Even as public health symptoms of COVID-19 are beginning to recede, the effects of the global pandemic on international trade remain prevalent. Transfer pricing is one area of concern which dates back to the Trump administration’s tariff policies. As operations slowly return to normal and multinational companies see imports rising to pre-pandemic levels, they should remain vigilant about supply chain impacts.
Challenges Under a New Administration
On May 17 a joint United States-European Union Statement on addressing Global Steel Access Capacity was released. They agreed that the U.S. and EU member states share similar interests in protecting national security and market economies, and can partner to hold countries like China that support trade-distorting policies to account. The Office of the United States Trade Representative released the testimony of Ambassador Katherine Tai entitled “The President’s 2021 Trade Policy Agenda”. The comments released indicate that the President’s focus included environmental protection and incentives to fight against climate change, promoting a goal of racial equity, and enforcing global trade standards. While the Biden administration has been under pressure to repeal many of its predecessor’s policies, administration has kept 25% tariffs on imports from China, and also reversed course on aluminum imports from the United Arab Emirates. After repealing them in January, they were set back to 10% in February. Likewise, China and other trading partners have not wavered on their penal tariffs.
Washington, D.C. insiders have noted that the President is not rushing to engage on the issue and is waiting for the United States economy to recover first. As the pandemic recedes, companies should follow the progress diligently, and prepare themselves for the economic ramifications that will likely come when President Biden addresses the issue of trade.
The Effects of a Volatile Economy
The resistance to address trade-related challenges also means that old challenges remain; perhaps most notably the clashing incentives of U.S. Customs and Border Patrol (customs) and the IRS when it comes to transfer prices. When importing goods and merchandise, customs values the goods using the transaction value method, or the price actually paid when the goods were sold, plus other costs, including commission, royalties, transportation, and proceeds.
The IRS, in contrast, applies a transfer pricing framework, which uses the “arms-length” and “best method” standards, allowing importers to choose the framework for valuing imported assets. The most common is the comparable profits method, which holds transactions between related buyers and sellers up against unrelated parties and assesses the differences.
As auditors from both agencies sift through imports and year-end tax burdens to ensure compliance, it is important to be aware of the IRS’ field audit guidance for transfer pricing, which will offer clues on issues that may arise during the audit process. For example, auditors that are working under approved Large Business and International (LB&I) campaigns may be required to issue a Mandatory Transfer Pricing request for documentation while other types of examinations may not result in a request for transfer pricing documentation unless there is a risk assessment concern.
Managing Audit Risk
With the global economy in recovery mode, companies must plan and document the repercussions of the trade environment on transfer pricing. Auditors take note of price changes in either direction or their effects on operating margins. To minimize associated burdens, companies should be prepared to explain the changes via historic and forecasting documents that show they were the result of broad changes in the supply chain and trading environment.
Preparing for Change
Biden’s “Made in America Tax Plan” calls for increases on taxes for multinationals. While we don’t have a crystal ball to tell us exactly what the future holds, understanding current transfer pricing policies will put businesses in a position to make decisions quicker as changes unfold. Knowing that the pandemic has forced significant commercial changes in import and export pricing, companies that reassess price modeling have a strong likelihood of finding efficiencies in both customs and income tax. Some companies have benefited from using some of the following strategies:
- Revisiting Harmonized (Classification) Codes for imported merchandise
- Reviewing intercompany pricing goods and royalty policies for transfer pricing purposes
- Revisiting intercompany pricing agreements from a customs perspective
- Assessing whether the customs dutiable value of the merchandise is overstated based upon
customs principles - Assessing a company’s cross-border service charge policy
Next Steps
Moving forward, companies should examine supply chain efficiencies and transfer pricing models through the lens of the pandemic and the broader changes it is likely to have on international trade. After seeing global supply chains collapse in March of last year, industries are placing significant capital in diversification and reshoring of suppliers, a trend that hopes to mitigate the likelihood of another supply chain failure. As trade inevitably continues the shifts that come with recovery from a major economic downturn, taking a hard look at the customs and income tax methodologies behind transfer pricing has the potential to offer significant savings.
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