(Last of two parts)
In last week’s article, we discussed briefly the link between transfer pricing (TP) and the customs valuation rules and the possible customs and tax implications of related party transactions.
One of the conditions on the acceptability of a declared value (particularly Method 1 or the Transaction Value of imported goods) for purposes of customs appraisement is that the buyer and the seller must not be related, or if related, such relationship did not influence the price of the goods. The Bureau of Customs (BOC) initially determines whether special treatment arising from a relationship influenced the “price actually paid or payable.” Once the issue is raised, the burden of proving otherwise lies with the importer.
The evidence of an arm’s length is established when the importer can demonstrate that transaction meets either the “circumstances of sale test” or the “test value method.” The ‘test value method” may be based upon previously accepted TV of identical goods, deductive value, or computed value. In practice, however, “test values” are, in most instances, not available. Consequently, the “circumstance of sale” condition is oftentimes resorted to by related party importers to justify their prices.
The circumstances of sale test examines the relevant aspects of a transaction, including the way in which the buyer and seller organize their commercial relations and the way in which the price in question was arrived at, to determine whether the relationship influenced the price. Under this test, the importer may prove, among others, the following: a) the price has been settled in a manner consistent with the “normal pricing practices” of the industry in question, b) the price is settled in a manner “consistent with sales to unrelated party” and c) the price is adequate to ensure recovery of all costs plus a profit.
The question frequently asked is: Will the BOC accept values determined pursuant to a TP study or information and conversely, will the Bureau of Internal Revenue (BIR) do the same and accept values computed in accordance with customs valuation rules?
As discussed in last week’s article, different sets of rules govern TP and customs valuation. Under TP rules, the appropriate TP method is chosen based on the best method rule. On the other hand, the customs valuation methods for imported articles are applied in their hierarchical order.
In an attempt to converge the two rules, the Technical Committee of Customs Valuation (TCCV) of the World Customs Organization issued Commentary 23.1 during its 31st session in October 2010, which essentially provides that business documentation developed for TP purposes may contain useful information for Customs and the use of TP study as a possible basis for examining the circumstances of the sale should be considered on a case by case basis.
Based on this pronouncement, the TCCV, approved new instruments that contained case studies, i.e., Case Study 14.1 during its 42nd (April 2016) session and Case Study 14.2 during its 45 (October 2017) session, in Brussels, on the use of TP documentation in assessing customs values, taking important steps toward better coordination between these two subject areas.
Case Study 14.1 highlights how the OECD-approved Transactional Net Margin Method (TNMM) of TP may be used to support that the related party transfer price was not influenced by the relationship – that the price between the related parties was settled in a manner consistent with the normal pricing practices of the industry.
The case study focused on the specific companies benchmarked in the TP study (using the TNMM). The TP study provided that the operating profit range determined to be at arm’s length is .64 percent to 2.79 percent. As compared to the importer’s operating profit of 2.5 percent, the analysis portion of the case explained that by working backwards from the arm’s length range provided by the TP study, the transaction between the exporter and importer could be deduced to be at arm’s length.
Case Study 14.2, on the other hand, describes a situation where the importer declared the price of imported luxury bags based on the value on the invoice issued by the related party seller. During post clearance audit, the customs authorities challenged the declared price. The importer’s TP policy showed that the import price of all luxury bags was determined using the TP Resale Price Method. At the end of each year, the importer calculated the import price of luxury bags based on the resale price and the targeted gross margin for the next year as recommended by a related party. After the targeted gross margin for a specific year was determined at 40 percent, the importer then calculated the import price of luxury bags to be imported using the Resale Price Method.
In that year, however, the actual sales income of the importer exceeded the estimated income. Its gross margin was 64 percent. The TP report indicated that the arm’s length (inter-quartile) range of gross margins earned by the selected comparable companies was between 35 percent – 46 percent, with a median of 43 percent. In its Conclusion, the TCCV stated that 64 percent gross margin did not fall within the arm’s length inter-quartile range and hence, resolved that the declared import price was not settled in a manner consistent with the normal pricing practices of the industry.
Based on the above, a TP study may seemingly be considered a source of information to prove the acceptability of the declared value of imported goods by importers. Though this guidance is not legally binding in domestic law, it is nonetheless persuasive and authoritative. In many jurisdictions, customs authorities cite these declarations.
TP is a major concern to business entities dealing with related companies. Aside from the BIR, transfer prices may also be the subject of scrutiny by the BOC. From a business perspective, the approval of the above instruments by the TCCV is an important development. It provides the opportunity to consider how TP documentation can be designed appropriately for customs purposes. The convergence and harmonization of TP and customs valuation rules will surely benefit companies on their related party transactions.
Mark Anthony P. Tamayo is a CPA-Lawyer and a Partner of Mata-Perez, Tamayo & Francisco Law offices (MTF Law). He is also a law professor and recognized professional lecturer. This article is for general information only and is not a substitute for professional advice where the facts and circumstances warrant. If you have any question or comment regarding this article, you may email the author at email@example.com or visit MTF website at www.mtfcounsel.com.