Transfer Pricing & Customs

Trump’s presidency has sparked a lot of recent discussions on customs and has brought this topic to the front lines. In fact, we may be witnessing a customs and trade war unfolding between the US, Canada, Mexico, China, and the EU. Customs and transfer pricing have always had an interesting relationship where customs authorities target a higher value of goods to increase import duties, while tax authorities aim for the lowest value of goods to increase corporate income taxes. Due to recent developments, I thought it would be beneficial to write about the interaction between customs and transfer pricing and the potential outcomes.

Customs value is essential for import duty and tax determination. Tariff codes drive the duty rate and are applied to the customs values to calculate the import duty and taxes. The customs valuation methods are largely based on the World Trade Organization (WTO). The methods to determine the value of goods are hierarchical. The first and primary customs valuation method is the transaction value method. The transaction value method follows a basic principle that all costs must be included in the actual transaction price upon the arrival of the goods to the import country to determine the fair value. The customs fair value should include costs such as freight, insurance, and commissions. Also, it is imperative to include in the specific transaction any transfer pricing adjustments, R&D assists, and royalties. Additionally, the WTO lists five more methods in the following hierarchical order: 1) Transaction value of identical goods, 2) Transaction value of similar goods, 3) Deductive method, 4) Computed method, and 5) Fall-back method. The risk of incorrect reporting of customs value could trigger higher customs duties, penalties, and non-clearance of goods.

Unlike customs value methods, transfer pricing methods are not hierarchical. The taxpayer may choose the most appropriate or best method to determine the arm’s length price on goods, services, and intellectual property. In the case of imported goods, the most common transfer pricing methods are non-transactional based, but rather profit-based such as the Comparable Profits Method (CPM) or Transactional Net Margin Method (TNMM). In these transfer pricing methods, the value of the goods is typically set on an aggregate basis and not per transaction. Such a transfer pricing adjustment would be applied on the total goods sold. Transfer pricing adjustments may occur on a real-time basis or retrospectively, in which case they should be considered for import value when declaring goods value for customs.

The recent tit-for-tat tariffs between countries are also causing companies to re-examine their supply chains and understand if there are any mitigations to avoid paying more duties. It is worth mentioning that one of the key differences between customs and transfer pricing is that while transfer pricing affects the legal statutory accounts of an entity, customs duties affect managerial profit and loss accounts. Therefore, during these turbulent times, the collaboration between customs, trade, compliance, supply chain, and tax teams is highly important. From a transfer pricing perspective, higher customs duties may result in reduced profitability of tested parties’ operating margins and would require changes to the transfer prices or require comparability adjustments, or a change to transfer pricing policies.