that adding the A prefix to the HTSUS number at the V-line level would take care of that (if more than one Special Program Indicator can be applied). If not, a new SPI covering both V and A might need to be added to the system.

We don't talk enough about customs value here. It is important, complicated, and interesting. It deserves more attention. There are, however, also fewer rulings and cases on valuation questions. Happily, this one (HQ H233376, Sep. 19, 2016) caught my eye. The issue is whether a royalty paid to a U.S. patent holder who is unrelated to the importer is dutiable when the royalty is paid not by the importer but by the importer's parent company.

The patents at issue are all utility patents, meaning that they relate to new and useful inventions rather than to the design aesthetics of the item. A utility patent generally involves the critical technology that defines or empowers the invention. The license grants to the importer (via a predecessor company, just to complicate matters) "to make, have made, use, sell, offer for sale and import Licensed Devices" worldwide. The license also authorizes the licensee to disclose to the manufacturer, who is in Malaysia, the information that is necessary to manufacture the products. Similarly, the manufacturer is authorized to use the patented technology to makes the item and to apply related trademarks.



When goods are imported pursuant to a sale, the customs valuation is usually the "transaction value." That is defined at 19 USC 1401a(b) as the price actually paid or payable for the merchandise when sold for exportation to the United States, plus specified statutory additions including "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States."

In 1993, Customs published an official notice detailing how it will analyze royalties for dutiability. We discussed that here. To summarize from my earlier post, under the test, Customs and Border Protection analyzes each royalty agreement on a case-by-case basis and asks three questions:

1. Was the importer merchandise manufactured under patent? If the answer is yes, then the payment is more closely tied to the production of the merchandise and is, therefore, more likely dutiable.

2. Was the payment involved in the production or sale of the imported merchandise? This question goes more deeply into the purpose of the payment. If the importer can show that the payment is for something other than the manufacture, production, or purchase of the imported goods, the payment may not be dutiable. Customs gave two examples in which the Court found that the putative royalty was for the use of the product in the United States, not for the patent rights related to the production or importation of the product. A positive answer to this question, therefore, leans toward dutiablity while a negative answer leans against.

3. Could the importer buy the product without paying the fee? If the fee is not optional and goes to the seller, it is more likely to be a dutiable part of the value of the merchandise. According to Customs, this question "goes to the heart" of whether the payment is a condition of sale. That means a negative answer to this question indicates dutiability.

In this ruling, Customs gave the short answer that the royalty is dutiable. The merchandise was manufactured under a patent and the patented technology is related to the production or sale of the imported item. Furthermore, Customs found that the importer could not buy the merchandise without paying the fee. Nevertheless, counsel for the importer (who was not me) argued against suitability of the royalty in this case.

Counsel first noted that the royalty is not paid to or for the benefit of the seller. This is a common argument and merits attention. How is a royalty part of the "price paid or payable" for the merchandise if it not paid to the seller? The answer is that the statute does not require that the royalty be paid to the seller to be dutiable. Rather, the statute requires that royalties be added to the dutiable value when they are "related to the imported merchandise" and when "the buyer is required to pay [the royalty], directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States." Note that the statute does not say to whom the royalty must be paid to be dutiable.

The question is not how much did the seller receive in exchange for the goods. The question is what is the total cost to the buyer to acquire the merchandise. This is entirely consistent with other parts of the statute which, for example, add assists, selling commissions, and packing materials to the entered value for duty. If the buyer did not pay this patent royalty, the seller would have to do so to acquire the legal right to manufacture the item. Because the buyer's parent paid it, the cost to the seller is reduced below what it would otherwise have been. This is exactly why the value of buttons provided by the buyer to the manufacturer for use in the production of shirts must be added to the entered value of the shirts. If the seller had to go buy the buttons, it would increase the price to cover the additional expense. This, therefore, is a losing argument, even when the patent holder is in the U.S.

To stick to this conclusion, Customs had to distinguish several prior rulings that appear to have conflicting results. I'm going to spare you the details. It should suffice to say that a patent royalty might not be dutiable if it is not a condition of the sale to the United States or is not fundamental to the manufacturer of the item. For example, a patent license relating only to the use of some item, as opposed to the manufacturer of it, is less likely to result in a dutiable royalty. Similarly, a design patent is less likely to be dutiable than is a utility patent.

The other question is whether a royalty paid to a U.S. patent holder can be a condition of the sale for export from the foreign manufacturer. After all, what does the manufacturer care if the buyer fails to pay the royalty? That is not its problem. Customs' analysis is more nuanced than that. It held that a condition of the sale exists where the right to use the patent "must be secured, either by the buyer or the manufacturer because the patent is necessary to produce the merchandise to be sold for export to the United States. i.e., [sic] the imported merchandise would not exist it the rights to the patent were not obtained." This gives the requirement that the royalty be a condition of the sale a broad and flexible interpretation that can be interpreted practically as well as under the terms of an individual contract.

All of that led Customs and Border Protection to hold the royalty in this case to be dutiable.

I have a question. The ruling clearly says, "the royalty payments at issue are made to the licensor, [Company A] (a U.S. patent holder who is not related to the company or to the manufacturer of the imported merchandise_, by [Company B], the parent of the company's parent." [Emphasis added.] So am I correct that the buyer did not actually pay this royalty? It was paid not by the parent company but by the grandparent company. This should be discussed in the ruling. The company, presumably the importer, is not responsible for the payment of the royalty. It seems possible that the company did not even know about it.

The statute covers "any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale . . . ." [Emphasis added.] It appears that Customs treated the royalty as indirectly paid, without stating so. Is that right?

I would read "indirectly" as relating to the method of payment to the seller, not to the party making the payment, which seems to be limited to the buyer. How do we know from this ruling that the buyer is required to make this payment, whether directly or indirectly? It seems clear that a related but legally separate entity is required to make that payment. I can see CBP's implied conclusion that this is an indirect payment by the buyer, but I think there needs to be some facts stated to support that conclusion. Otherwise Customs has effectively ignored the separate legal status of the companies and pierced a corporate veil without comment.

You may recall that last year my final exam for Trade Remedies was an elaborate, cinematic fact pattern involving the DC superhero universe. See here for that. Read the comments, which are really quite good.

This year, I was not able to string together quite as detailed a fact pattern for my Customs Law class. I did, however, ask this question. Tell me what you think is the correct answer. I will be flexible, but you should not need to stretch too much.

I'll be back soon. I promise.


QUESTION 3: 25 POINTS

Ralph Dibny is the CEO of Plastico, which imports plastic in various forms from suppliers all over the world into the United States. To find suppliers, Ralph relies on two representatives. Reed Richards is responsible for suppliers in South America. Patrick “Eel” O’Brian is responsible for suppliers in Asia. Neither representative is an employee of Plastico.

When Plastico wants to purchase materials from South America, Dibny contacts Richards who then finds suppliers that can provide the necessary material. Richards facilitates the transaction by locating and approving suppliers to Plastico’s standards, creating Plastico Purchase Orders, reviewing supplier invoices for Plastico, approving payment by Plastico, and arranging transportation. For these services, Richards earns a fee of 5% of the invoice price Plastico pays to the supplier. That amount is not shown on the commercial invoice for the imported product and has not been declared to Customs as part of the dutiable value of the merchandise.

Purchasing from Asia is a different process. Eel O’Brian has relationships with several plastic manufacturers throughout Asia. When a manufacturer in Asia has excess inventory, it contacts O’Brian and asks him to sell it to customers in the U.S. The supplier dictates the lowest acceptable price and usually refuses to take responsibility for the cost of shipping and transportation insurance, which must be paid by the customer, including Plastico. O’Brian will then contact Dibny and offer the merchandise to Plastico. If Plastico wants to purchase the merchandise on O’Brian’s terms, it agrees to purchase it from O’Brian. At that point, Plastico will create a Purchase Order naming O’Brian as the supplier. O’Brian places the order with the supplier, who ships the merchandise directly to Plastico in the United States according to the terms of Plastico’s P.O. with O’Brian. The supplier invoices O’Brian who then sends Plastico an invoice showing O’Brian as the seller and including a markup to add his profit. Plastico may not know the identity of the supplier until it receives the shipment, if even then. O’Brian has similar arrangements with several U.S. customers. He negotiates prices with the U.S. customer to maximize his income. The O’Brian’s markup is included in the commercial invoice used for entry and, therefore, has been declared to Customs as part of the dutiable value of the merchandise.

Plastico is always the importer of record and is not related to Richards, O’Brian, or to any foreign manufacturer of plastics. Transaction value is the applicable basis of appraisal.

Dibny has asked for your legal advice on whether the fee paid to Richards and O’Brian’s markup are legally part of the dutiable value of the merchandise. Dibny also wants to know whether there are adjustments Plastico can make to ensure that the amounts paid to Richards and O’Brian’s markup are not dutiable.

There used to be a time when I was able to keep this blog up, make each post funny, and occasionally interesting to the customs compliance pros. But, as periodically happens, then I get busy. It turns out that this is week 8 of 2016 and I am about to post ROTW number 5. I am not happy about that. Let's see what we can do to catch up.

Today's ruling is HQ H270670 (Feb. 17, 2016) and continues our focus on value questions. Value is complicated enough to make many compliance professionals quake.

The ruling involves purchases by "The Cereal Company" of premiums or toys. The only Cereal Company I can find online purports to be in Zambia. Thus, my assumption is that the Cereal Company is a pseudonym for an actual cereal company and that these toys are headed into boxes of puffed sugar and artificial color.

This case is honeycombed with players. The Cereal Company buys the toys from suppliers in China. An unrelated third party in the U.S. called Insight Promotions arranges for the toys to be wrapped and performs project management and testing. To save on alpha-bits, I will call that company "Insight." Insight outsources the wrapping to a third company in Canada called Econopac. Consequently, the goods go from China to Econopac in Canada and then to the United States. Econopac does not purchase the goods and does not have title. It invoices Insight for its services.

Insight Promotions performs additional services on behalf of the Cereal Company. Those include consultation about the toy design, communication with the manufacturer about production, testing, consultation with the buyer about packaging, management of the packing process, etc. According to Customs, the Cereal Company "reimburses" Insight for these services. I think the better term is "pays." Although, Insight may be reimbursed for the services from Econopac, assuming it pays Econopac.

For some reason, the Canadian Econopac is the importer into the United States. Think about that for a moment. Econopac does not own the goods, it is a toller providing services. The Cereal Company needs the merchandise and is the purchaser. Insight is supposed to be managing the process for The Cereal Company. There may be a perfectly good reason why this is set up this way. But, to my way of thinking, the Cereal Company might want to have more control over the compliance of its supply chain. It is a kick in the head when there is a problem with an entry and the party with the greatest interest in the goods, which I am assuming is the Cereal Company, is not the importer and can't easily get involved in the issue. But, that is a side issue for another day.

At entry, Econopac declares the value to be the sum of the following pebbles of value:

• The price paid by the Cereal Company for the toy
• Econopac's fee for wrapping
• The value of the wrapping material (plastic film)
• The additional fees for services charged by Insight

The question raised in the ruling is whether the additional services provided by Insight in the U.S. should be part of the dutiable value.

Uncle Sam, through U.S. Customs and Border Protection, assumes that the proper method of appraisal is transaction value. That means that the dutiable value will be the "price actually paid or payable for the merchandise when sold for exportation to the United States." That is, in other words, the total payment made for the merchandise by the buyer to or for the benefit of the seller.

Here, the payment to Insight is not a payment to the seller of the imported goods. The goods were sold by the supplier in China to the Cereal Company. Insight and Econopac were service providers, not sellers. On top of that, the services Insight provided were not closely related to production. It did not design the item nor did it provide manufacturing or production expertise. The payments to Insight, therefore, are not art of the price paid or payable for the imported merchandise. Which, I can say without waffling, is a good result.

I tend to get focused on classification here on the Customs Law Blog. But, this is not the Tariff Classification Law Blog. Our scope if broader. With that in mind, we should also look at the other side of the duty calculation: value. Most importers understand that value is usually "transaction value" plus statutory additions including assists, royalties, and commissions. Look at 19 USC § 1401a. Most of the time, that will get you through the day. But, it does not work when you don't have a sale for export to the United States or when the price is affected by the relationship between the parties. In those cases, we need to turn to an alternative method of valuation.

When transaction value fails, the statute requires that the goods be appraised based on a hierarchy of methods. The first alternative is the transaction value of identical or similar merchandise. For purposes of today, I am skipping that and going to deductive value. Why? Because its my blog.

The ruling for today is HQ H007667 (May 25, 2007). The merchandise is melons imported from Panama. At the time of entry, the melons were not sold to the importer. Rather, they were entered on consignment. After delivery, the importer took possession of the melons and advanced the grower $2 per box, but did not buy them. Rather, it sold them unrelated third parties, usually within a week of arrival. After the sale (which is the first time a sale in the U.S. occurs) the importer payed the grower the proceeds of the sale, less adjustments for delivered quantity, marketing and distribution expenses, customs duties, and an overhead charge. Essentially, the importer was acting as an agent for the grower by selling goods in the U.S. and being compensated for expenses plus a commission.

Under these facts, there is no sale for export to the United States. Consequently, there is no price paid or payable at the time of entry and no basis on which to apply transaction value. The ruling does not give a particularly cogent reason for skipping from identical or similar merchandise to deductive value. The issue seems to have been price volatility, but that is not important. We are looking at the deductive value analysis.

Deductive value starts with the sale price in the U.S. and deducts out expenses to try and arrive at an FOB foreign port price. The relevant sale price is the unit price at which the merchandise concerned is sold in the greatest aggregate quantity at or about the date of import. If the merchandise is not sold at or about the time of importation, the relevant price is the price at which the merchandise was sold in the greatest aggregate quantity after the date of importation but before the close of the 90th day after importation. That puts a stake in the ground setting the outermost limit for when a deductive value can be found. Here, the melons were to be sold within a week, which is at or about the time of importation.

Now, we have to back expenses out of that price to get to the entered value. According to 19 CFR § 152.105(d), the expenses to be deducted include:
           

5. But only in the case of price determined under paragraph (c)(3) of this section, the value added by the processing of the merchandise after importation to the extent that the value is based on sufficient information relating to the cost of that processing.

1. Profit and general expenses related to the sale in the U.S. (including the commission)

2. International shipment from Panama to the U.S.

3. Customs duties, MPF and HMT and the cost of phytosanitary certificates

Customs allowed the deduction for marketing and distribution costs as well as the profit. Profit, in this case, was expressed as an "overhead charge." Customs also allowed the deduction for ocean freight. Because the transportation from Panama to the inland point of unloading in the U.S. was shown on a single through bill of lading, Customs permitted the domestic transportation to be deducted. Finally, the customs duties, taxes and fees could be deducted.

After all of those deductions, what remains is the deductive value. Calling it "deductive value" should kind of make sense now.

The interesting thing about deductive value is that it inverts the recordkeeping requirements. The importer is still required to retain documents to support valuation, but the nature of those documents will change. Under deductive value, the there is no price paid or payable to the exporter and there will not be an invoice from the exporter or payment to the exporter that corresponds to the deductive value. Rather, the key documents are evidence of the post-importation sale in the U.S. and, very critically, evidence supporting any deductions from that sale price. An importer relying on deductive value needs records proving the cost of international shipment; the duties, taxes, and fees paid; marketing and distribution expenses; the profit it earned; etc.

This is sometimes a hard concept for compliance personnel who are used to matching a commercial invoice to a 7501 and payment record. It is, however, the way it works.

Some of you are screaming that I skipped over the issue of finding the price at the greatest aggregate quantity. That is an important issue and also impacts recordkeeping. What it means is that your starting price cannot be arbitrarily selected as the lowest price ever attained in the U.S. That would be inappropriate and not representative of true value.

Instead, the price to use as the starting point for your deductions is the single most common price at which the units are sold to an unrelated party. Assume you import 100 melons and make four sales: 15 units for $2 each, 10 units for $1.50 each, 40 units for $1 each, and 35 units for $1.50. Although the single largest sale was of 40 units for $1 each, that is not the price to be used. Rather, the price of the greatest aggregate quantity is $1.50, which was applied to the sale of 45 units (10 + 35). Yes, that is a recordkeeping issue as well.