What You Need to Know About the First Sale Rule

By Charles Crowley — December 20, 2013

Apparel and textile companies can dramatically and legally reduce landed costs for their exports in multi-tiered import transactions via the First Sale Rule.

The "First Sale" rule is a collaborative and proper legal process available to U.S. textile and apparel (and other) importers and global exporters to substantially reduce duties and taxes.  This rule has been the law of the land in the United States since Sandler, Travis & Rosenberg, PA won the seminal case establishing first sale as a viable option for valuation of merchandise in 1988. ST&R has also successfully applied it to save significant duties for U.S. and EU imports from more than 512 global vendors. 

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 percent 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 percent, 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 million annually in above-the-line expenses.

What's remarkable about using first sale import pricing is that it 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.

Substantiating the right to First Sale
Incorporating the First Sale rule (middleman pricing) into an import strategy is based on established law and is a sound business technique. But as with any complex business practice, the user must be able to legally substantiate that it is entitled to reap its benefits. With first sale, the importer must produce solid documentation stemming from a well-executed strategic plan.

In the 25 years since ST&R helped establish this rule, 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 which 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, meaning the parties must behave as if there were no relationship between them.

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.  ST&R maintains that coordination with customs authorities avoids potential penalties in the incorrect application of this rule.

Practical considerations: First Sale development, maintenance and review
ST&R recommends a feasibility analysis before embarking on a First Sale program. Of paramount importance is getting vendor support. This is one major reason ST&R maintains the world's only dedicated First Sale practice in Hong Kong/China. 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 confidentially share financial information and documentation regarding its costs with ST&R and to coordinate its accounting data in related party transactions. 

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, payments, and any many other elements of customs valuation must comport with the first sale rules. Working with outside accounting and customs professionals to pre-certify your transactions as first sale eligible is expected.

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. With 12 offices in six countries throughout North America, South America, Asia and Europe, ST&R and its related consulting firm Sandler & Travis Trade advisory Services, Inc. form the largest customs and international trade services provider in the world.


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