Customs valuation and transfer

pricing

September 2015

Topics

1. What is the issue

2. Key differences between customs and income tax

3. Approaches to managing the issue

4. The impact of transfer pricing adjustments

5. The risks of doing nothing

6. Issues for Customs Brokers

Customs and TP – What is the issue

1

“Customs and Border

Protection’s valuation

methodologies are not

analogous to the Berry Ratio or

OECD methodologies”

What is transfer pricing?

• Up to 60% of world trade occurs between related parties

• Transfer pricing simply refers to the determination of transfer

prices for transactions between related parties.

• Transfer pricing is not itself illegal – what is illegal or abusive is

transfer mispricing, also known as transfer pricing manipulation

or abusive transfer pricing

• Transfer prices should be arm’s length and not designed to

minimise tax

• Transfer price generally based on a comparison of conditions in a

controlled transaction to comparable transactions between

independent parties

Transfer pricing methods

• Comparable uncontrolled price method (identical/similar)

• Resale price method (Deductive)

• Cost plus method (computed)

• Transactional net margin method (no customs equivalent)

• Transactional profit split method (no customs equivalent)

The Customs Equation … where does TP fit?

VALUE x RATE = DUTY

additions /

deductions

which

sale

Valuation

method

related

parties

dumping Inward

processing

duty drawback classification other

concessions

Refund

free trade

agreements

What is the issue

Transfer pricing Customs valuation

Starting point OECD WTO/GATT

What is taxed Annual net taxable income Individual import

transaction values

How to they do that Annual tax return Import by import

Arm’s length price Assessed over the year –

can net off profits and losses

Each import must have

cost plus profit – no netting

How is it tested Entity comparables Product by product test

values

Test to be applied Most appropriate Hierarchy to be followed

Import country concern High prices reduces income

tax

Low prices reduces

customs duty

Comparison of valuation methods

• Customs must be applied in a hierarchical order – You cannot

chose the most appropriate as is the case with transfer pricing

• Most common method for transfer pricing is TNMM – profits

based

• There is no transfer pricing method that is similar to the

transaction value method

• Identical goods/Similar goods - similar to CUP

• Deductive – similar to resale minus

• Computed – similar to cost plus

Widening the gap

• ATO can now make adjustments without reference to the

underlying transaction

• Adjustments can go back to 2004 - Customs refunds can only go

back 4 years – double taxation

• Customs/ATO/Treasury working group to address differences

• Tax only adjustments

• WCO :

“It has been recognised that at this stage any alignment or

merger of tax and customs methodologies is not a realistic

proposition given the particulars of the existing legal frameworks

upon which they are based.”

Points of alignment – WCO report

• Use of transfer pricing studies by Customs auditors as a source

of useful information

• Circumstances surrounding the sale:

– how the buyer and seller arrange their commercial relations

– the way in which the price was arrived at

– that the price covers all costs plus a representative profit

“…information derived from the importer’s profit can potentially

give Customs assurance that the exporter/seller’s profit is

acceptable, which in turn may confirm that the price of the

imported goods is adequate…”

Points of alignment – WCO report (cont.)

• Adjustments:

– an adjusted price may be closer to arm’s length

– a tax only adjustment may show the price has been influenced

– no strong WCO direction that the adjusted price should be

used

– If an adjustment is to be considered: » Transfer pricing policy should be in place prior to importation

» Should set out the criteria to be applied to determine the final customs

value

» Customs may require the existence of the policy be reported in advance

of the ruling

– Australia, Canada, UK and US given as examples of how

adjustments handled

Approaches by importers to managing the issue

2

Options

Align the

customs

value with the

transfer value

Divorce the

customs value

from the

transfer value

Do nothing

1

3

2

Aligning the values

• Argue that with a TP adjustment individual transactions are arm’s length

• If using TNMM need to align domestic profit with arm’s length value of

imports

• TP adjustments to the price paid for goods will alter the customs value

which may alter duty payable

• Lump sum adjustments will need to be allocated to individual imports

• Will pay additional duty for increasing adjustments but hard to claim

refunds for decreasing adjustments

Separating the values

• Invoice price is operationally the easiest figure to use for customs

clearance

• However, using computed or deductive value will divorce the

transfer price from the customs value

• Will provide customs predictability – no post import adjustment

• Remove annual compliance cost

• Could produce an overall lower customs value

• Is it inconsistent to use different TP and customs values?

Case study

Facts

• Cost of making goods is $66,000. Parent company makes super profits

(say 50%) due to valuable IP. Initial price of goods is $100,000. May

be adjusted based on profit of the distributor.

Under transaction value

• Value of goods is $100,000 and duty is $5,000 (subject to TP

adjustment)

Under computed

• Customs value is based on cost of production and the usual profit (say

20%). Customs value is $80,000 and duty is $4,000.

Obtaining a customs TP ruling

Customs will provide a ruling allowing a particular valuation method

• Ruling will be binding for 5 years

• Where customs value is linked to TP, adjustment to the customs value

will be permitted within an agreed range

• Best chance of obtaining a refund if a downward adjustment

• Necessary if you wish to use an alternative valuation method

• Can be obtained in 2-3 months

Managing a restrospective adjustment

• Change in customs value may result in the original customs value being

incorrect

• If not disclosed, there will be a breach of the Customs Act

• Voluntary disclosure

• Pay underpaid duty

• Use spread sheet approach to make pro-rata adjustment

• Refunds applications must be made import by import

• Best if accompanied, or preceded, by a ruling

• GST

Do nothing

• Potential false statements:

– that parties are not related

– correct valuation method

– correct customs value

– correct duty payable

• Strict liability offences:

– 100% of the underpaid duty

– $8,100 per false statement

• Customs may reject transaction value – Significant operational impact

• Relationship damage – Trusted Trader

• True up in future periods – one period will be under valued, the other

period over valued

• Period of exposure - Penalties (5 years) Duty (4 years)

Issues for brokers

3

Questions for brokers

• First question – are there related party transactions:

– need to know for the related party indicator question

– Often see supplier nominated as unrelated where it has the same

name

• Second question – If related, on what basis are you formed the belief

that the relationship has not influenced the price

– Do you know the transfer pricing policy

• Third questions – If relationship has influenced the price, how should

value be determined

– if not using transaction value you should obtain a ruling

• Fourth questions –are post importation adjustments made

– what impact do these adjustments have on the customs value

Assess risk

High risk

• Adjustment to cost of goods

• Correcting past periods by

adjusting future periods

• Goods attracting duty

• Royalty adjustment

• R&D adjustment

• Transfer pricing policy is non-

existent or ad-hoc

• No ATO ruling

Low risk

• Tax only adjustments

• Finance or market support

adjustments

• Duty free goods

What to do now

• Assess which entities are likely to have related party transactions

• Make them aware of the customs issues associated with TP – the tax or

finance team needs to know

• Consider TP from a compliance perspective

• Consider historic exposure

• Consider TP as an opportunity to reduce duty in the future

Questions

25

CONTACT Russell Wiese

T: 03 8602 9231

E: rwiese@hunthunt.com.au

Lynne Grant

T: 03 8602 9246

E: lgrant@hunthunt.com.au