Convergence areas exist between transfer pricing and customs valuation. However, respective authorities’ approaches differ, which requires close cooperation within multinationals when setting prices, documenting them and communicating with various authorities in times of increased transparency.
Why multinationals need to consider the approaches adopted by customs authorities in their transfer pricing
The prices of goods in cross-border transactions are of great interest to both Customs and Transfer Pricing (“TP”) authorities. However, TP and customs valuation originate from different areas of taxation with different rules. This gives rise to different approaches between tax and customs authorities that could negatively affect total tax outcomes in each jurisdiction where goods are imported.
Despite efforts to converge disparate TP and customs policies, there is still, however, no internationally agreed approach. TP policies may be a useful information source. In addition, mandatory disclosure requirements (e.g. country-by-country reports, documents attached to tax return filings) provide increasing information access to various administrations worldwide including customs authorities.
This means that compliance from both a customs and TP perspective remains challenging and requires close cooperation between teams responsible for all taxes including customs.
What are some of the issues?
Whilst the price of goods can be perceived by tax authorities dealing with TP matters in the importing country as too high (thereby decreasing the taxable profit there), customs authorities may at the same time seek to challenge the prices perceived as too low (thereby decreasing the customs duties to be paid in the importing country). In an ideal world, transfer prices would be aligned with customs’ value. But in practice, tax authorities follow the OECD Guidelines for TP and the customs authorities refer to the General Agreement on Tariffs and Trade Valuation Code.
This may lead to different treatments of year-end adjustments of transfer prices to ensure an arm’s length profit margin of distribution entities, payment of license fee for intangibles or certain service fees when those payments relate to the price of goods. The multinationals which decide to monitor and change their transfer prices proactively during the tax year may also attract the attention of customs authorities due to the volatility of prices.
Whilst it is increasingly recognized that TP documentation may provide a useful reference point for customs purposes, the level of detail and information therein (as well as intercompany agreements) expected by tax and customs authorities may differ. In addition, procedures may be required for the transfer prices to be accepted for customs purposes, e.g. the reporting of the existence of a TP policy in advance of imports.
What companies can do
Based on the Transfer Pricing and Trade Compliance Survey published by KPMG LLP in 2020 (US)1, only 55% of respondents indicated that their company adequately understands the mutual implications of TP strategies and customs valuation topics.
Multinationals may wish to review the following areas to better understand the interdependencies of TP and customs value to achieve positive outcomes:
- Ensure stakeholder management and processes are in place to secure a holistic approach to intercompany transactions and awareness to involve customs and trade experts in all TP-related processes early on. The tax strategy of a multinational should also consider the integration of TP with other taxes, including customs, and proactively address tax transparency initiatives and developments.
- Perform a TP and customs health check to review existing intercompany transactions and manage potential risks and opportunities.
- Involve customs experts when defining or evaluating a TP policy (e.g. in conjunction with a supply chain reorganization) to review the overall structure and supporting documentation (including intra-group contracts) from a customs perspective.
- Prepare contemporaneous documentation that addresses customs rules and is aligned with TP-related economic analysis.
- Consider what information is available to tax and customs authorities (e.g. TP forms, documentation, etc.) and anticipate how authorities may approach that data to help prepare for potential future discussions with them on a holistic tax basis.
- Perform a risk assessment to understand how to best address year-end price adjustments in a given jurisdiction (customs authorities in different countries may have different approaches). This is particularly important in the post-COVID reality with some industries / companies undergoing supply chain disruptions / reorganizations.
- Obtain customs rulings and/or tax rulings / Advanced Pricing Agreements to secure the position in given countries and anticipate any issues before implementation.
Multinationals are encouraged to proactively manage their TP and customs interdependencies to secure outcomes and anticipate how tax and customs authorities may approach increasing access to information.