Internal Revenue Service Office of the Chief Counsel Carves Out Narrow Exception for Properly Applied First Sale Rule in Customs Law
On October 29, 2010, the Office of the Chief Counsel of the Internal Revenue Service (IRS) issued Chief Counsel Advice (CCA) 2010-43-028, which discusses the effect of the First Sale Rule under customs law on Internal Revenue Code (IRC) § 1059A.
Under the Customs Modernization Act, it is the responsibility of the importer of record to enter, classify and value goods entering the United States and provide any other information necessary to enable U.S. Customs and Border Protection (CBP) to properly assess duties, collect statistics, and determine whether all legal requirements are met. Under U.S. law, the transaction value of imported merchandise is the primary or preferred method for determining the value of imported goods. Generally, the transaction value is the price actually paid or payable for merchandise when sold for exportation to the United States, plus certain statutorily enumerated additions.
Before merchandise reaches the United States, however, it may have been subject to a series of sales. For example, it may be sold by its manufacturer to a middleman (in the same or a different country), who in turn sells the merchandise to a U.S. importer. In the case of a series of sales, the importer may, under criteria prescribed by CBP, choose a sale that occurred earlier in the chain and use the price paid at that point, as long as the importer can establish that the earlier sale was a sale for exportation to the United States. The option to choose the earlier sales price as the transaction value is known as the “First Sale Rule.” The United States International Trade Commission has provided guidance to ensure proper use of the First Sale Rule in customs law.
In CCA 2010-43-028, the IRS Office of the Chief Counsel discussed how this alternative valuation is treated for purposes of Federal Income Tax.
Given the option afforded by the first sale rule, importers often choose the first sale value because it minimizes custom duties. Use of first sale rule generally results in a disparity between the custom valuation and the income tax valuation because the income tax valuation is based on a later more valuable sale.
As discussed in the CCA, the conflict in tax law is apparent in IRC § 1059A(a), which provides:
If any property is imported into the United States in a transaction (directly or indirectly) between related persons (within the meaning of section 482), 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 custom value.
>> To read the complete Chief Counsel Advice Memorandum, click here.
In addressing the conflict for taxpayers who choose to take advantage of the First Sale Rule, the Office of the Chief Counsel cited to Treas. Reg. § 1.1059A-1(c)(2). The cited regulation allows taxpayers to increase the customs value of imported property by certain amounts that are properly not included in customs value, but which are incurred by the taxpayer and properly included in the transfer price of the property for income tax purposes.
Thus, the IRS Office of the Chief Counsel concluded that “an adjustment under section 1059A with respect to a value differential that results solely from an importers correct application of the first sale rule and subsequent real value added under Treas. Reg. § 1.1059A-1(c)(2) is not proper.”
Note, however, that the Office of the Chief Counsel limited its conclusion to only those situations where the taxpayer both correctly applied the first sale rule and subsequent real value was added. Thus, all other adjustments under § 1059A may nonetheless be appropriate.
Treas. Reg. § 1.159A-1(c)-7 stresses the independence of IRC § 1059A from IRC § 482. As discussed in the regulation, IRC § 1059A “in no way limits the authority of the Commissioner to adjust the taxpayers transfer price under IRC § 482 or other provision of the law. Consequently, where the basis or inventory value is determined under the arm’s-length standard of IRC § 482 as an amount less than the customs value, the taxpayer cannot adjust the basis or inventory value upward to equal such customs value by virtue of IRC § 1059A.
Not surprisingly, IRS Chief of Appeals Diane Ryan implied that the Commissioners discretion to adjust transfer price under IRC § 482 is frequently exercised. While speaking at the fall meeting of the American Institute of Certified Public Accountants Tax Division, she indicated that transfer pricing cases were “the largest deficiency cases in appeals.” Due to the increasing number of transfer pricing and other complex cases involving international issues, IRS Appeals now has a standalone unit for this area.
If you have any questions regarding correct application of the First Sale Rule, IRC § 1059A, or any other transfer pricing issues or regulations, please contact Fuerst Ittleman at email@example.com.