MEEKS, SHEPPARD, LEO & PILLSBURY

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1 MEEKS, SHEPPARD, LEO & PILLSBURY ATTORNEYS AT LAW JEFFREY A. MEEKS* 1735 POST ROAD, SUITE 4 RALPH H. SHEPPARD 570 LEXINGTON AVENUE FAIRFIELD, CT ROBERT J. LEO 24 TH FLOOR TEL: (203) , FAX: (203) TAYLOR PILLSBURY* NEW YORK, NY DIANE L. WEINBERG TEL: (212) RD ST., SUITE 202 ANDREA ABRAHAM FAX: (212) LAGUNA BEACH, CA MICHAEL JACKSON* TEL: (949) , FAX: (949) *ADMITTED TO A BAR OTHER THAN NEW YORK SENIOR COUNSEL U.S. Customs Law and Transfer Pricing A Primer Has your client valued the product correctly and declared that value to U.S. Customs and Border Protection upon importation into the U.S.? Has your client accounted for the issues that would impact that value? These are some of the questions counsel to multinational companies should ask. The valuation of merchandise is critical, because it determines how much duty and fees are paid. Undervaluation of imported or exported merchandise may lead to delays in shipments, additional physical examinations, rejected shipments, and civil or criminal penalties, depending on the circumstances. Overvaluation means lost revenue to a company, and may be seen by governments as an indication of capital flight or money laundering. These potential, severe problems underscore the importance of proper valuation or appraisement, and counsel's need to review and confirm that appraisement. The United States and most of its industrialized trading partners are signatories to the WTO s GATT (General Agreement on Tariffs and Trade) Valuation Agreement or Code, originally signed and ratified by the U.S. in 1979, and enacted into law in 19 U.S.C. 1401a. Proper appraisement is important, and will be enforced by U.S. Customs, even if the merchandise is "duty free." The following briefly explains the basics of U.S. valuation law, and serves as background to discussion about the Agreement' impact on trade. The transaction value of imported merchandise is U.S. Customs' primary method of appraisement, and is used in over 90% of all import transactions. U.S. law, 19 U.S.C. 1401a(b)(1), defines "transaction value" as:

2 The price actually paid or payable for the merchandise when sold for exportation to the United States, plus, unless already included, amounts equal to: A. The packing costs incurred by the buyer with respect to the imported merchandise; B. Any selling commission incurred by the buyer with respect to the imported merchandise; C. The value, apportioned as appropriate, of any assist. D. Any royalty or license fee related to the imported merchandise that the buyer is required to pay, directly or indirectly, as a condition of the sale of the imported merchandise for exportation to the United States; and E. The proceeds of any subsequent resale, disposal, or use of the imported merchandise that accrue, directly or indirectly, to the seller. If your client receives a commission from the supplier for the sales in the U.S., or the U.S. customer pays a royalty or license fee to your client any portion of which goes back to the supplier/seller, the proper value might not be reflected on the import documents. Selling commissions and fees paid to or for the benefit of the seller must be reflected in the value declared to U.S. Customs under U.S. law 19 U.S.C. 1401a. Your client should keep in mind that the price paid or payable is not necessarily the contract or purchase order price but the amount actually tendered by the buyer to the seller for the goods. If your client is related to the supplier or seller, he or she should be aware that U.S. Customs law treats "related parties" differently than non-related parties. While U.S. Customs will readily accept transaction value as the appraisement method for imports when the buyer and seller are not related to each other, they will hesitate to accept transaction value between related buyers and sellers unless certain conditions are met. 19 CFR et seq. The importer of record must demonstrate to U.S. Customs that the price charged by its related entity was either reached as result 2

3 of arm's length negotiations, or meets specified test values set forth in the regulations. Failure to satisfy U.S. Customs will result in use of another method of appraisement, which may result in a higher value, and increased duties affecting the profit margin. The following is a summary of the current state of U.S. Customs treatment of transfer pricing between related parties importing into the U.S. I U.S. Internal Revenue Code Section 482 Sets forth arms length pricing requirements in transactions between related parties. There are certain methods of valuation under the U.S. IRS transfer pricing rules. Under IRS rules, the goal is to use the transfer pricing method that produces the most reliable result. II III IV ADVANCE PRICING AGREEMENTS In 1991, IRS created Advance Pricing Agreements that permit the Government and the taxpayer to agree on the facts to which the APA applies, the transfer pricing method, and an expected range of results. APA is binding on IRS, not U.S. Customs. TRANSFER PRICING Goal of transfer pricing in related party transactions for IRS purposes is to clearly reflect income. Goal in related party transactions for Customs purposes is the correct appraised value and not income related to the merchandise. With their different goals, the transfer pricing determined by tax officials frequently differs from the value determined by Customs officials in related party transactions. Related Parties - Customs Issues Is transaction value acceptable (arm s length)? Circumstances of Sale Supporting evidence: Relevance of APA s and tax transfer pricing studies Test Values Based on customs value for previous entries for identical or similar goods Post Importation Price Adjustments: Does transaction value apply? Treatment of post importation increases and rebates. Importer s obligation to use reasonable care to declare correct customs value. V Legal Requirements U.S. Customs Value Law Section 402 of the Tariff Act of 1930, as amended by the Trade Agreements Act of 1979, 19 U.S.C. 1401a Implementing Regulations Part 152 of the CBP Regulations (19 CFR Part 152) 3

4 VI U.S. Customs Ruling HQ Customs ruled in August 2000 that transfer prices are acceptable for transaction value where a bilateral APA exists, Customs attended the APA Prefiling Conference, and reviewed the information submitted to IRS. This enabled Customs to conclude that price was not influenced by the relationship for purposes of the circumstances of sale test. VII VIII IX X XI XII CONFLICT BETWEEN IRS AND CUSTOMS IRS wants transfer pricing for imports to be at the lowest possible level in order to maximize the taxable profit in the subsequent resale in the United States. Customs generally wants the highest appraised value for the imports because that will result in collecting more duties. U.S. importer hopes for both a low value for Customs purposes and higher inventory value for tax purposes. IRC Section1059A Congress enacted section 1059A in 1986 as a result of a court case that encouraged taxpayers to declare a lower Customs value and a higher value for tax purposes. Section 1059A - importers may not claim a transfer price for tax purposes that is higher than the value claimed for Customs purposes, subject to certain adjustments. It establishes a limit on the price an importer can claim for tax purposes. TAX BASIS For tax purposes, taxpayer may increase declared Customs value of imports by adding amounts for International freight Insurance Post-importation transportation, construction, erection, assembly or technical assistance Any other amounts that are not taken into account in determining the customs value, which are not properly included in customs value, and which are appropriately included in the cost basis or inventory cost for tax purposes. IRS REPORTING REQUIREMENTS Importing taxpayer required to file IRS Form 5472 and explain any differences between its inventory cost and value declared to Customs. PROTECTION AGAINST IRS CHALLENGE Importing taxpayer should obtain both a Customs ruling on customs valuation and a Section 1059A ruling. CUSTOMS GENERAL ANNOUNCEMENT ON TRANSFER PRICING Customs does not accept IRS findings of arms length under section 482 for an acceptable transaction value. In 1993, Customs announced that the importer must justify its transfer price by demonstrating the price was not influenced by the relationship, based on the circumstances of sale, or establishing that, even if the price was so influenced, that the transfer price closely approximates a test value. 4

5 XIII XIV XV Transfer Pricing Methods for Tangible Property Transactional Comparable Uncontrolled Price (CUP) Resale Price Method Cost Plus Method Profit Based Profit Split Comparable Profits Method (CPM) Unspecified Methods Transfer Pricing Methods for Tangible Property (cont.) CPM Focused on operating profit of tested party Most frequently used method in APA context Comparability standards lower Data readily available Easy to apply prospectively Comparable Profits Method (cont.) Elements of the CPM Tested Party Comparables Profit level indicator Operating margin Return on capital employed/return on assets Berry ratio (cost plus on operating expenses) XVI EFFECTIVE JULY 30, 2012 A new U.S. Customs policy issued on post-importation adjustments to value of goods - 46 CUST. BULL. 23 at 1 (May 30, 2012) Previously allowed reductions only if formula in place prior to importation into the U.S. APAs and general transfer pricing policies were not considered to be prior formulas XVII NEW CUSTOMS POLICY IN 2012 WILL ACCEPT IMPORTER S RELATED PARTY PRICING IF: Company has written transfer pricing policy in place prior to importation That policy is prepared taking Section 482 into account Company uses its TPP in filing its tax returns Any resulting adjustment is reported or used in tax returns XVIII NEW CUSTOMS POLICY IN 2012 WILL ACCEPT IMPORTER S RELATED PARTY PRICING IF: Company s transfer pricing policy specifies how TP and any adjustments are determined for goods at issue Company has documented support from its books and financial statements for the adjustments No other conditions or factors affect CBP s acceptance of the transfer price 5

6 XIX WCO CASE STUDY 14.1 Position proposed by US and adopted by WCO in April 2016 Allows use of a transfer pricing study, based on the Transactional Net Margin Method (TNMM), to meet the circumstances of sale test. Case very fact specific and might not engender broad use. Key facts include: 1. The transfer pricing study based on TNMM is prepared by an independent firm; 2. The transfer pricing study is reviewed by the tax authorities of both the exporting and importing countries, and the arm's length profit range has been approved by the tax authorities; 3. The transfer pricing study is a key component of an Advance Pricing Agreement (APA) between the tax authorities and the exporter and importer; 4. Price under examination cannot be adjusted for customs or tax (in the year covered by the study) purposes. 5. All operating expenses incurred by the importer are paid to unrelated parties; and 6. Test value method does not establish that the price was not influenced by the relationship. Of course, this summary is provided for informational purposes only and not as legal advice. It does show how different U.S. Customs treatment can be from the U.S. Internal Revenue Service s treatment of transfer pricing and U.S. Customs current position attempting to bridge that difference. If you have any questions about this area, please do not hesitate to contact Robert Leo at: MEEKS, SHEPPARD, LEO & PILLSBURY 570 LEXINGTON AVENUE, 24 TH FL NEW YORK, NY (212) Robert.leo@mscustoms.com 6