First sale import pricing can be a huge win for apparel importers, vendors and factories alike. With the right kind of planning and teamwork, using the first sale rule benefits every tier of a multi-tiered transaction. Factories and vendors do not have to lower their prices–or their margins–in order to attract U.S. buyers and U.S. importers are able to reduce the landed cost of their goods. First sale is even allowed when all the parties to the transaction are related (have common ownership, share officers, etc.) as long as the rules and documentation requirements are met.
Sometimes referred to as middleman pricing, first sale was first established as a viable option for valuation of merchandise in 1988 in E.C. McAfee v. United States, 842 F.2d 314 (Fed Cir 1988), a case litigated by Sandler, Travis & Rosenberg, PA senior attorney Len Rosenberg. Simply stated, the first sale rule can be applied when there are two or more sales that give rise to an importation of merchandise. As long as all the rules substantiating first sale are met and documentation is established, the basis for dutiable value can be the first sale between the factory and the middleman/vendor, rather than the middleman/vendor and the importer.
As an example, consider a circumstance where a U.S. importer purchases 40,000 units of merchandise from a vendor at $25 per unit. This $10 million of merchandise, if it carries a duty rate of 25% ad valorem, would result in the payment of $2.5 million in duty.
Now, consider using the price between the factory and the vendor (the first sale) as the basis for dutiable value instead. If the factory charges the vendor $21.25 per unit, the total cost for the merchandise from factory to vendor is $8.5 million. At the same ad valorem duty rate of 25%, the duty owed on this importation would be approximately $2.1 million; an annual savings of nearly $400,000. Applying this formula to $100 million in sales would result in a savings of nearly $4.0 million annually in above-the-line expenses.
Substantiating the right to first sale
Incorporating the first sale rule (middleman pricing) into an import strategy is a sound business technique to reduce tax liability as long as the user can substantiate that it is entitled to reap first sale benefits. In order to do that, the importer must produce solid documentation stemming from a well-executed strategic plan.
In the 25 years since McAfee was decided, the courts and the government have refined the requirements for using first sale. Three factors must be present to establish the first sale as the basis for import valuation. First, the transaction upon with the value is based must be a bona fide sale for export; second, the goods must be destined for the United States; and third, the transaction must be at arm’s length. Once it is determined that these requirements are met, a clear documentation trail must be set up. The importer asserting first sale must be able to show a purchase order (PO) from the importer to the vendor, a PO from the vendor to the factory, an invoice from the vendor to the importer, and invoice from the factory to the vendor (provided with the shipment at the time of importation), payment from the importer to the vendor, and payment from the vendor to the factory. Depending on the complexity of the transaction, the paper trail can be even more complex.
Practical considerations: first sale development, maintenance and review
As the oldest international trade service provider working with clients on first sale matters, ST&R usually recommends a feasibility analysis before embarking on a first sale program. Of paramount importance is getting vendor support. First sale valuation requires a great amount of trust and transparency. It works best in cases where the importer and the vendor plan on a long-term relationship and consider each other trusted business partners. The importer will be asking its vendors to relinquish information and documentation regarding its actual costs, including any items it may be supplying to the factory that could influence the customs valuation of the goods.
After you’ve determined feasibility, you can establish the steps for capturing the first sale price. This is where the documentation trail is scrutinized. The importer must be able to prove the bona fides of the transaction upon which first sale is asserted. Purchase orders, invoices, actual payments, and any other elements of customs valuation must comport with the first sale rules. Working with outside experts to pre-certify your transactions as first sale eligible is recommended.
Finally, it is important to develop a plan for independent recertification and annual maintenance at the outset. Even the most seemingly insignificant changes in sources or supply chain flow can upset the first sale equilibrium. By pre-planning for regular process and recordkeeping reviews, the importer builds in assurances necessary to maintain a smooth first sale program.
CHARLES CROWLEY is a member of Sandler, Travis & Rosenberg, P.A., and serves as the firm’s First Sale Practice Leader.
Resident in the New York office, Mr. Crowley spends a significant amount of time working through the firm’s Hong Kong office assisting multinational corporations with a wide variety of customs and international trade activities, including first sale and other valuation matters, international supply chain security and management, intellectual property rights, import/export process management, duty refunds and tax/tariff reductions, foreign-trade zones and customs audits. He also advises clients on penalty matters and brings considerable insight to these issues as a former attorney with U.S. Customs and Border Protection’s Office of Regulations and Rulings and as a licensed U.S. Customs Broker in good standing since 1999.
Mr. Crowley can be reached at CCrowley@strtrade.com or at 212-549-0134