First-sale customs valuation can create a permissible tax valuation difference

Plain-English summary

Chief Counsel considered whether a difference between a taxpayer's customs valuation and income tax valuation necessarily violated IRC § 1059A when the difference resulted from correctly using the first-sale rule under customs law. The advice concludes that a difference caused by a correct first-sale valuation and later real value added may fall within the exception in Treas. Reg. § 1.1059A-1(c)(2)(iv). The advice also states that other adjustments may still be appropriate, and that § 1059A does not limit the Commissioner's authority to adjust transfer prices under § 482 or another applicable provision. The issue concerns how customs valuation rules interact with the amount included in tax basis or inventory cost.

Ruling snapshot

• Question: Does a correct first-sale customs valuation difference always violate § 1059A?
• Outcome: Advice given
• Key authorities: IRC §§ 1059A, 263, 471, and 482; Treas. Reg. § 1.1059A-1(c)(2)(iv) and (c)(7); Nissho Iwai American Corp. v. United States

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 201043028
       Release Date: 10/29/2010
       CC:INTL:B06:GASpring
       POSTF-126052-08

UILC: 1059A.02-00

date: August 13, 2010

 to:   ----------------------------------------------------------------------

from: Christopher J. Bello, Branch Chief, CC:INTL:6

subject: Applicability of Treas. Reg. § 1.1059A-1(c)(2)(iv)

       This Legal Advice responds to your request for assistance. This advice may not be
       used or cited as precedent.

       ISSUE

               Whether a difference between a taxpayer’s valuations for customs law purposes
       and for income tax purposes that results from the taxpayer’s correct application of the
       first sale rule under customs law always violates section 1059A or whether such
       difference may be permissible under Treas. Reg. § 1.1059A-1(c)(2)(iv).

       CONCLUSION

              A difference between valuations for customs law purposes and for income tax
       purposes that results from a correct application of the first sale rule does not violate
       section 1059A where such difference falls under the exception in Treas. Reg.
       § 1.1059A-1(c)(2)(iv).

       LAW

       I. Section 1059A

                Section 1059A provides:

                                  (a) In general.
                                     If any property is imported into the United
                                  States in a transaction (directly or indirectly)

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                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 customs value.

                (b) Customs value; import.
                   For purposes of this section –
                   (1) Customs value. The term “customs
                   value” means the value taken into account
                   for purposes of determining the amount of
                   any customs duties or any other duties
                   which may be imposed on the importation of
                   any property.
                   (2) Import. Except as provided in
                   regulations, the term “import” means the
                   entering, or withdrawal from warehouse, for
                   consumption.

Thus, generally, if a transfer price paid by an importer exceeds the value reported by
the importer for customs purposes, the amount by which the transfer price exceeds the
customs value may be disregarded for income tax purposes.

    Congress, however, recognized that there are legitimate and material differences

between customs and tax valuation principles and directed the Secretary of the
Treasury to provide rules that acknowledge such differences. Specifically, the
legislative history provides, in part:

         In enacting [section 1059A], Congress did not express
         the view that valuation of property for customs purposes
         should always determine valuation of property for U.S.
         income tax purposes. Instead, Congress was concerned
         only with establishing a limit on the price an importer could
         claim for income tax purposes. . . . The Act provides that
         importers subject to U.S. tax may not claim a transfer price
         for U.S. income tax purposes that is higher than would be
         consistent with the value they claim for customs purposes. . . .
         Congress expected that the Secretary will provide rules for

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          coordinating customs and tax valuation principles, including
          provision of proper adjustments for amounts such as freight
          charges, items of American content returned, sales commissions
          where customs pricing rules may differ from appropriate tax
          valuation rules. . . . In addition, in no event does a customs
          declaration or customs valuation constrain the ability of the
          Commissioner to adjust transfer prices under section 482.

Joint Committee on Taxation, General Explanation of Tax Reform Act of 1986, at 1062
(1987); Committee on Finance, Senate, S. Rep. 99-313, at 419 (1986); Conference
Report, House of Representatives, Rep. 99–841, at II-656 (1986). The Treasury
Department responded by issuing regulations that include Treas. Reg. § 1.1059A-
1(c)(2), which provides:

                 (2) Adjustments to customs value.—To the
                 extent not otherwise included in customs value,
                 a taxpayer, for purposes of determining the
                 limitation on claimed basis or inventory cost of
                 property under this section, may increase the
                 customs value of imported property by the
                 amounts incurred by it and properly included in
                 inventory cost for—
                         (i) Freight charges,
                         (ii) Insurance charges,
                         (iii) The construction, erection,
                 assembly, or technical assistance provided
                 with respect to, the property after its
                 importation into the United States, and
                         (iv) Any other amounts which are not
                 taken into account in determining the customs
                 value, which are not properly includible in
                 customs value, and which are appropriately
                 included in the cost basis or inventory cost for
                 income tax purposes. See § 1.471-11 and
                 section 263.

Thus, Treas. Reg. § 1.1059A-1(c)(2) recognizes that, where the differences result from
real value added, a taxpayer may report different amounts for customs and income tax
purposes without adjustment under section 1059A.

II. The First Sale Rule

    Under customs law, if both the manufacturer’s selling price and a middleman’s

selling price are statutorily viable transaction values for purposes of determining
customs duties, the first sale rule permits a taxpayer to choose the manufacturer’s lower

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price, rather than the middleman’s higher price, as the basis for determining transaction
value. This is known as the first sale rule. The court in Nissho Iwai American Corp. v.
United States, 982 F.2d 505 (Fed. Cir. 1992), confirmed the first sale rule as a proper
interpretation and application of customs law for valuation purposes, and explained the
circumstances in which it may be applied:

          Once it is determined that both the manufacturer’s price and
          the middleman’s price are statutorily viable transaction
          values, the rule is straightforward: the manufacturer’s price,
          rather than the price from the middleman to the purchaser, is
          used as the basis for determining transaction value. . . . The
          rule only applies where there is a legitimate choice between
          two statutorily viable transaction values. The manufacturer's
          price constitutes a viable transaction value when the goods
          are clearly destined for export to the United States and when
          the manufacturer and the middleman deal with each other at
          arm's length, in the absence of any non-market influences
          that affect the legitimacy of the sales price.

Given the option afforded by the first sale rule, importers often choose the first sale
value because it minimizes customs duties. Use of the first sale rule generally results in
a disparity between the customs valuation and the income tax valuation because the
income tax valuation is based on a later, more valuable sale.

ANALYSIS

   Section 1059A(a) caps the section 482 transfer price of goods at the customs

value reported for the goods. For this purpose, section 1059A(b)(1) provides that
customs value is the value taken into account for purposes of determining the amount of
any customs duties or any other duties that may be imposed on the importation of any
property.

    Treas. Reg. § 1.1059A-1(c)(2) 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. Treas. Reg. § 1.1059A-1(c)(2)(i) through (iii) provide
specific examples of such amounts. Treas. Reg. § 1.1059A-1(c)(2)(iv) further allows
customs value to be increased by any other such amounts that are not specifically
identified in Treas. Reg. § 1.1059A-1(c)(2)(i) through (iii).

   Accordingly, we conclude that an adjustment under section 1059A with respect to

a value differential that results solely from an importer’s correct application of the first
sale rule and subsequent real value added under Treas. Reg. § 1.1059A-1(c)(2)(iv) is
not proper. However, other adjustments under section 1059A may nonetheless be
appropriate, and section 1059A does not limit in any way the authority of the

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Commissioner to adjust a taxpayer’s transfer price under section 482 or any other
appropriate provision of the law. See Treas. Reg. § 1.1059A-1(c)(7).

  Please call Branch 6 at (202) 435-5265 if you have any further questions.