Notice to Test the Use of Reconciliation for Adjustments Made to the Price of Imported Merchandise by Related Party Companies under 26 U.S.C. 482

DEPARTMENT OF THE TREASURY

Notice to Test the Use of Reconciliation for Adjustments Made to

the Price of Imported Merchandise by Related Party Companies under 26

U.S.C. 482

AGENCY: Customs Service, Department of the Treasury.

ACTION: Final notice.

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SUMMARY: This notice announces Customs plan to conduct a test regarding

the use of reconciliation for those related party importers which have

reason to believe upward adjustments may be made to the price of

imported merchandise for tax purposes pursuant to 26 U.S.C. 482. This

notice invites public participation in the test, and sets out the

eligibility requirements for voluntary participation in the testing of

reconciliation, for this purpose, and describes the basis on which

Customs will select participants.

DATES: The test will commence no earlier than October 1, 1995, and will

run until December 31, 1996. To participate in this reconciliation

test, the application must be filed and approved by Customs on or

before October 1, 1995.

ADDRESSES: To be considered for voluntary participation in this test

applications should be submitted to Mr. William F. Inch, Director,

Office of Regulatory Audit, Office of Strategic Trade, U.S. Customs

Service, 1301 Constitution Avenue, NW., Room 2311, Washington, DC

20229-0001.

FOR FURTHER INFORMATION CONTACT: Matthew Krimski 202-927-0411.

SUPPLEMENTARY INFORMATION:

Background

Section 1059A of the Internal Revenue Code

Section 1059A of the Internal Revenue Code provides that in related

party transactions the amount of any costs--

(1) Which are taken into account in computing the basis or

inventory cost of such property by the purchaser, and

(2) Which are also taken into account in computing the customs

value of such property shall not, for purposes of computing such basis

or inventory cost for purposes of this chapter, be greater than the

amount of such costs taken into account in computing such customs

value.

The legislative history of section 1059A indicates that Congress

intended to preclude the ``whipsaw'' effect on U.S. revenue which

occurs when a party is allowed to claim a price for ``computing the

customs value of such property by the purchaser'' that is lower than

the price claimed for tax purposes.

When section 1059A was enacted, Congress was aware that the Customs

value statute recently had been amended to make price paid the critical

cost factor taken into account by the Customs Service in valuing goods

for duty purposes. The legislative history of section 1059A also

indicates that Congress wanted section 1059A to address this situation

by attempting to place a ceiling on ``the amount of any (such) costs''

that can be claimed for tax purposes. All of the applicable legislative

reports indicate, without exception, that Congress intended that

section 1059A would instill some uniformity on the amount of costs

which may be claimed to the IRS for tax purposes by limiting the amount

of such costs to the amount claimed to, and taken into account by, the

Customs Service in computing the Customs value.

The legislative history did state that appropriate adjustments may

be made in cases where customs pricing rules differ from appropriate

tax rules--as, for example, with the inclusion or exclusion of freight

charges. Finally, the history states section 1059A applies to transfer

prices subject to section 482 of the Internal Revenue Code.

In July of 1994, the Internal Revenue Service (IRS) issued final

regulations implementing 26 U.S.C. 482. The IRS subsequently began

considering whether and to what extent the 1059A regulations should be

amended in the context of the new section 482 regulations. The section

482 regulations, specifically 26 CFR 1.482-1(a)(3), permits a

controlled taxpayer, if necessary to reflect an ``arm's length

result,'' to ``report on timely filed U.S. income tax return (including

extensions) the results of its controlled transactions based upon

prices different from those actually charged.'' The IRS is considering

whether the 1059A regulations should be amended to allow the taxpayer,

under appropriate circumstances, to make the upward section 482

adjustment.

This document announces a test that will facilitate the IRS/Customs

decision

[[Page 46142]]

as to whether reconciliation procedures provide a viable and

appropriate circumstance for a taxpayer/importer to make a post entry

upward adjustment to the price of imported merchandise.

Customs Value Law

For Customs purposes the appraised value of imported merchandise is

determined pursuant to section 402 of the Tariff Act of 1930, as

amended by the Trade Agreements Act (TAA) of 1979. Transaction value is

the primary basis of appraisement. Transaction value is defined in

section 402(b)(1) as the ``price actually paid or payable for the

merchandise when sold for exportation to the United States'' plus

specified statutory additions.

Pursuant to section 402(b)(2)(A)(iv) the transaction value of

imported merchandise shall be the appraised value only if the buyer and

seller are not related, or if the buyer and the seller are related, the

transaction value is acceptable under 402(b)(2)(B). Section

402(b)(2)(B) provides that transaction value between a related buyer

and seller is acceptable if the buyer demonstrates that the declared

transaction value meets one of the following two tests: (1)

Circumstances of the Sale or (2) Test Values.

The reconciliation test, announced in this document, is designed

for participants that engage in related party transactions.

Related Party Transactions

Under section 402(g) of the TAA the following persons are treated

as related:

(1) Members of the same family, including brothers and sisters

(whether by whole or half blood), spouse, ancestors, and lineal

descendants.

(2) Any officer or director of an organization and such

organization.

(3) An officer or director of an organization and an officer or

director of another organization, if each such individual is also an

officer or director in the other organization.

(4) Partners.

(5) Employer and employee.

(6) Any person directly or indirectly owning, controlling, or

holding with power to vote, 5 percent or more of the outstanding voting

stock or shares of any organization and such organization.

(7) Two or more persons directly or indirectly controlling,

controlled by, or under common control with, any person.

For purposes of 402(g)(G), the phrase ``two or more persons

directly or indirectly controlling, controlled by, or under common

control with, any person'' is understood to cover the following

situations:

(1) Where one of them directly or indirectly controls the other;

(2) Where both of them are directly or indirectly controlled by a

third person; or

(3) Where together they directly or indirectly control a third

person.

For purposes of this test, Customs will consider the fact that the

related party importer has reason to believe that an upward adjustment

may be made to the price as evidence that the relationship may have

affected the price actually paid or payable for the imported

merchandise. Therefore, transaction value may not be acceptable.

Rather, the merchandise may be appraised under section 402(f). The

appraised value pursuant to section 402(f) will be derived from the

transaction value method. That is, the appraised value will be the

price for the imported merchandise after the upward section 482

adjustment is undertaken by the importer/taxpayer plus the applicable

statutory additions: Packing, selling commissions, assists, royalties/

license fees and proceeds of subsequent resale. In order to participate

in the test, the importer/taxpayer must agree that 402(f) is the proper

basis of appraisement, in the event an upward section 482 adjustment

is, in fact, claimed for tax purposes.

Title VI of the North American Free Trade Agreement Implementation Act

In order for the importer to comply with Customs value law, when

making upward adjustments, a mechanism must be established that permits

the importer to submit information related to the upward adjustment

after the time of entry. Customs has determined that the reconciliation

provisions of the North American Free Trade Agreement Implementation

Act (the Act) create a possible vehicle permitting these circumstances.

Specifically, Title VI of the Act, Public Law 103-182, 107 Stat. 2057

(December 8, 1993), contains provisions pertaining to Customs

Modernization (107 Stat. 2170). Subtitle B of Title VI establishes the

National Customs Automation Program (NCAP), an automated and electronic

system for the processing of commercial importations. Section 637 in

Subtitle B of the Act amends section 484 of the Tariff Act of 1930 by

establishing a new subsection (b) entitled ``Reconciliation''.

Reconciliation is a planned component of the NCAP. Section 631 of the

Act authorizes tests of planned NCAP components. Section 101.9(b) of

the Customs Regulations, provides the regulations governing the testing

of NCAP components. See T.D. 95-21 (60 FR 14211, March 16, 1995).

This test is established pursuant to those regulations.

Reconciliation

Reconciliation will allow an importer to provide Customs with

information not available at the time of entry summary filing and which

is necessary to ascertain the final classification and appraisement of

imported merchandise. The reconciliation must be filed no later than 15

months from the date of the first entry summary filed under that

reconciliation.

A reconciliation permits the liquidation of an entry summary/

summaries despite the fact that undetermined information will be

transmitted to Customs at a later time through the reconciliation

process. Assuming there are no other outstanding issues, the entry

summaries will be liquidated for all purposes other than that which is

identified by the importer as pending reconciliation. The

reconciliation will be liquidated in accordance with 19 U.S.C. 1500.

The liquidation of the reconciliation may be protested, in accordance

with 19 U.S.C. 1514, but the protest may only pertain to issues covered

by the liquidated reconciliation.

A draft notice was published requesting comments from interested

parties on July 5, 1995. We received ten comments and the following is

Customs analysis and response to those comments.

Discussion of Comments

Bond Requirement

Comment: The commenter, a surety company, states that language

should be added to clearly define the bond requirements for the

reconciliation entry.

Customs Response: All entries which are pending reconciliation must

be secured by a continuous bond. Customs will allow only one surety for

all entries under the reconciliation. If a participant changes sureties

during the reconciliation period, Customs must be notified before the

change is actually made. No additional entries will be added to the

first reconciliation, and a new reconciliation entry will be initiated.

In this situation, Customs will issue a separate reconciliation entry

number for the future entries to be filed during the remainder of the

reconciliation period. Both reconciliation summaries will be due at the

close of the reconciliation period.

A separate bond will not be required for the reconciliation entry.

The continuous bond on the subject entries will provide coverage for

the

[[Page 46143]]

reconciliation entry. The Basic Importation and Entry Bond Conditions

under 19 CFR 113.62 provide for an agreement of the principal and

surety to pay, as demanded by Customs, all additional duties, taxes,

and charges subsequently found due, legally fixed, and imposed on any

entry secured by the bond. The bond conditions as prescribed by

regulation also provide for agreement by the principal to file within

the time and in the manner prescribed by law and regulation,

documentation to enable Customs to properly assess duties on the

merchandise, collect accurate statistics with respect to the

merchandise, and determine whether applicable law and regulation are

met.

Bond Sufficiency

Comment: The commenter, a surety company, is concerned that a

continuous bond may not adequately cover the amount due on the

reconciliation entry.

Customs Response: For purposes of this test, Customs believes the

continuous bond for the entry summaries will adequately cover the

amount due on the reconciliation entry. Customs will monitor each

reconciliation individually and should additional coverage be deemed

necessary, it will be requested. Customs is conducting research into

bond sufficiency from the standpoint of the Chief Financial Officers

Act, with respect to all programs under the Mod Act.

Notice to Sureties

Comment: The commenter, a surety company, states that Customs must

notify the surety bonding the entries subject to reconciliation that

the importer is using reconciliation. Accordingly, the commenter

suggests that Customs advises the surety, electronically if possible,

as to which entries are subject to reconciliation as well as the

specific issue pending reconciliation.

Customs Response: Upon acceptance into this reconciliation

prototype, Customs will issue a confirmation letter to the participant.

This letter will provide the reconciliation entry number which is to be

utilized. In this document, Customs will also confirm that all entries

filed on behalf of the applicant, within the designated time frame,

meeting the scope as defined by the applicant, will be subject to

reconciliation of the entered value pending upward adjustments in

accordance with 26 U.S.C. 482. A courtesy copy of this confirmation

letter will be sent to the surety company, which is designated in the

application. This will serve as the notice to the surety that all

entries filed within the designated time frame, meeting the scope as

defined by the applicant, will be subject to reconciliation of the

entered value. The value element on the subject entries will be

liquidated on the reconciliation entry.

Identification of Reconciliation

Comment: The commenter, a surety company, asks how Customs will

identify such reconciliation.

Customs Response: Each reconciliation will be identified by a

separate entry number issued by Customs.

Scope of Reconciliation

Comment: The commenter, a surety company, is concerned that Customs

will be withholding liquidation pending reconciliation of the valuation

on all entries filed by the applicant, when in fact, not all

merchandise on those entries may be subject to the possible upward

adjustment.

Customs Response: For the purposes of this reconciliation

prototype, the importer is required to provide, in the application, the

scope of the reconciliation. The scope will be defined in the

application to include the importer, filer, surety, merchandise (by

Harmonized Tariff Schedule number) which will be subject to the

reconciliation, and reconciliation time frame (October 1, 1995 through

March 31, 1996, or the end of their tax year, whichever comes first).

During the reconciliation period, the entered value, with respect to

upward 482 adjustments, on the entries meeting the designated scope

criteria will be held open pending the reconciliation.

Liquidation

Comment: The commenter, a surety company, requests information

regarding the liquidation of the reconciliation.

Customs Response: The reconciliation is an entry, identified by

entry type 09. The reconciliation will permit the liquidation of the

entries despite the fact that the undetermined value information will

be provided to Customs at a later time. Upon liquidation of the

entries, any Customs decision entering into that liquidation, e.g.,

classification, may be protested pursuant to 19 U.S.C. 1514. When the

value information is provided in the reconciliation, the reconciliation

will be treated as an entry and liquidated. The liquidation of the

reconciliation may also be protested but the protest may only pertain

to elements contained in the liquidated reconciliation, i.e., the

protest may not re-visit elements previously liquidated in the entries.

Customs will take action to liquidate all reconciliation entries

filed pursuant to this prototype, and extend the liquidation if

necessary. Should the reconciliation NOT be filed, the importer will be

subject to liquidated damages as the terms of the bond have been

breached. In such a case, Customs will analyze the individual situation

and liquidate the reconciliation appropriately.

Possible Abuse of Reconciliation

Comment: The commenter, a surety company, states that Customs

should limit the number of reconciliations an importer can use, so as

to avoid separate reconciliations for each issue for each entry.

Customs Response: For the purposes of this test, the only element

open for reconciliation is valuation, specifically an adjustment to the

price made to comply with 26 U.S.C. 482. Customs will be able to

adequately monitor the amount of reconciliations requested through the

application process. The intent of the reconciliation is to link all

entries with common, undetermined value information to one

reconciliation entry.

Expansion to Include Downward Adjustments

Comment: The test should be expanded to include both upward and

downward adjustments.

Customs Response: This test is designed to address a specific issue

identified by the Internal Revenue Service. That is, if an importer

must make an upward adjustment to its transfer price in order to comply

with 26 U.S.C. 482, section 1059A acts as a bar to such adjustment if

the lower price was declared to Customs. The section 1059A bar does not

apply to situations in which the importer contemplates making a

downward adjustment to the price. Given the restricted scope of the

test, Customs has concluded that the test will continue to be limited

to importers that contemplate making an upward adjustment to their

transfer prices to comply with 26 U.S.C. 482. However, Customs is

analyzing whether downward adjustments to prices can and should be

addressed in future reconciliation tests.

Bases of Appraisement

Comment: There is no reason why section 1401a(a)(I)(f) must be the

applicable basis of appraisement in the proposed test.

Customs Response: As was stated in the initial notice, Customs

considers the

[[Page 46144]]

fact that the related party importer has reason to believe that an

upward adjustment may be made to the price of the imported merchandise

as evidence that the relationship may have affected the price actually

paid or payable for the merchandise. Therefore, transaction value will

not be considered to be the proper basis of appraisement. The importer

continues to have the right to have the hierarchy of appraisement

applied to its transactions. However, if the importer claims another

basis of appraisement, such as deductive value, then the importer will

not be able to participate in the proposed test. This is due to the

fact that the test is designed to determine how Customs can use the

prices that the importer paid to the seller and the upward adjustments

to those prices by using reconciliation. If a basis of appraisement is

used that does not use these adjusted prices then the information is

meaningless, for purposes of this test. Appraisement under section

402(f) of the Tariff Act of 1930, as amended by the Trade Agreements

Act of 1979 allows Customs to utilize the importer's information on the

price it paid, and to reasonably appraise the merchandise using that

information.

Providing Customs With IRS Form 5472

Comment: One commenter responded with a suggestion that the

Internal Revenue Service routinely provide the U.S. Customs Service

with the IRS Form 5472 which requests information on import

transactions and the related party status of the exporter/importer. The

information on the Form 5472 would identify differences between the

basis or inventory costs of imported goods as carried for IRS purposes

and the Customs value of the imported goods. If such differences did

exist, IRS Form 5472 requires an explanation for such differences and

if supporting documentation exists in the United States.

Customs Response: Under existing IRS confidentiality statutes, the

routine transfer of IRS information to the U.S. Customs Service is

prohibited. Only in cases where the Customs Service has a Customs

Regulatory Audit planned or in progress, can Customs request certain

specific information from the IRS and only in cases when the importer

has refused to provide the information voluntarily. The existing

provisions for these transfers are contained in Public Law 103-182

passed December 8, 1993.

Description of Test

This test will be limited to participants who meet the eligibility

criteria set forth below. It will cover entry summaries filed by those

participants from October 1, 1995 to March 31, 1996 or the end of the

participant's tax year, whichever comes first. Each reconciliation is

limited to one importer/filer/surety combination.

By statute, reconciliation must be filed within 15 months of the

entry summary. The reconciliation entry (i.e. the intent to file the

reconciliation) is considered filed when the application is submitted

to Customs. For purposes of this test, participants must file the

reconciliation summary, which provides the outstanding value

information, within 15 months of the filing of the first affected entry

summary or by December 31, 1996, whichever comes first. All

reconciliation entries will be filed to the attention of Matthew

Krimski, Office of Regulatory Audit, Office of Strategic Trade, U.S.

Customs Service, 1301 Constitution Avenue, NW, Washington, DC 20229.

Customs will advise participants where additional duties resulting from

the reconciliation are to be tendered.

All entries which are pending reconciliation must be secured by a

continuous bond. Customs will allow only one surety for all entries

under the reconciliation. If a participant changes sureties during the

reconciliation period, Customs must be notified before the change

actually is made. No additional entries will be added to the first

reconciliation, and a new reconciliation entry will be initiated. In

this situation, Customs will issue a separate reconciliation entry

number for the future entries to be filed during the remainder of the

reconciliation period. Both reconciliation summaries will be due at the

close of the reconciliation period.

The continuous bond on the subject entries will provide coverage

for the reconciliation entry. The Basic Importation and Entry Bond

Conditions under 19 CFR 113.2 provide for an agreement of the principal

and surety to pay as demanded by Customs all additional duties, taxes,

and charges subsequently found due, legally fixed and imposed on any

entry secured by the bond. The bond conditions as prescribed by

regulation also provide for agreement by the principal to file within

the time and in the manner prescribed by law and regulation,

documentation to enable Customs to properly assess duties on the

merchandise, collect accurate statistics with respect to the

merchandise and determine whether applicable law and regulation are

met.

The reconciliation is an entry identified by entry type 09. The

reconciliation will permit the liquidation of the entries despite the

fact that the undetermined value information will be provided to

Customs at a later time. Upon liquidation of the entries, any Customs

decision entering into liquidation e.g. classification, may be

protested pursuant to 19 U.S.C. 1514. When the value information is

provided in the reconciliation, the reconciliation will be treated as

an entry and liquidated. The liquidation of the reconciliation also may

be protested, but the protest may only pertain to elements contained in

the liquidated reconciliation, i.e. the protest may not re-visit

elements previously liquidated in the entry.

Note: In those cases in which the Harmonized Tariff Schedule

(HTS) classification is determined by the unit value, the

classification for those commodities also will be held open pending

the reconciliation.

Customs will take action to liquidate all reconciliation entries

filed pursuant to this prototype and extend the liquidation if

necessary. Should the reconciliation not be filed, the importer will be

subject to liquidation damages as the terms of the bond have been

breached. In such cases, Customs will analyze the individual situation

and liquidate the reconciliation appropriately.

Application

Applications will be submitted to Mr. William F. Inch, Director,

Office of Regulatory Audit, United States Customs Service, 1301

Constitution Ave. NW., Room 2311, Washington, DC 20229-0001. All

applicants will be notified in writing of approval or disapproval

regarding test participation. All applicants who meet the eligibility

criteria will be chosen to participate in this test. The application

must address the ability to meet the eligibility requirements. The

applicant must consent, in the application, to all the conditions set

forth in the description of this test and eligibility criteria. The

applicant must set forth in the application the date on which the

applicant's tax year ends. The following information must be included

in the application:

1. Importer and IR number;

2. Filer;

3. Surety;

4. Reconciliation Time frame (October 1, 1995 through end of tax

year or March 31, 1996, whichever comes first;

5. Merchandise, by Harmonized Tariff Schedule number, impacted by

the possible 482 adjustment;

6. Countries of origin of impacted merchandise; and

7. Ports of entry through which the subject merchandise will be

imported during the reconciliation period.

[[Page 46145]]

By applying, applicants agree that the value for merchandise

covered by all entry summaries filed by them or on their behalf on or

after October 1, 1995 until the end of the tax year or March 31, 1996,

whichever comes first, shall be finally determined by the liquidation

of the reconciliation filed in accordance with the test. The Office of

Regulatory Audit will review the application to determine that the

applicant has met all eligibility requirements.

Documentation Required to Support Reconciliation

The approved participant shall maintain and produce upon Customs

request all relevant documentation to support the change in the entered

value. The reconciliation shall include the following information:

1. The entry numbers and entry dates, total entered value and ports

of entry of all entries filed with Customs falling within the scope of

the test.

2. Broken down by entry number, a cumulative list of units imported

by classification number and the change (final entered value) to that

entered value.

3. Proposed duty due pursuant to reconciliation.

In order to support the reconciliation, the approved applicant

shall maintain and produce upon Customs request all relevant

documentation to support the change in entered value. The approved

applicant may be required to provide any or all of the following

documentation:

1. The IRS Schedule M-1, and the Form 1120 Corporate Tax Return.

2. Any and all other supporting documentation filed along with the

M-1 and the Form 1120 that was furnished to the IRS.

3. Any or all IRS documents or communications with the participant

regarding the relevant 482 adjustment.

4. Any and all documentation including any books and records or

computerized data to relate the 482 adjustment to the entries filed

with Customs.

Such information and supporting material should be provided in a

format or electronic media commonly in use. Examples are an IBM

compatible computer 3.5 disk utilizing a software product such as

Access or Excel or other similar spreadsheet or database application

such as Lotus 1, 2, 3.

Verification

Customs Regulatory Audit, in conjunction with other Customs

disciplines, will determine if any verification effort is necessary to

establish the accuracy of the details submitted. The extent of the

verification will be determined by Regulatory Audit, and if an audit is

required, established Regulatory Audit procedures will be followed.

Eligibility Criteria

In order to qualify for this test of reconciliation, importers must

have reason to believe they may invoke the IRS regulations to make

upward adjustments to the price of the imported merchandise. Importers

must provide, on an entry-by-entry basis, the electronic entry of

merchandise and the electronic entry summary of required information

(ABI). Other requirements and conditions are as follows:

1. The test only applies to the related party transactions engaged

in by participants who qualify under Internal Revenue Service Section

482 requirements to make upward adjustments and which are not subject

to Antidumping/Countervailing Duty proceedings.

2. Participants' tax year must end between October 31, 1995 and

March 31, 1996.

3. Customs decision to allow a company to participate in the test

program will be made in consultation with the Internal Revenue Service.

4. Each participant must provide U.S. Customs with the methodology

that will be used to arrive at the final price of the imported

merchandise.

5. Each participant agrees that appraisement is under section

402(f) of the Tariff Act of 1930, as amended by the Trade Agreements

Act of 1979, if, in fact, an upward section 482 adjustment is made for

tax purposes.

6. Entries involving merchandise under this test will not be

eligible for drawback.

Selectivity Criteria

The Office of Regulatory Audit, in conjunction with other Customs

disciplines, will review the application to ensure the eligibility

requirements are met. All applicants who meet the eligibility criteria

will be allowed to participate, provided no other Customs office

objects.

Objectives of the Test

The objectives of this test are:

1. To work with the trade community to further compliance in the

value area regarding related party transactions.

2. To allow companies intending to make Internal Revenue Service

Section 482 adjustments, which may ultimately result in an upward

adjustment to the price for merchandise, the opportunity to reconcile

their business operations regarding U.S. Customs and Internal Revenue

Service requirements applicable to related party transactions.

3. To determine if reconciliation is a viable method to ensure a

coordinated and consistent Customs response to Internal Revenue Section

482 adjustments which result in the upward adjustment of the Customs

valuation under Section 1059A.

5. To test the type of information needed by Customs to process a

reconciliation.

Test Evaluation Criteria

The criteria which will be used to evaluate whether or not

reconciliation is a viable means to allow importers which make upward

adjustments to the price of imported merchandise will be based on

measurable outcomes which include:

1. The number of participants;

2. Customs resources expended to administer and monitor the

program;

3. Customs resources expended to verify final reconciliation entry

claims and the methodologies applied;

4. Amount of additional revenue collected;

5. Survey of participants on the conduct of the test and its effect

on their business operations; and

6. IRS and Census satisfaction with the results of the test.

Dated: August 30, 1995.

Edward F. Kwas,

Assistant Commissioner, Office of Strategic Trade.

[FR Doc. 95-21909 Filed 9-1-95; 8:45 am]

BILLING CODE 4820-02-P