To support the use of transfer pricing studies as an aid in establishing that prices paid or payable are not influenced by the relationship between vendor and purchaser, the World Customs Organization (WCO) has sought for many years to reconcile differences between transfer prices for tax purposes and customs values for import appraisal purposes.
Concerns centered around the differences between the price of imported goods considered deductible as a cost of goods sold for tax purposes and the transaction value based on that price but adjusted to derive the customs value for import appraisal purposes. Generally, transfer pricing studies rely on OECD tax principles; economists apply these principles with a focus on income tax outcomes. Because of these differences, transfer pricing studies are not sufficiently granular, and fail to take into account the periodic (tax) versus transactional (customs) nature of the required analyses.
Customs legislation requires that the importer appraising its imports purchased in related party transaction be positioned to demonstrate that prices paid or payable are not influenced by the relationship if it chooses to appraise its imports based on the transaction value methodology, failing which an alternative method of appraisal must be undertaken. It offers two alternative tests that may be used to establish the lack of influence:
- demonstrating that the declared value closely approximates one of four test values; or
- demonstrating that the vendor and purchaser settled the transaction price as if they had been dealing at arm's length, the so called "circumstances surrounding the sale" test.
The WCO Technical Committee on Customs Valuation recently published a commentary on the use of transfer pricing documentation in the form of case study 14.1, which remains subject to approval by the WCO Council. The document describes the use of a transfer pricing study, based on the Transactional Net Margin Method (TNMM), to meet the second test and concludes that the circumstances of sale test may be satisfied by reference to a transfer pricing study. However, the impact of the case study on domestic customs authorities is likely to be much reduced by the carefully crafted, restricted facts scenario, and the caution that use of transfer pricing studies must be considered on a case by case basis.
The case study relies on a number of facts that undermine its utility, key amongst which are:
- The transfer pricing study is prepared by an independent firm;
- The transfer pricing study is based on the TNMM;
- 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;
- The transfer pricing study is a key component of an Advance Pricing Agreement (APA) reached by the tax authorities and the exporter and importer;
- No adjustment of the price paid or payable is required to determine the customs value, implying that the price paid or payable is inclusive of all dutiable costs and does not include any non-dutiable costs;
- The importer does not make any compensating adjustments for tax purposes in respect of the year covered by the transfer pricing study;
- The price paid or payable, the basis of import appraisal, does not undergo significant changes over the course of the year under review;
- All operating expenses incurred by the importer are paid to unrelated parties;
- It is not possible to establish a lack of influence by reference to the test value method.
Customs authorities have been left with many ways to distinguish the facts, and therefore the conclusions reached, of the case study. Dismissal of the ability to rely on a transfer pricing study to establish a lack of influence should not flow from a failure to find comparability of (i) the facts of a dispute relating to influence on the transaction value with (ii) the listed undermining facts of the case study, whether the latter are taken alone or cumulatively.
Preparation of transfer pricing reports by independent firms is commonplace, but not necessary. The taxpayer/importer/exporter may be sufficiently resourced to produce its own transfer pricing reports based on OECD principles and sufficiently astute to make allowances as required to ensure that the study is useful for import appraisal. Tax and customs authorities should not presume that the transfer pricing study is flawed, intentionally or not, because it has been prepared by the taxpayer/importer/exporter.
Is the TNMM the only OECD principled means of conducting a transfer pricing study that is useful for customs purposes?
Why must the transfer pricing study be sanctioned by a tax authority in order that a customs authority may rely upon it? Why must the transfer price be the subject of an APA? Must we presume that the customs authority has no independent means of establishing its utility for import appraisal purposes?
How do adjustments for tax or customs purposes deny the ability to rely on the transfer pricing study? And why must not the importer's operating expenses be incurred to related parties? Can these elements not be accommodated in the analysis?
The temporal distinctions drawn for tax and customs purposes are the basis of the condition that there be no significant changes in the prices paid or payable during the course of the year under transfer pricing study. However, the concern raised may be eliminated by further development of the scope of the transfer pricing study.
Finally why, as implied, must the circumstances of sale test take a back seat to the test value method?
While the WCO Technical Committee has taken an important step in the harmonized use of transfer pricing studies for tax and customs purposes, it will be well worth watching to see whether its recommendations result in significant global use with positive results, or in general dismissal based on tax/customs distinctions or the over-conditioned facts of the case study. Some countries, such as Canada, already permit importers to make wide use of transfer pricing studies to demonstrate a lack of influence by the relationship on prices paid or payable in the transaction value, and do not require that each of the fact boxes of this case study be checked.
The case study also serves as a reminder of the importance of developing and maintaining contemporaneous documentation for tax and customs transfer pricing purposes. However, this documentation is not limited to transfer pricing reports. It includes written agreements binding the transfer pricing parties in respect of the sale/supply of goods, services and intellectual property rights with reference to the transfer pricing report and related principles. These are best drafted by experienced lawyers in order to ensure they are legally robust and properly cross referenced. Tax and customs planning advice relating to the structuring and documenting of international transactions benefits from solicitor-client privilege that exists only when taxpayers/importers work with lawyers.
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