Importers Need to Prepare Middleman Documentation Supporting First Sale Claims

When a CBP import specialist first looks at whether a first-sale transaction has occurred, the import specialist will be focusing primarily on the transaction itself because "they're appraisers for classification. Then they do valuation, but not at the level of audit," said Teresa Halpin, KPMG director of trade enforcement and advisory services. Halpin was previously with CBP as the New York field director for CBP's Office of Trade Regulatory Audit.

She continued, "When an import specialist conducts these transactional analyses, they're determining whether you're actually filing for first sale. Because they don't know. They don't know until they ask the questions. And once they determine there's this multi-tier transaction, they have to determine whether they're going to accept it at the [CF-] 28, [or] whether they're not accepting it [and will] issue a [CF-29 form] ... If they refer to audit, basically it's, it'll be a comprehensive review."

CBP is able to use this approach through an expanded interpretation of Treasury Department Decision 96-87, said Rodrick Lawlor, KPMG director of trade enforcement and advisory services.

If an importer is under audit, it may need to ask its middleman for more information, such as journal entries of transactions from the middleman, according to Irina Vaysfeld, principal at KPMG.

“We've been asking for journal entries for many, many years. We can also do first sale in the context of when the middleman is not buying finished goods. They may be buying assembly services of some sort, and the middleman may be providing materials free of charge or at a reduced cost,” Vaysfeld said. “So in those cases, we're building up that first-sale value through a cost worksheet, customs value worksheet summary. So, it's very case dependent on the documentation that you may need to support for sale.”

Importers may need to have conversations with their vendors about making these types of documents available. This may divert from how both sides have traditionally interacted in the past, Vaysfeld said.

As companies consider using first sale as a means to mitigate the impact of higher tariffs, they need to address the areas where CBP has elevated its trade enforcement efforts. Two areas in particular where CBP has homed in are valuation and country of origin, according to Halpin.

"Even in just the last two months, in working with KPMG, it's seeing a significant uptick in the CF-28s guided towards country of origin. And that's even within the context of a first sale transaction," Halpin said. CF-28 forms are those that CBP sends out as a formal request for information to ensure compliance.

According to Halpin's presentation, importers' value mitigation strategies have been subject to higher degrees of scrutiny from CBP, particularly as it relates to transfer pricing and first sale for export declarations. KPMG has also seen a "significant rise" in country of origin inquiries related to country-specific AD/CVD orders and China Section 301 risks, according to Halpin. Emerging enforcement activities also could occur with Section 232 steel and aluminum content declarations, the presentation said.

Based on CBP rulings, there is an increasing focus on bona fide sales, the transfer title of risk of loss and arm's length sales, according to Lawlor.

"The lessons that I think all can learn from some of these recent adverse first sale rulings, is it's really a substance over form," Lawlor said. "So, as a starting point, yes, you want those purchase orders, those invoices, to be separated. You have to demonstrate that there's been succinct or distinguishing factors of each sale level. But CBP is starting to lean in a little bit more into determining, okay, what would be the overriding factors? What are the commercial trends?" CBP may be looking at information confirming Incoterms, multi-tier transactions indicating a risk of loss, master supply agreements and insurance documents listing beneficiaries, he said.

"What they're looking to do is identify what the margin was recognized on that individual commodity, and compare that margin to that related seller's overall margins of like kind merchants during a set period," Lawlor said. "So when we talk about some of the challenges in doing that, you have to work with a team like KPMG to really identify the structure of that transaction, get the cost sheet manufacturer, identify the raw material inputs, the labor inputs. ... and then, using accounting principles, rolling that back up the corporate structure as you move up the corporate chain."

He continued: "Because remember, sometimes a seller could be a related entity of another foreign holding company, right? So it becomes a very complicated process, and one that CBP recognizes that companies will often get tripped up on."

As importers respond to potential audits, being able to demonstrate that an importer has taken reasonable care might help its case, Lawlor later said.

"It still carries a lot of weight from the CBP perspective," Lawlor said. Actions such as providing the right documentation with the right data shows that a company has taken due diligence, and that can serve as a basis for mitigating penalties, he continued.

"When you have this evidence of the programs and procedures you have put into place, it goes a long way," Lawlor said.