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Issue 03, 2005 (22 February)
 "First Sale Rule" Helps Realise Duty Savings

Given the keen competition in the global marketplace, vendors from around the world are constantly seeking ways to offer savings opportunities to their customers. US importers of Asian goods are always searching for ways to lower the cost of products without compromising quality, delivery schedules, or favourable relationships with suppliers. The "First Sale Rule" (FSR) offers suppliers a competitive edge in negotiations with US customers. As long as careful attention is paid to documentation, this approach can enhance relationships with US buyers at little, if any, real cost.

Since the FSR was established as a viable appraisement tool by the US courts in 1988, First Sale Valuation (FSV) has offered a mechanism for US buyers to achieve lower landed duty-paid costs without adversely affecting the profit margins of their offshore suppliers. Applicable to multi-tiered transactions where a US importer purchases goods from a middleman who, in turn, has contracted with a factory for the production of the goods, FSV allows merchandise to be appraised based on the value of the sales price between the middleman and the factory.

All merchandise imported into the US is subject to appraisement, and the preferred method under the customs valuation statute is transaction value. Transaction value is defined as "the price actually paid or payable for the merchandise when sold for exportation to the United States," plus certain additions. Only where transaction value is deemed unacceptable can the importer enter its merchandise under one of the remaining statutory appraisement methods: transaction value of identical or similar merchandise; deductive value; computed value; or, if none of these applies, a method of valuation that closely approximates one of the above.

The vast majority of goods imported into the US from Asia are appraised according to transaction value, which is reflected as the invoice price between the vendor (either middleman/trading company or factory) and the importer. Import duties are then assessed on the appraised value of the goods.?/font>

FSV, by lowering the value of a product on which duties are assessed, can effectively reduce the amount of duty paid. This is particularly useful for a number of product categories in which Hong Kong is a major supplier to the US market. For example, duty rates for apparel products are generally about 20% but can exceed 30% in some cases. Footwear duty rates can be as high as 48% and may also include an additional duty unrelated to value. Imports of hard goods, such as electronics and jewellery, are generally subject to lower duty rates, but FSV may still be useful if a sufficient volume of imports is anticipated.

Two cases litigated by the US international trade law firm Sandler, Travis, & Rosenberg, P.A. before the US Court of International Trade (CIT) established FSV as a viable appraisement tool and set forth the requirements an importer must meet in order for duties to be assessed based on the first sale within a multi-tier transaction. These cases, The American Air Parcel Forwarding Co. Ltd v. United States (1987) and Synergy Sport International Ltd. v. United States (1993), concerned the importation of wearing apparel. A third case, Nissho Iwai Corp. v. United States (1992), involved the purchase of subway cars. In these cases, the CIT found that US Customs and Border Protection (CBP) must appraise merchandise and assess duties based on the manufacturer's price, as opposed to the higher price paid by the importer or the US customer. The court set forth the following requirements using this methodology:

  • a middleman must serve as a buyer in the first sale (i.e., from the manufacturer) and then as a seller in the second sale of goods exported to the US;?/font>
  • at the time of the first sale, the goods must be clearly destined for export to the US; and
  • the foreign manufacturer/seller and middleman/buyer must be unrelated or, if related, conduct their transactions at "arm's length."

Under the FSR, then, a US importer can achieve lower duty payments in a multi-tiered transaction as long as these requirements are met and it can produce the original invoice covering the first sale.?/font>

For example, in a traditional three-tiered transaction, a US customer will issue a purchase order to a vendor for a certain quantity of goods at an established price, say US$1,000. The vendor will, in turn, purchase these goods from a manufacturer for a lower price, say US$900. The vendor's profit is US$100 on the transaction. Typically, an invoice for US$1,000 will be issued from the vendor to the US customer. This invoice is presented to CBP at the time of importation and the customer pays duty (say 10%) based on the value of the goods as reflected in this invoice.?/font>

Now consider this transaction using the FSR. Invoicing and payment remain unchanged, but now it is the invoice between the vendor and the factory that will be presented to CBP for purposes of merchandise appraisement and duty assessment. As a result, the US buyer will incur a duty liability of US$90 rather than US$100. The vendor/middleman's price and profit margin have not changed, but the US customer is able to realise a substantial reduction in its landed duty-paid costs.

Practical considerations to setting up an environment to use the FSR can at first seem daunting and even prohibitive. However, with careful planning and the proper document trail, first sale can be established to the satisfaction of the US government. The parties to the transaction must be prepared to substantiate that the goods were subject to two bona fide sales, that both sales were at arm's length, and that the goods were destined for export to the US at the time of the first sale. A careful review of documentation flow by experts in the field is necessary to ensure that the information presented to CBP is accurate and substantiated. In order to establish that the first sale price is accurate, the vendor, the factory, and the US buyer must be prepared to present the following:

  • purchase orders with copies of terms between all parties;
  • confirmations;
  • invoices;
  • written contracts or sales agreements;
  • bills of lading for final products and materials;
  • proof of payment (e.g. letters of credit);
  • 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, bar codes, and other unique merchandise or carton marks; and
  • examples of country of origin marking on finished goods, hang tags, etc.

In addition, where the middleman/vendor and the factory are related, it may be necessary to review the books and records of each to ensure that the transaction can be seen as one at "arm's length," i.e., that the relationship did not affect the purchase price of the goods.

While it may seem that the existence of a relationship between the middleman/vendor and the factory could produce an obstacle to acceptance of FSV, such a relationship can actually provide an opportunity for additional savings to the US buyer. CBP has approved the shifting of certain expenses that are unrelated to the manufacture of the goods from the books of the manufacturer to the related middleman/vendor. Such a practice allows for further reduction in the first sale price without impacting the purchase price between the US buyer and the middleman/vendor. Additional duty savings can thus be achieved.