Customs valuation vs transfer pricing rules Part 1
by Atty. Mark Anthony Tamayo
(First of two parts)
Corporate taxpayers who source imported goods from related foreign suppliers should ensure that they do not only comply with transfer pricing (TP) rules but also with the rules pertaining to the valuation of imported goods for customs purposes.
Both TP and customs valuation rules essentially require that an “arm’s length” or “fair” value (i.e., transfer price between the parties must not be influenced by the relationship or it must be set in the same way as if the parties were not related) be set for cross-border transactions between related parties and associated enterprises.
For customs purposes, the primary method of valuation under Section 701 of the Customs Modernization and Tariff Act (CMTA) is the transaction value (TV) of the imported goods (Method 1), which is basically defined as the “price actually paid or payable” for the goods when sold for export to the Philippines with certain dutiable adjustments.
One of the conditions on the applicability of Method 1 is that the buyer and the seller must not be related, or if related, such relationship did not influence the price of the goods. Under the CMTA, the parties are deemed related if, among others, they are legally recognized partners in business; one directly or indirectly owns, controls or holds 5% or more of the outstanding voting stock of the other; one of them directly or indirectly controls the other; and both of them are directly or indirectly controlled by a third person.
The fact that the buyer and seller are related, though, does not by itself make the TV unacceptable. The existence of a relationship, however, serves to alert the Bureau of Customs (BOC) to the fact that there may be a need to inquire as to the circumstances surrounding the sale. Each import transaction is assessed independently.
Assuming the issue (that the price has been influenced by the relationship) is raised by the BOC, the importer can establish arm’s length by demonstrating that an examination of the “circumstances of sale” indicates the relationship did not influence the price actually paid or payable or the transaction value of the imported articles approximates certain “test values”. If the importer fails to refute the allegation, the BOC may proceed to determine the customs value by applying, in sequential order, alternative methods of valuation i.e., Method 2 – TV of identical goods, Method 3 – TV of similar goods, Method 4 – Deductive value, Method 5 – Computed Value, Method 6 – Fallback Method.
The TP rules are embodied in Bureau of Internal Revenue (BIR) Revenue Regulations (RR) 2-2013. It essentially follows Organization for Economic Cooperation and Development (OECD) guidelines that adhere to the internationally accepted “arm’s length” principle, which requires a comparison of the conditions of a taxpayer’s-controlled transaction with conditions of comparable uncontrolled transactions. RR 2-2013 also adopts OECD pricing methodologies that include the Comparable Uncontrolled Price Method, Resale Price Method, Cost Plus Method, Profit Split Method and the Transactional Net Margin Method.
The TP methodologies used to evaluate intercompany transactions are selected according to the “most appropriate method or best method” rule, which is the method that provides the most reliable measure of an arm’s length result (of a controlled transaction) under the facts and circumstances. Unlike in the customs valuation rules, there is no strict priority of methods and no method will invariably be considered more reliable than others. Furthermore, a taxpayer can aggregate all imported products from a related party (or parties) for purposes of illustrating arm’s length treatment under the best method rule.
For tax purposes, TP determines the income that each related party earns and the amount of income tax that is payable in both the country of export and the country of import. A higher transfer price may result in lower taxable income in the importing country and higher taxable income in the country of export. Conversely, a lower transfer price may lead to a reverse situation.
For customs purposes, the transfer price has a direct bearing on the determination of customs value. The higher the price of imported goods, the higher the customs value and applicable customs duties and VAT on importation, while a lower price results in lower customs duties and VAT payable.
The gap, therefore, between TP and customs valuation rules may present a concern for multinational companies as both the BIR and BOC have the authority to challenge prices relating to cross border transactions between related parties. It is necessary, therefore, that companies address and comply with both TP and customs rules. It is inevitable that any TP planning should always include customs valuation planning or vice- versa.
Noncompliance with both rules may result in a significant risk of penalties.
Thus, in an import transaction between related parties, the BIR may, as a matter of procedure, verify (during audit) whether the import value (of an inventory, for instance) declared was overvalued resulting in an over declaration of deduction for income tax purposes.
The BOC, meanwhile, is mandated under its rules to check, either at the border (before imported goods are released from customs custody) or during post clearance audit whether the value declared for purposes of customs appraisement was undervalued, resulting in short payment of customs duties and VAT on importation.
In next week’s article, the author will discuss the ways to establish the acceptability of the transaction value of the imported goods.
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Mark Anthony P. Tamayo is a CPA-lawyer and a partner at Mata-Perez, Tamayo & Francisco Law offices (MTF Law). 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, email the author at info@mtfcounsel.com or visit the MTF website at www.mtfcounsel.com.
From the The Manila Times Website March 10, 2018