APAC transfer pricing and customs valuation interplay: developments and tips
Multinationals importing goods in the APAC region face varying compliance requirements across the jurisdictions. Shubhendu Misra and Michiel Friedhoff of EY explain several approaches to managing and avoiding disputes with the customs authorities
The interaction between transfer pricing and customs valuation can be challenging anywhere in the world, but this is especially the case in the Asia-Pacific (APAC) region.
Unlike in the EU, the implementation of the World Trade Organization customs valuation rules is not harmonised across the various countries in the APAC region as these are independent customs jurisdictions. In addition, due to the high duty rates in the region on average, the financial impact of customs valuation-related matters can be significant for businesses and customs authorities alike. This makes reviewing intercompany transactions and transfer pricing adjustments a key priority for customs authorities across the APAC region.
This article provides insights on the interplay between transfer pricing and customs valuation in the region. It also suggests approaches to managing disagreements with customs authorities, including illustrations for South Korea and Thailand.
Both transfer pricing and customs valuation have rules regarding the acceptability of intercompany prices. The aim is to ensure related parties interact with each other as if they are not related and therefore comply with the arm’s-length principle. However, there are also differences between these sets of rules, specifically in how they are implemented. Transfer pricing generally focuses on the profitability of a legal entity, while customs valuation focuses on an acceptable price for each individual product and import transaction.
The World Customs Organization (WCO) is of the opinion that despite these differences, transfer pricing documentation can be a valuable source of information for customs valuation purposes (see WCO Technical Committee on Customs Valuation (TCCV) Commentary 23.1, TCCV case studies 14.1 and 14.2, or the WCO Guide to Customs Valuation and Transfer Pricing (June 2015, updated in 2018)).
While most customs authorities agree on some degree of usefulness of transfer pricing documentation, practical implementation can vary significantly across the APAC region. In addition, multinational enterprises (MNEs) should recognise that transfer pricing documentation is seldom drafted with customs valuation in mind.
The acceptability of intercompany transactions’ prices
From a customs perspective, it should be demonstrated that the relationship of the parties has not influenced the price in a transaction. Most MNEs assert that this requirement is met if the importer earns a remuneration in line with a transfer pricing benchmark validated by an independent service provider. As customs authorities will point out in this situation, simply providing transfer pricing documentation will not be sufficient. In practice, it is up to the importer to demonstrate that the intercompany prices are acceptable from a customs valuation perspective.
Customs authorities across APAC regularly use import price databases to challenge import prices as being too low. Complying with the requests of customs authorities (i.e., higher import prices) may, in turn, result in scrutiny from tax authorities (i.e., a higher import price results in a lower corporate income tax base in the importing market). According to the WCO, customs authorities may not use customs valuation databases to determine the customs value of imported goods as a substitute value for imported goods or as a mechanism to establish minimum values (WCO Guidelines on the development and use of a national valuation database as a risk assessment tool). Nevertheless, it is likely that this will not be a successful proposition.
A first step in such cases is to determine if the import prices in the database relate to products that are identical or sufficiently similar. This includes not just the product itself but also the other details of the sale (for example, commercial level, quantities, and timing). Alternatively, the importer will have to demonstrate that the intercompany prices, while potentially being lower than prices from an import price database, should still be acceptable from a customs valuation perspective. Please refer to the section “Customs valuation support file” below for suggestions as to how this can be addressed.
Retrospective transfer pricing adjustments
In all jurisdictions in the APAC region, certain actions are required in the case of retrospective transfer pricing adjustments. Failure to report transfer pricing adjustments may lead to, among others:
Additional duties and other import taxes;
Significant fines; and
Interest once discovered by the customs authorities in an audit.
As a starting point, the customs value becomes final once the import declaration is accepted by the customs authorities, with certain exceptions. As retrospective transfer pricing adjustments occur after the time of importation, this creates challenges from a customs valuation perspective. Some APAC jurisdictions have well-defined procedures and sometimes even guidance available. However, for the majority of jurisdictions, the treatment of retrospective transfer pricing adjustments is a grey area and requires a case-by-case analysis.
One point that customs authorities across the APAC region generally agree on is that if a transfer pricing adjustment results in an increase in the customs value of imported goods, then additional duties and other import taxes (if applicable) must be paid. In many jurisdictions, however, obtaining a refund in the event of a lower customs value due to a transfer pricing adjustment is not possible in practice. Nevertheless, there are some jurisdictions in the APAC region where refunds can be obtained if certain procedures are followed, such as Australia, Japan, New Zealand, Singapore, and Korea. Often, proactive alignment with the customs authorities is required to qualify for refunds.
In certain jurisdictions, businesses can apply for rulings to obtain certainty on how to treat retrospective transfer pricing adjustments or other customs valuation-related matters. This usually involves explaining the logic of the transfer pricing model, and providing legal agreements and other relevant documents. As part of such a ruling, the parties agree how potential transfer pricing adjustments should be treated for customs valuation purposes. This provides certainty for the importing business and helps to avoid audits and fines.
Businesses importing into Korea can submit a voluntary disclosure informing the Korea Customs Service (KCS) of retrospective transfer pricing adjustments. However, customs authorities can decide not to accept such disclosure. This may not immediately result in an audit, but there is a high likelihood that the customs authorities will investigate this sooner or later.
As part of the audit, the KCS tends to strictly examine transfer pricing adjustments. In addition to the payment of additional duties, import taxes, and penalties, the importer may lose the right to deduct import VAT for any additional VAT assessed in the audit. This would result in an additional cost of 10% of the amount of the transfer pricing adjustment (plus additional duties and taxes).
The restrictions on the recoverability of the VAT assessed in customs audits appear to have been eased under the revised VAT legislation in 2023. However, the authorities are still strictly applying the regulation in determining when import VAT on transfer pricing adjustments can be treated as deductible. To manage this risk, importers can apply for an advance customs valuation arrangement. This provides protection against audits and penalties, and facilitates the deductibility of import VAT.
In other jurisdictions, obtaining a customs valuation ruling may not be the answer. For example, in Thailand, while there is an administrative process to obtain legally binding customs valuation rulings, this often does not provide a workable solution. Thai Customs is generally more inclined to consider and issue a non-binding ‘consultation letter’. In practice, this can generally be relied upon to support taxpayers’ valuation position and assist with challenges at the port level or during customs audits.
In the case of retrospective transfer pricing adjustments, a voluntary disclosure is possible if this leads to a duty shortage. A voluntary disclosure helps to support an assertion made to Thai Customs that there is no duty evasion intent in relation to the price adjustment, and the case should be settled without penalties. Nevertheless, interest surcharges will still apply.
Customs valuation support file
Given the challenges surrounding intercompany prices and retrospective transfer pricing adjustments in the APAC region, several MNEs have instituted ‘customs valuation support files’.
In the event of an audit, it is difficult to swiftly provide a high-quality and consistent response taking into account all the relevant considerations and data sources. As mentioned, simply handing over transfer pricing documentation is generally not sufficient, as this does not specifically address the acceptability of import prices from a customs valuation perspective.
A customs valuation support file can explain the customs valuation logic regarding various matters; for example, intercompany pricing, transfer pricing adjustments, and other generally scrutinised topics, such as royalties and value-added service fees. This allows the importing business to provide a timely, consistent, and high-quality response to queries from customs authorities. It also allows the creation and maintenance of contemporaneous documentation (for example, customs-specific benchmarks) as this often may not be possible to do after the fact, especially when disputes arise in post-clearance audits years after the relevant import transactions.
This may help to:
Reduce disagreements with customs authorities;
Avoid unnecessary additional duty payments and fines; and
Limit delays at the port.
In addition, by carefully reviewing the customs valuation position, a business may identify potential risks or opportunities.
Prospective transfer pricing adjustments
MNEs are increasingly looking into prospective transfer pricing adjustments to avoid customs valuation challenges on account of retrospective transfer pricing adjustments. If an MNE utilises prospective transfer pricing adjustments, it will actively monitor the profitability of the importing entity. If the profitability is not in line with the benchmark, it will adjust the price of the imported goods within the year. The aim is to avoid retrospective transfer pricing adjustments at the end of the year, or at least to reduce the quantum of the adjustment.
At first glance, this seems like a good solution from a transfer pricing and a customs valuation perspective. However, prospective transfer pricing adjustments do not come without their (customs) challenges. Customs authorities in the APAC region actively compare the prices of imported goods to the prices of other importers and the historical prices of the importer. Significant price fluctuations, upward or downward, can raise a red flag.
What is considered as significant will differ per jurisdiction and is usually not public knowledge. In the case of a reduction of the price of the imported goods, customs authorities can simply continue to determine the customs value based on the previous (higher) price, thereby avoiding a reduction in customs duties payable. However, in the case of a significant increase in the price of the imported goods, the customs authorities may take the position that the customs value of the previous imports was too low. This could result in retroactively increasing the price of the previously imported products (sometimes covering the imports of multiple years), resulting in additional customs duties.
In addition, they may claim that the previous import declarations were incorrect, potentially resulting in additional fines and interest. A careful implementation of prospective transfer pricing adjustments is therefore key in the APAC region.
The importance of proactive customs planning
The interplay between transfer pricing and customs valuation is a challenging dilemma for most MNEs importing goods in the APAC region. Due to the complexity, combined with varied practices in the different jurisdictions, it needs to be navigated carefully. A solution that works in one country may not work in another.
A key recommendation is to engage in proactive customs planning to avoid being non-compliant and incurring additional duties and other import taxes, fines, interest, etc. Potential solutions that can be considered include:
A customs valuation support file; and
Implementing prospective transfer pricing adjustments.
The views reflected in this article are the views of the author and do not necessarily reflect the views of the global EY organisation or its member firms.