The intertwined challenge: Customs Valuation & Transfer Pricing
The core tension lies in the differing objectives of tax and customs authorities. Tax authorities generally aim to ensure profits are appropriately allocated across jurisdictions, often encouraging higher intercompany prices for imported goods to minimise profit shifting. Conversely, customs authorities seek to maximise dutiable value to collect higher tariffs, often scrutinising low declared values. This creates a tightrope walk for multinational companies to manage.
- The collision course: Tariffs fundamentally alter market prices, impacting traditional transfer pricing methods. This can lead to the “paradox” of paying duties on inflated values while reporting lower values for income tax purposes, creating a risk of double taxation or regulatory challenges from both sides.
- Differing cost inclusions: Transfer pricing and customs valuation often involve different cost elements. For instance, intercompany management services might be included in the transfer price but not be dutiable for customs. Understanding these nuances is crucial to avoid overpaying and to compliantly manage declared values.
- The arm's length principle: Both customs and tax authorities require that related-party transactions adhere to the arm’s length principle - meaning prices should be comparable to those charged between unrelated parties. However, how this is demonstrated and accepted can vary. A transfer pricing study alone may not suffice for customs; additional, customs-specific analysis is often required.
- Profit margin depression: Substantial tariffs can significantly depress the profit margins of US importing subsidiaries. This can lead to non-compliance with existing transfer pricing policies, necessitating the renegotiation of intercompany prices and a re-evaluation of risk allocation.
- The timing of adjustments: While retrospective transfer pricing adjustments are permissible for tax purposes, their impact on customs value can be problematic. Customs authorities often prefer that the dutiable value be objectively ascertainable at the time of importation. This highlights the need for proactive, in-year adjustments to transfer pricing policies.
- The 1059A conundrum: US IRC Section 1059A limits the inventory cost for income tax purposes to the customs value, creating a direct link. Companies aiming for low customs values to reduce duties must be mindful of the impact on their cost of goods sold for income tax purposes.
Strategic planning opportunities for lowering US import duties
Beyond merely reacting to tariff changes, multinational companies can proactively implement strategies that align customs and transfer pricing objectives for duty mitigation.
1. Leveraging "first sale for export" opportunities
This powerful but often underutilised provision allows US importers, under specific conditions, to declare the price paid in an earlier sale in a multi-tiered transaction as the dutiable value, rather than the final price paid by the US importer.
- How it works: If a manufacturer sells to a trading company (the "first sale"), and that trading company then sells to the US importer, duties can potentially be based on the lower price of the first sale rather than the higher price of the second sale.
- Key requirements: To qualify, the first sale must be bona fide, conducted at arm's length, and the goods must be clearly destined for the US at the time of the first sale. This requires robust documentation, including contracts, invoices, and proof of title transfer.
- Transfer Pricing link: For related-party transactions, substantiating the arm's length nature of the first sale price often relies on thorough transfer pricing studies and market benchmarking. The analysis underpinning both customs and transfer pricing must be aligned and consistent.
2. Unbundling costs
Many multinational companies bundle product prices with payments for royalties, intellectual property, and services. By meticulously unbundling these elements, companies can often remove non-dutiable components from the customs value, thereby reducing the dutiable base.
- What to unbundle: Common examples include international freight and insurance costs incurred after the goods leave the country of export, certain selling commissions, interest charges, advertising, marketing, and general management fees that are not directly related to the imported goods.
- Strategic advantage: This allows for more precise allocation of value across different transaction components, potentially reducing the impact of tariffs on certain elements while maintaining compliance with both tax and customs regulations. Careful documentation is vital to justify any exclusions.
What action should multinational companies take to mitigate the impact of tariffs?
The current trade environment demands a proactive and integrated approach to managing intercompany transactions. We urge multinational companies to consider the following actions:
- Conduct a comprehensive supply chain & valuation review: Analyse your existing supply chain, identify all intercompany transactions involving tangible goods destined for the US, and review your current customs valuation methods. This includes a detailed assessment of your product classifications and origin rules.
- Align Transfer Pricing and Customs Valuation policies: Ensure your transfer pricing documentation and policies are not only compliant with tax regulations but also support your declared customs values. This requires a collaborative effort between your tax and customs teams to ensure consistency and avoid conflicting positions.
- Explore and document "first sale for export" opportunities: If your supply chain involves multiple related-party sales before importation into the US, assess your eligibility for the first sale rule. Develop robust documentation to substantiate the bona fide nature and arm's length pricing of the first sale.
- Implement cost unbundling strategies: Review your intercompany invoices and agreements to identify non-dutiable costs that may currently be included in your declared customs value. Assess whether there is an opportunity to unbundle these elements, and ensure they are separately identified and justified.
- Review intercompany agreements: Proactively assess whether your existing intercompany agreements adequately address the allocation of tariff costs and allow for necessary pricing adjustments in response to unforeseen trade measures.
- Consider Advance Pricing Arrangements (APAs) or Customs rulings: For material exposures, explore Bilateral Advance Pricing Arrangements (BAPAs) with tax authorities, and consider seeking binding rulings from customs authorities on specific valuation methods. This can provide certainty and mitigate future disputes.
- Prioritise ongoing monitoring and agility: The policy environment remains unpredictable. Continuously monitor changes in tariff regimes, and conduct scenario analysis and modelling to support the refinement of your strategies to ensure ongoing compliance and optimal cost efficiency.
By taking a deliberate, phased approach to strategic change and integrating customs and transfer pricing considerations into every supply chain decision, multinational companies can not only mitigate immediate tariff risks but also build long-term resilience and maintain a competitive edge in a dynamic global trade environment.
