First Sale Customs Valuation: Legally Lowering the Landed Costs of Goods

Tuesday, December 16, 2014 - 16:51

Each year, millions of dollars are paid in customs duties unnecessarily because importers fail to take advantage of the "First Sale Rule," a legal route to reduce duty liability. Importers typically pay customs duties on the price paid to their vendors. With the First Sale Rule, an importer declares the value of its merchandise based on the first sale of a multi-tier transaction and therefore lowers its duty exposure. Importers deal with multiple parties to get their goods from the foreign factory door to the domestic retail floor, and each of these interactions can add to the ultimate cost of the imported product. Perhaps none has a bigger effect, however, than the importer’s purchase from a vendor or middleman who buys the merchandise from the original manufacturer. This price usually represents a substantial markup and is used to calculate duties when the goods are imported into the U.S.

Fortunately, these types of transactions also open up the possibility of substantial duty savings. A unique aspect of U.S. customs law, the First Sale Rule allows companies that import into the U.S. to lawfully reduce their duties by entering goods at a lower value than the price actually paid to the foreign vendor. Most U.S. importers are eligible to take advantage of this benefit because, whether they realize it or not, they usually purchase foreign goods through multiple parties, not directly from the manufacturer. First Sale can even be used if the vendor is related to the importer and/or the factory or there are multiple levels of vendors. While it has sometimes been difficult to obtain the needed information from business partners to take advantage of First Sale, experience shows that this problem can be overcome, and especially in times of economic struggles and factory closings, vendors are more likely to cooperate with their customers.

The best data on the use of First Sale into the U.S. is from 2008, when Congress directed the U.S. International Trade Commission to undertake a review. The ITC found that in fiscal year 2008, the First Sale methodology was utilized for only 2.4 percent of total U.S. imports and by a mere 8.5 percent of importers. Even with this limited scope, the use of First Sale was found to be more widespread in sectors with the highest average tariffs, such as footwear and apparel. The fact that these industries are using First Sale is not at all surprising given that this methodology is employed to legally reduce duties. Importers in other industries can certainly achieve additional duty savings using the First Sale Rule once the legal obligations are met.

This article reviews the structure and legal requirements of a First Sale transaction and lists some best practices for taking advantage of this duty savings opportunity.

First Sale Transactions

The dutiable value of a First Sale transaction is based on the purchase price between the vendor and the factory rather than the price between the vendor and the importer. As a result, no duty is ultimately paid on the vendor’s markup or any additional charges on the subsequent sale. This differential presents a duty savings of 10-20 percent, but as the government statistics above indicate, most importers are not taking advantage of this cost-saving methodology.

The validity of First Sale is well established and is supported by over 20 years of case law, including several Court of International Trade decisions that set forth the requirements an importer must meet in order for duty to be assessed based on the first sale within a multi-tier transaction. Specifically, there must be two bona fide sales, the goods must be destined for export to the U.S. at the time of the first sale, and the foreign manufacturer/seller and middleman/buyer must either be unrelated or conduct their transactions at arm’s length. The court has established that when these criteria are met, U.S. Customs and Border Protection (hereinafter “U.S. Customs” or “Customs”) must base the dutiable value of the goods on the manufacturer’s price to the vendor.

Bona Fide Sales. The first requirement for First Sale is that there must be two bona fide sales. With two bona fide sales, the same party serves as the buyer in the first sale (usually from a foreign manufacturer) and the seller in the second (usually to a U.S. importer or consignee). On the contrary, when that intermediary is functioning as an agent, the actual sale is between the foreign seller and the importer, with the agent acting as a facilitator. In that case, the pertinent issue is whether the commissions the agent receives for its services are part of the transaction.

U.S. Customs defines “sale” as the transfer of property from one party to another for consideration, or payment. Evidence of consideration includes payment by check, bank transfer or other commercially accepted means. In determining whether property or ownership has been transferred, Customs considers whether the potential buyer assumes the risk of loss (i.e., is liable for goods when lost or damaged during shipment) and acquires title to (i.e., legally possesses or owns) the goods. In addition, Customs will examine whether the potential buyer pays for the goods (i.e., consideration passes between the parties).

Even if the second party does not actually possess the goods, there are other means to satisfy Customs with respect to the risk of loss. For instance, a foreign middleman could serve as consignee in care of its customs broker so that title and risk of loss would pass to the middleman for at least some time during transit of the goods between the manufacturer and the U.S. importer. Transaction documents, the shipping terms and insurance contracts would need to indicate this to be the case.

Other evidence of bona fide sales includes whether the buyer and seller are independent of each other. Specifically, Customs considers whether the potential buyer provided (or could provide) instructions to the seller, was free to sell the items at any price it desired, selected (or could select) its own customers without consulting the seller, and could order the imported merchandise and have it delivered for its own inventory.

Documentary evidence to support bona fide sales includes contracts, distribution and similar agreements, invoices, purchase orders, bills of lading, proof of payment, correspondence between the parties, and company reports or brochures.

Destined for Export. The second requirement is that the goods must be clearly destined for export to the U.S. at the time of the first sale. To make such a determination Customs considers evidence such as production orders and/or manufacturing instructions and other unique specifications of the merchandise to conform to the buyer’s standards; examples of labels, logos, stock numbers, barcodes and other unique merchandise or carton marks; and examples of country of origin marking on finished goods, hang tags, etc., any warranty cards provided, or other types of certification required for entry and/or sale of the goods in the U.S.

Relationship Between Factory and Middleman. The third requirement is that the middleman buyer and the factory seller either be unrelated or negotiate at arm’s length. A sale will be considered at arm’s length if the relationship between the buyer and seller did not influence the price of the merchandise or the transaction value closely approximates a test value.

Always a clear indicator of an arm’s length sale is when the factory makes a profit. In addition, the circumstances of sale test will be met if the price is settled or negotiated in a manner consistent with normal pricing practices in that industry or with the way the seller settles prices with unrelated buyers. Another way to satisfy this test is to show that the price is adequate to ensure the recovery of all costs plus a profit that is equivalent to the firm’s overall profit in sales of such merchandise. Alternatively, the transaction value will be deemed to closely approximate a test value if Customs has previously accepted a comparable transaction value, deductive value or computed value for identical or similar merchandise for goods already exported to the U.S. at or about the same time as the imported merchandise.

Best Practices

Finally, we present here some best practices that can help importers get the most out of their utilization of the First Sale Rule.

  • Importers who are thinking of implementing First Sale should focus on vendors with whom they plan to stay for the foreseeable future. A good working relationship is a bonus because the vendor will be sharing confidential information with the importer’s customs compliance team.
  • Shifting certain administrative, service or other costs from the production facilities to a related middleman can augment the use of First Sale. These costs include overhead or service-related costs such as payments for managers, costs for sourcing or obtaining materials, payroll, accounting and legal expenses, and charges for non-production-related equipment. Once these costs are shifted from the books of the manufacturer to those of the related vendor, a further reduction in the dutiable First Sale price can be realized without affecting the purchase price between the U.S. buyer and the vendor.
  • Since importers are obligated to exercise reasonable care when declaring entry data, they should work with their vendors to ensure that First Sale invoices are properly prepared.
  • It is critical that First Sale transactions be carefully developed. While the concept has been in place for some time, most importers are unsure of how to con­struct a compliant document trail. However, with careful planning and coordination with suppliers overseas it is a goal that can be achieved and will be well worth the effort.

Laura Siegel Rabinowitz is Special Counsel in the International Trade and Customs practice at Kelley Drye and Warren LLP. Ms. Siegel Rabinowitz has extensive experience in handling international trade projects for a wide range of clients, including importers, exporters, retailers, manufacturers, customs brokers and freight forwarders. Her experience covers a wide range of commercial and enforcement laws and policies administered by U.S. Customs and Border Protection, including duty preference programs, tariff classification, valuation, entry procedures, antiterrorism initiatives, trade compliance and audit programs, marking, penalty defense and other import requirements administered by federal agencies (FDA, CPSC) involving health and safety of imported goods. 

Please email the author at lrabinowitz@kelleydrye.com with questions about this article.