Multinational corporations often base the value of imported merchandise on the transfer price established for tax purposes. In most countries, transfer prices are established based on the arm's-length standard using transfer-pricing methods enumerated in the Organization for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations or local tax regulations. Customs values are based on a hierarchy of valuation principles followed by most World Trade Organization (WTO) member countries. While both sets of rules are designed to reach arm's-length values, because of the differing origins and standards, the transfer price set for income tax purposes may not withstand the scrutiny of the Customs authorities and in some cases could result in the company paying more import duties and fees than planned.
Customs valuation
Almost all customs duties are imposed on the basis of ad valorem duties, (that is, as a percentage of the value of imported goods). WTO member countries are expected to value imported goods based on principles set forth by the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994 (the GATT Customs Valuation Code or Valuation Code) and its interpretative notes, the decisions of the GATT committee on valuation, the advisory opinions, commentaries, explanatory notes, studies and case studies of the technical committee on valuation in the World Customs Organization. Although there are interpretive differences among certain WTO countries, the basic customs valuation principles are generally harmonized.
The GATT Customs Valuation Code requires that imported goods be appraised based on the following valuation methods starting with transaction value and going down the list in a hierarchy order.
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Transaction value: the price paid or payable for the imported goods when they are sold to the country of importation plus amounts for certain selling commissions, royalties, production assistance, packing or proceeds of a subsequent resale. In related-party sales, this price has to be arm's length.
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Transaction value of identical goods: a previously accepted transaction value of identical goods from the same country of exportation around the same time period
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Transaction value of similar goods: a previously accepted transaction value of similar goods from the same country of exportation around the same time period
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Deductive value: the resale value in the country of importation less certain costs incurred including selling and general and administrative expenses
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Computed value: the costs of manufacturing plus a reasonable profit
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Fallback value: any other reasonable method, which usually is a modified version of one of the above valuation methods
The preferred method of customs valuation is transaction value. However, when the parties are related, transaction value can only be used if the parties can show that their relationship "... did not influence the price of the goods." 19 US Customs section 1401a(b)(2)(B). While this is a similar objective of the transfer-pricing methodologies, the GATT Customs Valuation Code dictates a distinctly different manner in evaluating the arm's-length nature of related-party transactions.
Differences between tax and customs methodologies
While there are a number of differences in the application of transfer pricing and Customs rules, two differences are particularly important in the context of current transfer-pricing practice.
The first of these deals with the level of transactional detail required. Customs valuation provides related parties with two possible methods to show that the prices paid for imported goods were not influenced by the relationship of the parties and that transaction value should not be ruled out. Firstly, the companies can provide evidence that the declared values closely approximate the transaction value, deductive value or computed value of similar or identical goods exported to the country of importation at or about the same time. Secondly, the companies can provide an analysis of the circumstances of the sale of the imported merchandise to prove that the relationship between the buyer and seller did not influence the price. This analysis could include documenting arm's-length negotiations, comparing the company's pricing to unrelated third parties and analyzing whether the organization's manufacturing profit is equivalent to the overall profit of the organization over a representative period of time.
While transfer pricing, in theory, also focuses on specific transactions or the "most narrowly defined" set of transactions, as a practical matter many transfer-pricing studies are carried out at a relatively aggregated level, and often on a legal entity level. Moreover, such aggregation is appropriate if combining two discrete transactions leads to more accurate measures of arm's-length pricing. However, testing the arm's-length nature of a group of transactions does not necessarily imply that each of the individual transactions is priced correctly, which is the customs standard.
Year-end adjustments, in which lump-sum payments are made to bring financial results within a targeted range, (see "Reduction of compliance costs and transfer pricing risks with keep-well agreements," elsewhere in this guide) are often used in transfer-pricing studies. This also presents problems from a Customs perspective. Retroactive price changes to Customs values must be reported to the Customs authority in the country of importation. Additional duties and fees will probably be due on price adjustments that increase the import price, while refunds are not usually available for reductions in price. Therefore, taxpayers are caught in a bind in which they are forced to correct the Customs base when transfer prices increase, but are prevented from lowering the Customs value when transfer prices decrease. On top of this, penalties are typically assessed for not disclosing retroactive price adjustments.
Acceptable method possible
It should be possible to develop transfer prices and transfer-pricing documentation that is acceptable for Customs purposes as well as tax. However, this requires: (1) establishing that the transfer prices for each transaction are arm's length (or at least that the related-party relationship did not influence the price of goods); and (2) minimizing the need for after-the-fact adjustments by getting prices set at arm's length levels on a prospective basis.
Biographies |
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Douglas Zuvich is the national leader of KPMG's US trade and customs services practice. He is based in Chicago and assists multinational companies with all aspects of their customs and international trade activities. Zuvich began his career as an auditor with US Customs. In his current role, he focuses on the areas of global customs valuation, import/export process management, trade technology solutions, duty refunds and tax/tariff reductions, foreign-trade zones, customs audits, regulatory compliance and penalty issues. Zuvich is a summa cum laude graduate of Queens College, certified public accountant, licensed Customs House broker, and an MBA from New York University's Stern School of Business. In addition to being a regular lecturer for various international trade associations, he is an active member of the board of directors for the American Association of Exporters and Importers.
Thomas Herr is a senior manager with KPMG's global transfer pricing services practice and is based in Minneapolis in Minnesota. Herr has over nine years of transfer pricing experience working with companies in a wide range of industries on international and state transfer-pricing issues. He spent two years in London assisting US and European companies with their European transfer-pricing issues. He has experience of a wide range of transfer-pricing issues, including structuring tax-efficient transactions, preparing global documentation, assisting in tax audits and advanced pricing agreements and advising on transfer-pricing processes. Herr has published articles on transfer-pricing issues in International Tax Review, BNA Tax Management - Transfer Pricing Report, and the Journal of International Taxation. |
