Challenges with transfer pricing in customs valuation Part 2

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1 Workshop on Advance Ruling for Customs Valuation and Challenges with Transfer Pricing co-organized by the Delegation of the European Union to Thailand and Department of Customs Thailand Challenges with transfer pricing in customs valuation Part 2 Prof. Santiago Ibáñez Marsilla University of Valencia (SPAIN) 21 November 2012

2 Outline Possible loss of tariff: identifying the interest of the importer. Pricing databases Experience of other countries with advance rulings on customs valuation USA Canada Australia - Spain

3 Possible loss of tariff: Identifying the interest of the importer (1) In general, we assume that the best scenario for an importer consists in minimizing customs value and maximizing the value for CIT purposes (thus reducing profits). Taxpayer* Tax Administration TP CV TP CV

4 Possible loss of tariff: Identifying the interest of the importer (2) When the authorities force consistency in valuations (customs value and CIT value), the importer will usually decide based on the tax rate of both taxes. Imagine Maraco Th imports watches. The customs tariff is 10%. The CIT rate is 25%. Maraco Th will prefer a high customs value (taxed at 10%) if that allows a high CIT value (reducing profits that are taxed at 25%). But if the tariff rate were 40% and the CIT rate 25%, Maraco would prefer a low customs value.

5 Possible loss of tariff: Identifying the interest of the importer (3) But that is not always the case. Imagine now that the importer has losses in previous years that he can compensate for a limited time. The additional profit will not be taxed until full compensation of past losses. Here the importer might prefer a low customs value even if that results in higher profits. Imagine Maraco Th had losses of 1M $ pending compensation and about to expire. Maraco Th will prefer a low customs value (saving taxes at 10%) because no additional CIT will result.

6 Possible loss of tariff: Identifying the interest of the importer (4) The situation is more complex when we factor in the tax implications for the foreign related party. If the foreign parent company is resident in a country that credits CIT paid by the subsidiary, a low customs value could minimize the global burden. Imagine Maraco Jp pays income tax at 30%, but is allowed a tax credit for CIT paid by Maraco Th. Here the CIT of Maraco Th is irrelevant for the group, and therefore the saving is in reducing customs duties. Notice: They would be paying extra CIT in Th!

7 Possible loss of tariff: Identifying the interest of the importer (5) The situation would be different if Maraco Jp paid CIT at 15%. Then it can not credit the full 25% paid by Maraco Th. If the tariff is 10% the balance is neutral (although customs duties are paid inmediately and CIT is deferred: for financial reasons they might prefer a low customs value). Again, they would be paying extra CIT in Th. Imagine now the same situaton but with a 5% tariff. The group would prefer a high customs value. They would pay less CIT in Th. Imagine now the same situaton but with a 15% tariff. The group would prefer a low customs value. They would pay more CIT in Th.

8 Possible loss of tariff: Identifying the interest of the importer (6) If the residence country of the parent company has established a CIT with exemption of foreign income, then the parent company gets no tax credit for the CIT paid by the subsidiary. Here, in general, the importer will declare a high customs value if that allows him a high value for CIT purposes. Imagine the customs tariff is 10% and the CIT rate is 25% in Th. Maraco Th will prefer a high customs value (taxed at 10%) if that allows a high CIT value (reducing profits that are taxed at 25%). Now imagine the customs tariff is 40% and the CIT rate is 25% in Th. Maraco Th will prefer a low customs value (saving 40%) even if that means higher profits in the CIT (paying additional tax at 25%).

9 Conclusions Possible loss of tariff: Identifying the interest of the importer (7) Assuming consistency between customs valuation and value for CIT purposes, in order to know the global preference of the taxpayer we need to determine: If the residence country of the exporter has a credit regime or an exemption regime for foreign income. If it is a credit regime, we need to know if the tax rate is higher or lower in the residence country of the exporter than in the importing country. We need to be aware of the relationship between the tariff rate and the CIT rate in the importing country. We need to take into account other special circumstances of the taxpayer (such as the existence of losses pending compensation)

10 Legal starting point: Pricing databases (1) WTO s Decision regarding cases where customs administrations have reasons to doubt the truth or accuracy of the declared value. Decision 6.1 TCCV The reasonable doubt standard Legal consequence: Transaction value might be rejected The question is: A discrepancy of the declared price with the results offered by a pricing database, is enough grounds to satisfy the reasonable doubt standard?

11 TCCV : Pricing databases (2) Case Study The excessively low price triggers an investigation. The investigation reveals that: 1) The accounting records do not support the declared value; 2) The importer fails to provide any additional evidence, other than the invoice; 3) Suspicious and unjustified payments in a foreign country are detected disguised as administrative charges. Under the circumstances, the TCCV finds that there are enough grounds to reject the declared price as basis for TV. Legal consequence: Transaction value might be rejected

12 TCCV : Pricing databases (3) Case Study The excessively low price triggers an investigation. The investigation reveals that: 1) The importer does not keep detailed accounting records to support the declared value; 2) The importer fails to provide any additional evidence, other than the invoice; 3) The importer fails to evidence the amount paid. Under the circumstances, the TCCV finds that there are enough grounds to reject the declared price as basis for TV. Legal consequence: Transaction value might be rejected

13 WTO s DSB : Pricing databases (4) Case Colombia-Indicative prices and restrictions on ports of entry, WT/DS/366R. Colombian law provided the systematic rejection of prices declared below the reference prices established by the authorities. The panel upheld Panama's claims that Colombian law establishing indicative prices was inconsistent as such with the obligation established in the Customs Valuation Agreement (CVA) to apply, in a sequential manner, the methods of valuation provided in Articles 1, 2, 3, 5 and 6 of the CVA and with Article 7.2(b) and (f) of the CVA (prohibition of a system which provides for the acceptance for customs purposes of the higher of two alternative values; prohibition of minimum customs values).

14 Pricing databases (5) Colombia-Indicative prices (2) The Panel's analysis in the previous sections demonstrates that payments made by importers in the situation described by Article e) of Decree No and Article of Resolution No are payments strictu sensu and not guarantees in the form of a cash deposit ( ) Accordingly, the Panel concludes that Colombia's use of indicative prices as mandated by Article e) of Decree No and Article of Resolution No constitutes customs valuation within the meaning of the Customs Valuation Agreement.

15 Pricing databases (6) Colombia-Indicative prices (3) The Panel therefore understands that the Customs Valuation Agreement imposes an obligation on national authorities to determine the customs value of imported goods based on the "transaction value" and, whenever that is not possible, to sequentially apply the customs valuation methods provided for in Articles 1, 2, 3, 5, 6 and 7.1 of the Agreement ( ) The Panel considers that, inasmuch as the customs values for subject goods are established on a fixed basis for broad categories of products without any examination of the specific circumstances surrounding the transaction at issue, indicative prices do not reflect any of the methodologies set out in the referred provisions. In fact, as acknowledged by Colombia, "the customs value as determined following the methods of the [Customs Valuation Agreement] will indeed be different from the indicative price in practically all cases".

16 Pricing databases (7) Colombia-Indicative prices (4) ( ) However, the structure and design of the indicative prices system as provided ( ), prevents Colombian customs authorities from sequentially applying the customs valuation methods provided in Articles 1 through The Panel therefore finds that Article e) of Decree No and Article of Resolution No as well as the various resolutions establishing indicative prices, which together mandate the use of indicative prices for customs valuation purposes, are inconsistent with the obligation to conduct customs valuation of subject goods based on the sequential application of the methods established by Articles 1, 2, 3, 5 and 6 of the Customs Valuation Agreement.

17 Conclusions Pricing databases (8) Price databases can be used as triggers for an investigation about the acceptability of the price declared. A risk management instrument In order to reject the declared price ( reasonable doubt test), Customs must provide additional elements, such as inconsistency of the declared price and the accounting records; or suspicious payments that the importer fails to appropriately explain. Price databases are not acceptable as an alternative valuation system.

18 Experience of other countries with advanced rulings on customs valuation The administrative interpretation in: USA Canada Australia Spain* * Court interpretation

19 Experience USA (1) USA CBP Informed Compliance Publication (published: April 2007) Determining the acceptability of transaction value for related party transactions (ICP 2007) CBP has determined that an APA or transfer pricing study by itself is not sufficient to show that a related party transaction value is an acceptable transaction value. CBP has noted that although the broad goal of both the relevant provisions of the customs and the tax law is the same, i.e., to ensure that related party transactions are at arm s length, there are substantial differences in the legal requirements. ( ) Importers are required to declare the customs value on an entry-by-entry and product-by-product basis. ( ) If an importer purchases different products from a related company, it is necessary to determine the correct customs value for each product, not for all the products as a whole.

20 ICP 2007 (2) Experience USA (2) The IRS s goal of clear reflection of income does not necessarily require a valuation of each transaction for each product, and the IRC section 482 regulations allow for aggregation of transactions and offsetting adjustments in appropriate circumstances. Although the transaction-based methods utilized by the IRS in determining an arm s length price under Section 482 have some similarities to the customs methods, they are not the same. The comparable profits method (CPM) has little similarity to the customs methods. For example, the profitability of the related party is usually compared with the profitability of companies that perform similar functions, e.g., contract manufacturer. Most CPM cases apply an interquartile range test. That is, if the related party s profit falls within an acceptable range of profits for the comparable companies, the IRS arm s length requirement is met.

21 Experience USA (3) ICP 2007 (3) In contrast, under the customs methods for determining the acceptability of transaction value, product similarity is required. For example, the all costs plus profit method relevant to the application of circumstances of sale requires that the transfer price be adequate to ensure recovery of all costs plus a profit equivalent to the firm s overall profit realized over a representative period of time in sales of goods of the same class or kind. Similarly, the circumstances of sale test is met where the price was settled in a manner consistent with the normal pricing practice of the industry in question. The industry in question depends on the product that is imported and not the functions that the seller performs. In addition, under the test value method, the customs value law requires consideration of customs values relating to identical or similar merchandise.

22 ICP 2007 (4) Experience USA (4) CBP recognizes that in some cases, the underlying facts and the conclusions reached in an APA or transfer pricing study may contain some relevant information about the circumstances of sale and thus may be considered in applying the circumstances of sale test. an APA that is based on the comparable uncontrolled price method (CUP) has the most relevance for customs valuation purposes and would be given much more weight than an APA that is based on the comparable profits method (CPM), which generally has the least relevance for customs valuation purposes In addition to the methodology used, other relevant considerations are whether the transfer pricing study has been considered by the IRS, whether the APA is bilateral or unilateral, and whether the products covered by the study are comparable to the imported products at issue.

23 Experience Canada (1) Canada Border Services Agency Memorandum D (9 April 2001) Transaction value method for related persons Referring to the acceptability of prices between related parties (examining if the relationship did influence the price), Memorandum D states: The Canada Customs and Revenue Agency will accept, for valuation purposes, a price paid or payable which is derived from one of the methods set out in the OECD s report, unless there is information on prices available which is more directly related to the specific importations.

24 Experience Canada (2) Canada Border Services Agency Memorandum D (18 October 2006) Income Tax transfer pricing and customs valuation CBSA will accept transfer prices established through an APA negotiated between income tax and the taxpayer as a price paid or payable, but will adjust for subsection 48(5) of the Customs Act additions and deductions, as required. For customs purposes, as previously noted, reductions in the price paid or payable by the Canadian purchaser to the foreign vendor made after goods are imported will not be allowed. Where the differences in the calculation of these two values are due to factors that are not legislative requirements, attempts will be made to reduce the number of cases where customs valuations are found unacceptable for tax purposes or vice versa.

25 Experience Australia (1) Australian CBP Pactice Statement No: PS2009/21 (published: 13 July 2009) - Applying for a Valuation Advice relating to Transfer Pricing By applying and documenting various accounting and economic testing methods, a transfer pricing study aims to verify whether the group s transactions are arm s length for tax purposes. This transfer pricing study may also be useful for Customs and Border Protection s purposes where the data includes values for traded imported goods. Before any adjustment can be made to the Customs value, there must be an actual transfer of funds related to the transaction that flows into or out of Australia. Customs and Border Protection will not accept adjustments to the Customs value when the transfer pricing arrangements between related parties are merely notional adjustments.

26 Experience Australia (2) Customs and Border Protection recognises that in some instances, an applicant for a VA may also negotiate an Advance Pricing Arrangement (APA) with the Australian Taxation Office (ATO). While there may be some overlap between the two, Customs and Border Protection must not issue a VA for transfer pricing based on unseen APA documentation. The applicant must produce the APA and any documents that supported the APA to substantiate the VA application. VA: Valuation Advice

27 Experience Spain (1) Judgement of the Tribunal Supremo of 30 November 2009 The authorities uplifted the customs value. The importer imputed the uplifted value as a cost for CIT purposes. Tax authorities rejected the CIT value, merely stating that the customs value and CIT value follow different methodologies. The CIT value was determined by a different method, resulting in a lower value. The methodology used for customs value purposes was an acceptable one for CIT purposes. The Tribunal Supremo held: Both customs valuation and CIT share the same concept of value. The customs methodology was acceptable for CIT purposes. The authorities can not ignore their previous decision (stoppel). Consistency demands that they accept their previous customs- value determination. NOTICE: Consistency works both ways!

28 Challenges with transfer pricing in customs valuation Part 2 Thanks for your attention! Prof. Santiago Ibáñez Marsilla University of Valencia (SPAIN) santiago.ibanez@uv.es