Important Considerations for Transfer Pricing and Customs Valuations
Even though rules for transfer pricing and customs valuation have similar objectives, multinational enterprises (“MNEs”) that focus solely on transfer pricing are increasingly facing customs issues around the world. Most tax authorities follow the principles set forth in the Organisation for Economic Cooperation and Development’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the “OECD Guidelines”) for transfer pricing purposes, and follow the principles outlined in the World Trade Organization Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (“WTO Customs Valuation Agreement”) for the value of goods for customs purposes.
These guidelines share similar objectives, but exhibit significant differences in their application. This can lead to challenges for MNEs seeking to apply transfer pricing methods for customs purposes. Key issues include the need to demonstrate that the intercompany transfer price is acceptable for customs valuations purposes, and proper accounting for retroactive transfer pricing adjustments has been accurately reflected for customs valuation purposes. Since the convergence, or even harmonization, of transfer pricing and customs valuation rules is unlikely, tax authorities are generally not required to accept values calculated in accordance with customs valuation methodologies, and customs authorities are not required to accept values derived for tax purposes.
When can you use intercompany transfer prices for customs valuation purposes?
The WTO Customs Valuation Agreement requires using one of the following valuation methodologies: (i) transaction value; (ii) transaction value of identical or similar merchandise; (iii) deductive value; (iv) computed value; and (v) derivative value. These methods generally must be applied in sequential order to determine an arm’s length value for the imported article. The primary valuation method is often (i) transaction value, which is defined in the U.S. customs regulations as the “price actually paid or payable for the merchandise when sold for exportation …” plus any statutory additions that may not be already included in the price. How the “price actually paid or payable” is determined is not relevant, as it should be “considered without regards to its methods of derivation [and] may be the result of discounts, increases, or negotiations, or may be arrived at by the application of a formula.”
If a comparable sale occurs between unrelated parties, then the invoice price is the “price actually paid or payable,” and the arm’s length nature of the transaction is apparent. Additional scrutiny must be exercised if a price is set for a transaction that occurs between related parties. U.S. customs regulations require that (i) an examination of the circumstances of the sale of the imported merchandise indicates that the relationship between the seller did not influence the price actually paid or payable; or (ii) the transaction value of the imported merchandise closely approximates certain test values (i.e., the circumstances of sale test or the test values method). If either test is satisfied, the transaction value is acceptable for valuation purposes.
The circumstances of sale test identified under the U.S. customs regulations (ii) above can be satisfied in two ways. First, show that the related-party price is consistent with normal industry pricing practices or comparable to the price charged in transactions with unrelated parties. Second, show adequate cost recovery plus a profit margin comparable to sale of merchandise of the same class or kind.
The test values method also identified under the U.S. customs regulations (ii) above establishes test values that are based on values of identical or similar merchandise exported to the United States at roughly the same time the related-party transaction occurred. The test values must consist of either (i) transaction values of identical or similar goods; or (ii) the deductive or computed values of identical or similar merchandise. If the related-party transaction value closely approximates either of the tested values, it will then be acceptable.
What role do transfer pricing studies play in a customs valuation setting?
The U.S. Customs and Border Protection (“CBP”) agency views an importer that relies solely on an Advanced Pricing Agreement (“APA”) or a transfer pricing study to conclude that a transaction value is acceptable would not be exercising reasonable care. This concerned many MNEs who relied on transfer pricing studies as useful evidence. The CBP seeks to determine the arm’s length value for a particular article that is imported into the country. Conversely, the Section 482 Regulations allow for aggregation of transactions and offsetting adjustments. There are additional differences in the methodologies applied for customs and tax purposes. For example, if an importer asserts that a transfer price was set in a manner consistent with normal pricing practices of the industry in which it operates, the CBP requires that the importer presents objective evidence of these normal pricing practices and that the transfer price was set in accordance with these practices. This is unlike the Section 482 Regulations that emphasize identifying comparable companies that engage in similar functions and have a comparable risk and asset profile.
Retroactive price adjustments due to transfer pricing also have an impact on declared customs values. The CBP’s Reconciliation Program is set up in such a way that if a MNE believes that it will likely make a transfer pricing adjustment, it can flag all entries subject to a later adjustment. By flagging these entries, the CBP becomes aware the entries’ values may change. It is then the MNE’s responsibility to reconcile these flagged entries and file reconciliation entries within 21 months.
The CBP acknowledges that transfer pricing studies and other transfer pricing-related documentation can act as a starting point for proving the acceptability of pricing used in a customs context. However, simply relying on tax-related documentation is becoming less acceptable, and a supplementary analysis should be prepared. Any existing transfer pricing documentation detailing transactions in an aggregated fashion needs to be supplemented to test the acceptability of the transfer prices at the product or product-family level and consider potential retroactive transfer pricing adjustments. MNEs should also ensure that internal controls are established and all applicable additions to value (e.g., dutiable intercompany royalties, cost sharing payments) are accounted for so as to avoid adjustments and potential penalties.