Import compliance specialists have long worried about issues surrounding customs valuation for imported merchandise, especially when it comes to related party transactions within multinational enterprises. The concept of what constitutes an “arm’s length” transaction, and how to prove it, has been the source of much debate between Customs and Border Protection (CBP) and with trade professionals over the years. Customs valuation issues in the context of transfer pricing have become a hot topic as of late, and import compliance personnel need to be aware of the trends and issues they portend.

This article marks the first of a series our customs practice group will present on the emerging issues related to customs valuation and transfer pricing among multinational related parties.  Our articles will be centered on US practice, but from many of these lessons are equally applicable abroad given the overall similarities in approach by tax and trade authorities in other jurisdictions, the common framework applied by World Trade Organization (WTO) (i.e., the Agreement on Implementation of Article VII of the GATT dealing with Customs valuation rules), the OECD model Transfer Pricing Guidelines for Multinational Enterprises, and the network of tax treaties around the world. We begin this first article with a review of why transfer pricing has emerged as a more significant customs valuation issue.

Interest in Transfer Pricing Issues is on the Rise

More recently, both CBP and businesses have become more focused on customs valuation issues. A few indicators worthy of note:

  • CBP focused assessment audits (FA) invariably incorporate valuation as a core component of the audit. Large multinational related party importers are prime targets for FAs, and this means transfer pricing issues are front and center.
  • Our practice has seen a marked increase in the number of valuation issues being raised formal information requests (so called CF-28s), and other CBP inquiries.
  • There has been a marked increase in the number ruling and internal advice requests related to valuation issues.
  • In September 2011, CBP surprised the trade bar with a request for advance comment on a proposed rule change that would recognize post–importation adjustments to transfer prices for customs purposes in certain circumstances. It is aimed at related party sales that are priced according to a transfer pricing formula, and where the importer participates in the CBP reconciliation program. This latter proposal is still in gestation, but would mark a major change from past practice.

For many reasons, this added attention to valuation issues should not be surprising. Besides border protection and security, CBP’s main purpose is to collect revenue on imports, and correct “arm’s length” valuation is a core statutory mandate with a long history. In the current budgetary environment, collecting the right amount of revenue is important.

But there are other important drivers. These have driven an uptick in requests for rulings and other guidance, and again, for transfer pricing formulae:

  • Unusual transfer pricing schemes/formulae have proliferated as multinational businesses have developed ever more integrated supply chains and complex business structures.
  • For the sake of consistency, and to satisfy the transfer pricing authorities at the Internal revenue Service (IRS), declared transfer pricing policies and formulae are critical in this environment.
  • As the United States has accelerated its move toward an “information economy,” intellectual property and know how have become critical growth components. Transfer of that knowledge to overseas manufacturing facilities, and the resulting imports back raise novel transfer pricing and “assist” issues.

All Customs Roads Point to Established Transfer Pricing Policies and Formulae

Of course the concept of establishing an accepted transfer pricing method has long been enshrined in the tax law. Internal Revenue Code section 482 prescribes various methods for approximating an “arm’s length” price in related party transactions (e.g., comparable uncontrolled price, resale price, cost plus). These approved pricing methods have spawned an industry for establishing justifiable intercompany pricing policies, often using third part transfer pricing studies, and in many cases entering into an advance pricing agreement with the IRS to validate the method selected. Most multinational companies adopt established transfer pricing policies and formula for tax purposes, and to ensure some level of predictability and support in case the tax auditor comes knocking at the door. Multinationals that do not act with a thorough awareness of these rules or fail to maintain information and documentation to support their transfer prices under IRS standards are treading on very thin ice indeed.

Customs Valuation –The Neglected Child?

Customs valuation issues often arise as part of, or after, the process of setting transfer prices for tax purposes has occurred. As a practical matter, given the relative importance of getting your transfer pricing right from a tax standpoint, the customs element often takes a distant second chair, if factored into the analysis at all. This is a mistake. While no company should set their transfer pricing policies based primarily on customs value considerations, customs valuation is still an important component if, for example, you are importing significant amounts of products every year. Many corporate treasury offices do not realize this and may overlook the customs component of the equation. In fact, most transfer pricing studies commissioned by companies are limited to opining on whether the company’s transfer pricing method should be accepted under the tax rules. They often expressly do not opine on the customs valuation component. Tax and Customs Valuation Can Live in Harmony That is not to say, however, that you need to upend your current tax-oriented transfer pricing policies to cover the customs valuation component. Just as is the case with the IRS and transfer pricing, CBP also craves certainty and predictability in the customs valuation world, and will look to objective criteria/support it can rely on to set a predictable customs valuation. We have seen a trend toward CBP accepting an IRS pricing methodology if the company can demonstrate how it fits within customs rules – and it often can be with a little thought and an understanding of the interplay between the two sets of rules.

The Goal is to Support Transaction Value When Possible

Indeed, CBP has shown a distinct preference for using “transaction value” in related party transactions over all other customs valuation methods wherever possible. Transaction value is based on “the price paid or payable” when sold for export to the United States (plus certain additions like assists, royalties, etc.). In a related party transaction, transaction value works if you meet the circumstance of sales test which requires that the import value cover all costs of the merchandise plus profit. This test is far easier to administer than alternative customs valuation methods (like deductive value and computed value), but CBP needs to find support that a transfer pricing formula predictably meets the cost plus profit test. Note that the September 2011 proposal to allow post-importation adjustments to transfer prices is in part an acknowledgement that CBP would prefer to allow companies to use transaction value with post-entry adjustments over other methods of valuation.

What Does This Mean For Your Company?

So what issues are critical for customs compliance and transfer pricing experts focus in your company:

  1. Be prepared for CBP to scrutinize your customs valuation/transfer pricing policies.
  2. For customs valuation purposes, you must be able to justify your transfer pricing mechanisms using documentation and information that fits the CBP required mold.
  3. CBP wants to keep you in transaction value, so look for ways to accommodate this preference if you can.
  4. CBP is more accepting of transfer pricing formulae as long as they are properly supported, documented, and consistently applied. 
  5. In many cases, existing transfer pricing studies or other support can be gathered to justify the customs valuation box. The keys are to recognize the commonalities and differences in the rules and the drivers for transfer vs. customs valuation, and to draw out those elements that will support the valuation requirements. Certain transfer pricing methods are preferred by CBP (e.g., cost plus), but creative application of tax transfer pricing rules to the CBP rubric is key.

In future installments of this series we will explore in more detail specific issues related to the customs valuation/tax transfer pricing dilemma note above, some unusual situations that can arise in this context, the interplay of customs valuation and unfair trade practices claims (antidumping and countervailing duty), and developments related to the recent post importation adjustment proposal.