September, 2019

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Sales for Export from China: Customs Valuation Plays

Mark K. Neville, Jr.

With the trade sanctions against China under the Section 301 regime continuing in full swing, the 25% ad valorem additional tariffs that accompany imports of products subject to Lists 1-3 are in place and a List 4 for tariffs for most product lines not already contained in Lists1-3 is also being readied. Importers of goods into the US continue to debate the best strategy to deal with the problem of dramatically increased tariffs.

Assessment of duty

Of course the levy of customs duties is the function of three separate criteria applied in tandem. These are tariff classification, which assigns the duty rates; the customs valuation, against which the ad valorem rates will be applied and country of origin; which will determine whether the duty rate to be applied will be the normal tariff rate (NTR)1 or a special duty rate (tariff preferences such as the Generalized System of Preferences or free trade agreements) or the Column 2 rate, for imports from those countries, currently only North Korea and Cuba, which have not been granted NTR status.2

When we first addressed this China challenge some months ago3 we had primarily focused on two of these three factors: tariff classification and origin-shifting strategies. If the List 4 tariffs take effect, there won’t be many China-origin goods that will escape the tariffs by a shift out of one tariff provision into another because nearly 100% of the tariff provision will attract the tariffs. And shifting enough of the production capability from China to another country so as to ensure a country of origin shift due to substantial transformation, creating a “product with a new name, character, or use” to use the operative phrase, will be a challenge.

Customs Valuation

That leaves the second factor, customs valuation. Simply put, if the customs value of the imported goods has been lowered, the duty burden will be lowered. Relieving the normal customs duty may not been a sufficient incentive to pursue valuation strategies, but the additional China tariffs are a game changer. There are two potential strategies which have gained a lot of traction with importers. These are the First Sale for Export (FSFE) doctrine in its classic form and a variant of that which we might term “Purchaser in America.”

Let’s look at each of them.

First Sale for Export

There is ample anecdotal evidence that many advisors have been touting a “First Sale for Export” strategy as a means of managing the impact of the China tariffs.

The primary customs valuation method is transaction value, which looks to a qualifying sale for exportation to the US.4 Briefly stated, the FSFE doctrine works where there are these back-to-back sales by looking at either (1) a sale from a foreign factory to a middleman vendor or (2) a sale from a vendor to a selling company affiliate as a qualifying “sale for exportation to the US.” Another way of looking at it is where a US customer places an order on a foreign vendor but the foreign vendor fills the order by itself placing an order on a factory. The importer must show that there is a qualifying, bona fide sale between those foreign parties and that the goods are “irrevocably destined for the US.” If so, there are back-to-back qualifying sales for export and customs duty is levied on the “First Sale” price, i.e., that price paid by the vendor to the factory or the sales company to the vendor.5

The FSFE doctrine comes into play here if the Chinese vendor and the importer seek to lower the tariffs by outsourcing functions. The two separate scenarios:

Manufacturing outsourced by Vendor
Factory to vendor—sale price $70
Vendor to Importer—sale price $100
10% Duty assessed on FSFE price--$7


Selling function outsourced by Vendor
Vendor to SalesCo—sale price $70
SalesCo to Importer—sale price $100
10% Duty assessed on FSFE price--$7

If the vendor has already outsourced its production to factories that perform a contract manufacturing function, or if the vendor has transferred its sales functions to a separate sales company affiliate, then there is already the structure for FSFE in place.

But be careful here—the key words above were “bona fide” and “qualifying” as in the bona fide sale for export. That means that if the factory and the vendor are related parties—and for customs valuation purposes that status has a very low threshold, e.g., as little as 5% ownership—then the importer must prove that the relationship did not influence that First Sale price. In essence, the importer has the same Transfer Pricing obligations that apply in all related party transactions.6 Then, too, there must be a bona fide sale, meaning that there must be a transfer of title and an assumption of risk of loss for consideration from the factory to the vendor. That could be a problem in the selling function outsourced scenario if the SalesCo has little substance and might be characterized as a selling agent rather than as a company under its own direction and control. We will see this issue arise in the Purchaser in America model.

There is also a risk to bona fide sale status if there is a “flash title.” This occurs where the identical sales terms apply to both sales, e.g., EX Works or FCA, and will usually result in US Customs and Border Protection (CBP) denying that there was a bona fide sale. Instead, the vendor must be seen to have taken title and assumed risk of loss for a defined period. An example would be where the vendor buys from the factory at EXW terms and resells to the vendor at FCA terms. Finally, in order to function as the basis for transaction value the First Sale price must be adjusted to account for any dutiable assists or other statutory additions.7

Beyond that, the parties must show that the goods were clearly destined for the US at the time of the First Sale. A drop ship to the US, use of back-to-back purchase orders using same model or style numbers and covering the same quantities, US-centric sizing or the need to meet US regulatory regime, ensuring the goods are not inspected after they leave the factory—these are all useful ways to meet this second criterion.

If the vendor has not relied on contract manufacturers to this point but, instead, has manufactured the goods and sold them directly to the US customer, there is another tactical move. That would involve the vendor setting up a new entity to act either on the sales side—as a trading company for the sale to the US customer—or on the manufacturing side to function as a limited risk contract manufacturer. In other words, the vendor would create a new three-tiered sales model. In this iteration, as before, the vendor would be anticipating a low markup First Sale, and the US duties would be assessed on this much lower price rather than the price ultimately paid by the US customer. The cautionary note must be again be sounded—the foreign entities would be related parties and FSFE treatment will be denied unless the importer can meet the transfer pricing inquiry by CBP that may well follow.

One thing that is certain: CBP knows about this popular move into FSFE and is closely scrutinizing these claims. Importers looking to make entry with the benefit of FSFE must be prepared to justify their claims,8 and they should notify CBP in advance of their intention to enter goods on a First Sale basis.

The following are some of these pointers to keep it simple:
  • Back-to-back orders from importer to vendor and from vendor to factory--showing same model or style numbers and quantities
  • Factory and middleman vendor are not related (e.g., less than 5% or more ownership) unless importer is prepared to prove they meet the “arm’s length” standard
  • No “dutiable assists” provided (otherwise, the first sale piece must be adjusted)
  • Proper invoices from factory and from middleman that tally with the purchase orders
  • Proper proofs of payment for both sales
  • Different sales terms –e.g., EXW and FCA--for the two sales
  • US-centric requirements--FDA approval, heat treated packaging, UL, etc.
  • Drop ship from China to US customer

Purchaser in America

A variation on the classic FSFE strategy has also generated a lot of attention and some importers may be in discussions with vendors to apply this alternative. Here, the Chinese vendor sells to a related US entity, perhaps newly set up for this purpose, with either the US affiliate purchaser or the Chinese vendor itself acting as Importer of Record (IOR).9

This approach has been by some as a species of “first sale.” I am confident that many who have been pushing a “First Sale” workaround are in fact, looking to what I have termed a Purchaser in America strategy.

The US affiliate would then resell to its customer on a post-clearance, i.e., domestic US-sale, basis. The bulk of the vendor parties’ markup would be earned on the domestic sale in the US, which would shield the markup from the additional 25% tariff but would expose the vendor’s or its affiliate’s markup to US income tax. You will have recognized this as the mirror image of the FSFE strategy, where the bulk of the mark up is earned in the foreign First Sale. We should note that this strategy of a sale from the Chinese vendor to an affiliated US entity has been pursued for many years along the Northern Border, by many companies in the US and in Canada looking to export to the other country.

While there are some differences between the two, on balance, Canadian and US customs authorities will display a near-identical level of interest in and take remarkably similar approaches to their analyses of these “Purchaser in…” strategies.

Canada experience

In contrast to the US customs valuation statute, Canada has a singular “Purchaser in Canada” requirement10 and does not recognize First Sale for Export. In order to minimize the customs duty impact, many US companies have elected to set up Canadian entities and to sell to that entity as a sort of “poor man’s first sale.” The Canadian entity then resells to Canadian customers; in that way the duties are assessed on the lower price paid by the importing entity, which is the Purchaser in Canada. Canada can be counted on to scrutinize this arrangement to determine if the Canadian entity has enough substance to qualify as a buyer/reseller.

US experience

In the case of the US, too, there has been a longstanding practice of perhaps 30 years’ standing with CBP closely examining whether there is sufficient substance in the related party importer for it to qualify as a buyer in a sale for exportation to the US.11 While this arose especially in the context of imports from Canada it has been applied more generally.

Effect of China tariff

In the context of the special China tariff regime, with a Purchaser in America strategy we will see a US affiliate of the China vendor as the putative buyer/importer. CBP will want to determine whether the US entity would qualify as (i) a true buyer/reseller or, instead (ii) where there is insufficient substance and functionality, it is merely a selling agent for its parent company.

In that latter case, CBP would look to a transaction value appraisement based on a sale for export from China to the US customer. The customs duty, including the additional China tariffs, would be assessed against that final US customer’s price, albeit after backing out any nondutiable charges (NDCs). There would be no concern about including the importer’s markup since it would be a deemed selling agent, whose markup is dutiable. 19 USC § 1401a (b) (1) (B). This would be the very same approach, well-honed after years of application to imports from Canada.12

The general rule is succinctly set forth in a 2012 ruling13 :

To determine whether a transaction between two parties is a bona fide sale, CBP must consider the circumstances of the transaction, including: passage of title, assumption of the risk of loss, payment of consideration, ability of the buyer to instruct the seller, ability of the buyer to resell the merchandise at any price to any customer, and the ability of the buyer to order merchandise for the buyer’s own account, i.e., the overall relationship of the parties and whether it demonstrates that they act as buyer and seller.

There are a number of different criteria which CBP will apply in its review of the question whether the importer is a true buyer of the imported goods. The first and foremost question is whether the buyer owns the imported goods, i.e., takes title and assumes risk of loss. Then there is an inquiry into whether the buyer shows ownership attributes including, inter alia, whether the importer
  1. freely negotiates and sets its own pricing with customers
  2. earns a profit that varies on its resales and not a stated percentage markup, which would be more a sales commission)
  3. needs authorization or approval from its vendor for sales or for pricing
  4. has orders placed to it by customer
  5. issues invoices to its customers
  6. receives payments by customers into its own bank account
The inquiry into the role of the US affiliate as a “buyer” vs. a selling agent here will present most of the same dynamics that we discussed earlier in the context of International Financial Reporting Standard (IFRS 15) standards on the status of limited risk distributor vs. sales agent.14 In both instances, the challenge is to prove that the US-based affiliate is a stand-alone entity acting in its individual capacity as buyer and reseller.

And once that hurdle has been overcome, then the additional burden that accompanies all related party transactions will kick in. The importer, in this instance the US entity, will need to prove that the relationship did not influence the price. In other words, the US entity will need to justify the low profit earned by the Chinese vendor and/or the high profit earned on its own resales to the US customers.

Final Words

As with most things in life, the truth lies in the middle between the two extremes of “FSFE is a walk in the park” and “FSFE is impossible.” In the case of related party sales involving the Chinese vendor, CBP will insist on a demonstration of arm’s length pricing. With the Purchaser in America strategy you will encounter the additional hurdle of showing a bona fide sale for export to a buyer/reseller with real substance. In short, there are NO easy solutions here.


1. “Old timers” and students of the trade laws will recognize the “most favored nation” (MFN) phrase.

2. The Rates of Duty are assigned by origin per General Note 3, Harmonized Tariff Schedule of the United States (HTSUS).

3. See Neville, “China Trade Sanctions: What to do,” 29 JOIT 26 (Sept. 2018).

4. Per 19 USC § 1401a.

5. For further background, see Neville, “Further Thoughts on First Sale for Export,” 27 JOIT 31 (Jan. 2016). I understand that a prominent online marketplace is referring its customers to this article in explaining the advantages of FSFE..

6. For a recent CBP analysis of this First Sale price in a related party context, see ruling no. H263045 (3/15/19).

7. 19 USC § 1401a (b) (1).

8. To rebut the presumption that the price paid by the importer is the appropriate basis for determining transaction value, the importer must provide evidence that at the time the middleman purchased, or contracted to purchase, the imported merchandise, the goods were clearly destined for exportation to the United States and that the manufacturer and middleman dealt with each other at arm’s length. Treasury Decision (“T.D.”) 96-87, 30 Cust. Bull. 52/1 (January 2, 1997). CBP stated in T.D. 96-87 that it is looking for “a complete paper trail of the imported merchandise showing the structure of the entire transaction” and must establish whether the transaction is “at arm’s length.” See, e.g., the discussion in ruling no. H005222 (6/13/07).

9. Depending on the sales terms, the Chinese vendor can act as a non-resident importer of record. For more on IOR status generally, see, Neville, “The Right to Import Goods,” 25 JOIT 14 (Oct. 2014).

10. Customs Act, Section 48. See Canada Border Services Agency, “Customs Valuation--Purchaser in Canada,” Memorandum D13-1-3 (2014).

11. See, e.g., Victor Woolen Products v. United States, 175 F.3d 1327, 1334 (Fed. Cir. 1999), vacating Id. v. Id., 21 CIT 1109 (1997); ruling nos. H023094 (7/22/10), H249150 (1/28/14) and H263559 (7/1/16).

12. This was a departure from its original perspective, which was that if there were not a bona fide sale for export to the importer to support a valid transaction value appraisement, then an alternative method of appraisement would be needed. Orbisphere Corp. v. United States, 13 CIT 866 (1989).

13. Ruling no. H008101 (10/9/12), citing to ruling nos. H092448 (5/4/10), 547197, (8/22/00) and 546602, (1/29/97).

14. Neville, “International Accounting Standard on Distribution, Principal vs Agent,” 29 JOIT 29 (Nov. 2018).

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