first sale

What is the “First Sale” Rule and How Does it Affect Me?

By Bruce Leeds, Senior Counsel, Braumiller Law Group

Carol works in import compliance for Acme Corporation. Her customs broker advises her of a shipment from Kung Pao Industrial Company in China and asks for clearance instructions. Carol has never heard of Kung Pao Industrial Company so she does some research.  The commercial invoice shows the purchase order number so Carol contacts the Procurement Department. She is directed to the Procurement Specialist responsible for the order. He explains that Acme Corporation placed an order with Smith Company in New Jersey for Flanges at a price of $125 each. Smith Company in turn subcontracted production of the Flanges to Kung Pao at a price of $100 each. Kung Pao then shipped the Flanges direct to Acme Corporation. The commercial invoice showed the price of $100 each. 

Carol’s dilemma:  What unit price should be used for entry? $125 each or $100 each? 

Of course the answer is not simple. This is an instance of a “first sale” transaction and it happens more often than you would think. 

The First Sale Rule applies in circumstances such as the example above. A US company places an order with a middleman in the US. The middleman in turn subcontracts to a foreign supplier. The supplier then ships the product either to the middleman or to the original US company that placed the order, meaning either could be the importer of record.  The entered value could be the amount on the original purchase order or the price paid by the middleman to the foreign supplier.

Customs’ policy on how to derive a dutiable value in a first sale transaction is largely based the decision of the US Court of Appeals for the Federal Circuit in Nissho Iwai American Corporation v. United States. 

This case involved public transit cars purchased by the Metropolitan Transit Authority (MTA) of New York from the US office of Nissho Iwai Corporation, a Japanese trading company. MTA paid Nissho Iwai $844,500 per car. Nissho Iwai in turn contracted with Kawasaki Heavy Industries in Japan to manufacture the cars to MTA’s specifications. The cars were then shipped by Kawasaki to Nissho Iwai under terms of FOB Kobe, Japan. The US importer was Nissho Iwai. The dutiable value was calculated at the price paid by the MTA to Nissho Iwai, less certain amounts for components of US origin. 

Nissho Iwai protested this valuation, stating that the entered value should be based on the price paid by them to Kawasaki. The case went to the US Court of International Trade, which upheld Customs position that the value should be based on the price paid by MTA to Nissho Iwai, stating that the contract between these parties “was the contract which most directly caused the goods to be exported to the United States”. The case was then sent to the US Court of Appeals. 

We will spare the suspense and state that the Court of Appeals reversed the decision of the Court of International Trade. In doing so the Court cited an earlier decision “that the price of the initial sale from the manufacturer to the middleman must be used for appraisal, not the price of the sale from the middleman to the purchaser” and also 19 U.S.C. § 1401a(b)(1) which states that Transaction Value is based on the “price actually paid or payable for the merchandise when sold for exportation to the United States.”  The Court further stated that the sale must be one negotiated at arm’s length, free from any non-market influences, and involving goods clearly destined for the United States.

So where does this leave us? What is Carol supposed to do?

Treasury Decision (T.D.) 96-87, dated January 2, 1997, dealt with appraisement of first sale transactions. The TD stated that “the importer must prove that at the time the middleman purchased, or contracted to purchase, the goods were ‘clearly destined for export to the United States’ and the manufacturer (or other seller) and middleman dealt with each other at ‘arm’s length.’  In reaching a decision, Customs must ascertain whether the transaction in question falls within the statutory provision for valuation, i.e., that it is a sale for exportation to the United States, and that the parties dealt with each other at ‘arm’s length’.”

To accomplish this TD 96-87 advised that the importer must provide a description of the roles of the parties involved and must supply relevant documentation addressing each transaction that was involved in the exportation of the merchandise to the United States. The documents may include purchase orders, invoices, proof of payment, contracts, and any additional documents that establish how the parties deal with one another. The objective is to provide Customs with “a complete paper trail of the imported merchandise showing the structure of the entire transaction.”  If unable to provide this information, the sale between the middleman and the manufacturer cannot form the basis of transaction value.

If the importer cannot provide sufficient proof that the first sale – the sale from the original manufacturer or seller to the middleman – is a bona fide sale to the United States, the price paid by the party that originally placed the order (the “second sale”) is presumed to be the Transaction Value.

To use the $100 each price paid by Smith Company to Kung Pao Industrial Company as the Transaction Value of the flanges, Carol must provide the evidence described in TD 96-87. If not, the value will be the $125 paid by Acme to Smith Company. What if Acme enters the flanges at the $100 each price appearing on Kung Pao’s invoice and doesn’t say anything about the order with Smith Company? If Acme were to undergo an audit or the CEE were to send a Form 28 asking for a copy of the purchase order, Acme could be in deep trouble. 

On April 8 we will be offering an online seminar on the subject of the First Sale Rule.  Go to Events – Braumiller Law Group for more information.

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