Since the introduction of the Transaction Value System of customs valuation by Canada on January 1, 1985, the Canada Border Services Agency (CBSA) has maintained a stated policy of denying refund claims of related party importers who seek to amend declared values for duty to account for adjustments that decrease transfer prices after importation. The CBSA's interpretive proposition that value for duty reduction is precluded is based on its statutory exclusion as "rebates or decreases in the price paid or payable effected after goods are imported". In contrast, if transfer prices are adjusted such that they are increased after importation, Canadian importers face the compliance obligation to amend entries and pay additional duties and taxes as applicable. Bending under the pressure of adverse findings by the Canadian International Trade Tribunal (CITT) and the Federal Court, the CBSA has corrected this imbalance by effecting a major change in policy. Subject to meeting evidentiary requirements, Canadian importers may now seek refunds of customs duties in cases where transfer prices are adjusted downward after importation if the adjusted prices paid or payable were the subject of an agreement in writing at or prior to importation.
It is commonplace for related parties to engage in international commercial agreements pursuant to which purchases of imported goods are "transfer priced". Prudent multinational enterprises establish transfer pricing policies, and support and sustain them on the basis of transfer pricing studies by reputable economists. Historically, transfer pricing studies tended to focus on transfer pricing for income tax purposes. Little attention has been placed on customs valuation by transfer pricing studies.
As income tax and customs valuation considerations often do not align, prudent multinational enterprises must focus more attention on the customs valuation aspects of transfer pricing in international commercial agreements and related transfer pricing studies. A uniform approach should be undertaken that accounts for both similarities and disparities between income tax and customs valuation/transfer pricing principles. It follows that contemporaneous documentation must substantiate transfer pricing for both income tax and customs valuation purposes.
The introduction of the new CBSA policy may lead Canadian importers to conclude that refunds of overpaid customs duties will be automatic. This is not so. Rather, importer claims will be tested by the CBSA. The importer will be expected to demonstrate that:
- prior to importation, the adjusted purchase prices paid or payable, in determined amount or by formula, have been the subject of a written agreement by the related parties to the sale for export transaction;
- the related parties priced and adjusted the prices of goods in accordance with their agreement;
- the amounts paid/adjusted conformed to the agreement relating to purchase prices paid or payable;
- the practices of the related parties were otherwise consistent with the terms of the agreement;
- a transfer pricing study was undertaken to demonstrate that the prices paid or payable were not influenced by the relationship, and the transfer pricing study examines each transfer payment, whether it be for discrete items or categories of goods, services, and/or intellectual properties.
The change in CBSA policy will give rise to a reduction in government revenue normally collected by application of the Customs Act.As a matter of practice, it should be expected that the CBSA will conduct many more customs valuation trade verifications and that they will have a particular focus on transfer pricing aspects of customs valuation. Under Canadian customs law and administration, customs valuation verification of pricing, as well as any adjustments to the price paid or payable that are applicable in establishing the transaction value, are subject to greater scrutiny if these payments are made to related suppliers or other members of a multinational enterprise group comprised in whole or in part by the supplier and the purchaser.
As the government of Canada seeks to recapture or balance the loss of revenue resulting from the new CBSA policy, it is anticipated that the CBSA will conduct more verifications of values declared by related party importers when importers claim refunds of overpaid duties based on transfer pricing adjustments and otherwise.
For example, it would not be surprising to find that Canadian importers who purchase goods from related suppliers have overlooked their obligations to report upward adjustments of transfer prices, or that those who purchase not only goods but also services from members of the multinational enterprise have not sufficiently documented that the amounts paid for services meet the arm's length test, and that the services are rendered for the operation of the business in Canada and are legitimately justified for Canadian business operations. In the course of trade verifications of customs valuation practices, the CBSA has increased its focus on these upward price adjustments and services payments for purposes of determining whether or not they are either part of the "price payable" or "subsequent proceeds", and therefore properly part of the dutiable transaction value. Royalty payments, otherwise not dutiable for reason that they are not paid as a condition of sale, are also expected to receive increased scrutiny to determine whether or not they conform to transfer pricing norms.
The new CBSA policy on downward price adjustments will also impact income tax compliance and reporting by importers. A refund of duty will generally be included in the income of the importer in the year received for income tax purposes and must be timely reported. In addition, as importers revisit their transfer pricing documentation to implement a uniform approach to tax and customs transfer pricing, care should be taken to reflect the latest guidance from the CRA on contemporaneous document standards (See Revised CRA Policy Heralds Focus on Contemporaneous Transfer Pricing Documentation on the Bennett Jones Thought Network).
Finally, importers must be mindful of the recent international initiatives, led by the OECD, to impose more onerous transfer pricing documentation requirements, including detailed country-by-country reporting (See Businesses Face More Onerous Transfer Pricing Documentation and Country-by-Country Tax Reporting on the Bennett Jones Thought Network). While these are not yet Canadian law, it is important for importers to consider their internal management reporting structure and how their organization would meet the more onerous international standards.
The change in CBSA policy will evoke increased vigilance on the part of the CBSA to ensure quid pro quo: an entitlement to refunds balanced by fulfillment of obligations by Canadian related importers. There has never been a more critical time in the history of the transaction value system in Canada for related party importers to closely examine their transfer pricing practices for entitlement to refunds and compliance with Canadian customs valuation law. That examination includes a careful study of the nature of the international commercial transactions and documents evidencing their terms and practices, and transfer pricing policies and studies.
Given what is at stake, prudent related party importers will engage Canadian legal counsel with customs valuation and transfer pricing expertise to study transfer pricing for both customs valuation and income tax purposes under the umbrella of solicitor-client privilege, and to assist in their applications for customs duty refunds.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.