E-Tailing Franchise Fees Not Included in Price Paid for Valuation Purposes, CBP Says

However, in situations in which the buyer hasn't established that the transaction value is acceptable for related party transactions, an alternate method of appraisement must be used to establish the customs value of the imported merchandise, the ruling continued.

This ruling involves an unnamed buyer who makes e-tailing franchise fee payments to a parent seller company. The buyer had asked CBP whether transaction value is an appropriate method of appraisement for import transactions when the buyer purchases goods from its parent company.

The buyer, a subsidiary of the unnamed seller, is an online retailer of high-end apparel products for women and men in the North American market, according to CBP. The seller had launched an overseas market, which it used to develop procedures and operating expertise to run the business. As the online retailing market rapidly expanded, the buyer was established to serve the North American market as a warehousing and resale operation, CBP said.

A 2016 audit conducted by CBP's Trade Regulatory Audit Directorate determined that the buyer's activities related to the use of the transaction value method "presented an unacceptable risk to CBP," CBP said.

"Specifically, Regulatory Audit raised concerns about the dutiability of so-called 'e-tailing franchise fees' identified on the general ledger and not included in the customs value of imported goods," CBP said. "According to the finding sheet attached to Regulatory Audit’s report, the Buyer did not document what the e-tailing franchise fee was for, who received it, or how it was calculated."

A February 2018 report on a subsequent follow-up audit said the franchise fee that the buyer paid included both dutiable and non-dutiable costs that had been commingled, CBP continued, and the audit determined that the transaction value was inapplicable.

The importer disagreed with these findings, and the matter was referred to the Office of Regulations & Rulings for internal advice.

In its submissions to CBP, the importer provided the agreement that discusses the e-tailing franchise fee. The fee is calculated by applying a benchmarked Berry Ratio (i.e., the ratio of gross profit to operating expenses) to the buyer’s budgeted financial results at the start of each accounting period, CBP said. If the e-tailing franchise fee calculated in this manner does not cause the buyer’s budgeted operating margin to fall within a benchmark arm’s-length range, an upfront adjustment to the e-tailing franchise fee is made to bring the budgeted operating margin to the nearest edge of this range, the agency continued.

The importer also hired consulting firm Deloitte to produce a transfer pricing analysis that the company submitted to CBP.

According to the ruling, CBP homed in on this point in Deloitte's analysis: "The global pricing policy of the intercompany transfers is that they are transferred at cost, and this policy is applied consistently to flows in and flows out of the Buyer."

CBP's Apparel, Footwear and Textile Center of Excellence and Expertise had focused on a number of issues, the first being whether the e-tailing franchise fee that the buyer pays to the seller should be included in the transaction value of the goods that it purchases from the seller. The franchise fee could be dutiable in three ways, according to CBP: "(1) as part of the price actually paid or payable for the imported merchandise; (2) as an addition to the price actually paid or payable for certain royalties or license fees; or (3) as an addition to the price actually paid or payable for certain proceeds of subsequent resale, disposal, or use of the imported merchandise."

Based on past rulings and lawsuits, CBP found that even if a total payment is "all inclusive," it doesn't encompass payments totally unrelated to the imported merchandise.

"CBP has therefore generally held that service fees that are entirely separate from the amounts paid for the imported merchandise are not part of the price actually paid or payable," CBP said. The ruling later continued, "The separate nature of these fees is also supported by the lack of nexus between the e-tailing franchise fee payments and the production or sale of the merchandise."

CBP also examined the angle of royalties, ultimately determining that "the intellectual property rights covered under the Agreement do not relate to the production or manufacture of any goods. Under its business model, both the Buyer and the Seller purchases branded goods from third-party designers to sell on their website; neither designs or develops any merchandise of its own."

Given these analyses, CBP determined that the e-tailing fees "do not result from the subsequent resale, disposal, or use of the merchandise. Instead, they result from the Seller’s provision of services -- namely, retail and buying, technology, marketing, operations, creative (i.e., photography, artwork, etc. used on the website) and head office/financial services -- that do not relate directly to the imported merchandise. The calculation methodology, which depends on the Buyer’s overall financial results, confirms the lack of direct connection between the payment and the imported merchandise."

As CBP examined whether it would be acceptable to related-party price as a transaction value, the agency recommended the deductive value method, whereby "imported merchandise is appraised on the basis of the price at which it or identical or similar merchandise is sold in the United States in its condition as imported and in the greatest aggregate quantity either at or about the time of importation, or before the close of the 90th day after the date of importation."

"Here, provided the required information is available and the technical requirements have been satisfied, the deductive value method is an appropriate method of valuing the imported merchandise," CBP continued.

However, if the requirements of the deductive value method cannot be met, an importer should consider the computed value as an alternative method of appraisement.

"Here, as the Seller does not manufacture the imported merchandise, it is unlikely to have access to the information required for a computed value calculation. Nonetheless, we recommend that you provide the Buyer with the opportunity to do so," CBP said.

Another method, if the others don't work, is to use the "fallback method," which provides for appraisal on the basis of a value derived from one of the previous methods, reasonably adjusted to the extent necessary to arrive at a value, CBP said.

"As the imported merchandise at issue appears to have been imported for resale to North American customers, such a flexible application of the deductive value method may be appropriate here," CBP said. "We note, however, that certain limitations exist under the fallback method. For example, merchandise may not be appraised on the basis of the price in the domestic market of the country of export, the selling price in the United States of merchandise produced in the United States, minimum values, or arbitrary or fictitious values."