Section 1059A regulations relating to the basis of property imported into the United States.

On October 23, 1997, Tax Executives Institute submitted the following comments to the Internal Revenue Service concerning regulations under section 1059A of the Internal Revenue Code on the interaction of the tax statute with the Customs Service regulations for determining the customs value of imported property. The comments, which took the form of a letter from TEI President Paul Cherecwich, Jr. to IRS Associate Chief Counsel (International) Michael Danilack, were prepared under the aegis of the Institute's International Tax Committee, whose chair is Joseph S. Tann, Jr. of Ameritech Corporation. Alan Richer of General Electric Corporation materially contributed to the preparation of the comments.

This letter addresses a problem in respect of the interaction of the section 1059A regulations with the Customs Service's regulations and rulings.

Section 1059A was added to the Internal Revenue Code by the Tax Reform Act of 1986. The statute resulted from congressional concern that prior law may have provided taxpayers with an incentive to claim a low cost for goods imported for resale to minimize customs duties, but to use a higher cost to reduce taxable income to the importer, particularly when goods were purchased from a related, non-taxable supplier. S Rep. No. 99-313, 99th Cong., 2d Sess. 418 (1986). For this reason, section 1059A provides that the amount of any costs taken into account in computing the basis (or inventory cost) of property imported into the United States in a transaction between related parties is limited to the property's customs value. "Customs value" means the value taken into account in determining the amount of customs duty or any other duties on the importation of any property. I.R.C. [sections] 1059A(b)(1). "Import" refers to the filing of the entry documentation required to secure release of imported merchandise from the U.S. Customs Service. Treas. Reg [sections] 1.1059A-1(b)(1).

A problem arises when a mistake has been made in the value of the goods claimed for customs purposes. Treas. Reg. [sections] 1.1059A-1(d) provides that the taxpayer is bound by the value finally determined by the U.S. Customs Service, including the value of the products and their classification. The finality of the Customs Service's determination turns on when "liquidation" occurs. "Liquidation" refers to the ascertainment of the customs duties occurring on entry of the product and, with certain exceptions, becomes final (and conclusive for both parties) 90 days after Customs' posting of the notice of liquidation (unless a protest is filed). 19 C.F.R. [sections] 159.1 (Customs Regulations).

The Treasury regulations allow adjustment of the tax basis only where "reliquidation" has occurred under the Customs Regulations. On occasion, an importer discovers that it has made an error in valuing its goods and takes voluntary action to correct that error. The issue addressed here is that if the error is discovered after liquidation becomes final, the importer is prevented from making an adjustment to its cost basis used for computing federal income tax, even though it has voluntarily tendered the proper amount to Customs.

The Secretary of the Treasury is authorized to refund duties or other receipts when an error has occurred (in a procedure commonly known as a "reliquidation"):

Notwithstanding a valid protest

was not filed, the Customs

Service may, in accordance with

regulations prescribed by the

Secretary, reliquidate an entry or

reconciliation to correct ... a

clerical error, mistake of fact, or

other inadvertence ... not

amounting to an error in the

construction of a law, adverse to

the importer and manifest from

the record or established by

documentary evidence,

in any entry, liquidation,

or other customs transaction ...

within one year after the date of

liquidation....

19 U.S.C. [sections] 1520(c)(1). The reliquidation provisions are incorporated into the Treasury Regulations by reference:

[R]eliquidation under 19 U.S.C.

section 1520(c)(1) (to correct a

clerical error, mistake of fact, or

other inadvertence within one

year of a liquidation or

reliquidation) will be taken into

account in the same manner as,

and take the place of, the original

liquidation in determining

customs value.

Treas. Reg. [sections] 1.1059A-1(d). The Treasury Regulations clearly contemplate that a taxpayer will obtain a reliquidation of customs duties from the Customs Service before adjusting the value of goods for tax purposes. The Customs Service has ruled, however, that the income tax consequences resulting from the application of Code section 1059A are not "adverse to the importer" for purposes of 19 U.S.C. [sections] 1520(c).

In Headquarters Ruling 222981 (July 1, 1991) (a copy of which is attached), the Customs Service considered a situation where the importer sought to increase the value of imported goods based on a mistake of fact in the valuation. The requested reliquidation would not have resulted in a refund of duties or the imposition of higher fees. The importer argued that the mistaken valuation was "adverse" under 19 U.S.C. [sections] 1520(0(1) because the undervaluation would limit the importer's basis or inventory cost in the goods and result in an increase in the importer's income tax liability. The Customs Service denied the request for reliquidation, stating that "the plain wording of 19 U.S.C. [sections] 1520(0(1) demonstrates an underlying legislative intent that a protest be denied if it would not result in a remission or refund of duties to the protestant." The ruling recognizes that the tax consequences of undervaluation can be adverse to the importer, but limits the application of section 1520(c) to those effects that are "squarely within the Customs realm." There is nothing in the statutory language, the agency held, to indicate a congressional intent to extend its applicability beyond liability for customs duties.(1)

The Customs ruling creates a Catch 22 for importers. Section 1059A of the Code assumes the underpayment of Customs duties in order to adjust the import value, but the Customs Service has held that 19 U.S.C. [sections] 1520(c)(1) does not apply in an underpayment situation. Section 1592 of Title 19 -- the Customs penalty provision -- leaves taxpayers exposed for five years on underpayments and permits voluntary disclosure to avoid the imposition of penalties. Such a disclosure, however, does not constitute a "reliquidation" -- the event required by Treas. Reg. [sections] 1.1059A-1(d).

To remedy this conundrum, TEI recommends that Treas. Reg. [sections] 1.1059A-1(d) be clarified to either (i) provide that all errors voluntarily disclosed to the Customs Service will qualify for exemption under section 1059A, or (ii) incorporate the voluntary disclosure provision of 19 U.S.C. [sections] 1592 into the regulations. These changes are required to avoid penalizing taxpayers that have voluntarily corrected an honest mistake.

TEI appreciates this opportunity to present our views on the section 1059A regulations. If you have any questions, please do not hesitate to call Joseph S. Tann, Jr., chair of TEI's International Tax Committee, at [phone], or Mary L. Fahey of the Institute's professional staff at [phone].

(1) The correctness of the Customs Service's analysis in this ruling is beyond the scope of this letter. We suggest, however, that the plain language of 19 U.S.C. [sections] 1520(c) conditions relief upon the liquidation being "adverse" to the importer, not that it result in higher customs duties. Moreover, section 1059A seemingly brings the adverse result "within the Customs realm."