New Tariffs Increase Costs on Imported Goods—Can Transfer Pricing Changes Help?
The Trump Administration’s most recent tariff policies threaten to disrupt decades of trade liberalization benefiting companies of all sizes. To counteract the changes major trading partners have retaliated with increased duty rates on US exports in targeted sectors, representing hundreds of billions of dollars in trade.
Although trade deficits, unfair trading practices, and national security considerations have all been referenced as a rationale for higher duties, many companies fear substantial cost increases in well-planned supply chains. At the same time, multinationals also need to manage transfer pricing tax audit risk in the US and elsewhere.
Some Observations for Balancing Customs and Transfer Pricing
Multinational companies importing and exporting dutiable goods face a dilemma when managing cross-border pricing. Companies importing dutiable goods normally pay higher duties when transfer prices are increased, all things being equal. Conversely, higher purchase prices often lead to lower taxes payable in the importing country. In practice, US Customs and Border Patrol (customs) and the IRS, along with other tax authorities, have clashing incentives when assessing the transfer prices of goods.
Unfortunately, tax authorities and customs may not have a consistent auditing valuation practices for goods, and companies can be whipsawed in the process. In other words, a customs audit could result in an increase in dutiable value, while a transfer pricing auditor would lower inter-company Cost of Goods Sold (COGS) to reach a higher taxable income result. Here’s a look at why:
- Under US Customs Regulations, the preferred method for valuing imported merchandise is “the price actually paid or payable for merchandise” with four other methods applied in sequential order
- US transfer pricing rules reference the “Arm’s-length standard” and the “Best Method”
- Customs auditors normally review intercompany prices on a transaction-by-transaction basis
- Transfer pricing auditors often assess annual profit margins when testing transfer pricing (Comparable Profits Method, Transactional Net Margin Method)
- A customs auditor is not obligated to accept a transfer pricing study as valid proof of acceptable
In the US, taxpayers may not use an inventory cost that is higher than the cost charged for customs purposes under §1059A.
Why not lower the customs dutiable value and charge higher royalties?
One seemingly straightforward answer to the question of lowering the customs dutiable value would be to reduce the dutiable value of imported goods while increasing royalties or charging higher service fees. For example, a company could lower inter-company goods prices by $1 million to capture duty savings, while reducing taxable income through a higher royalty payment of $1 million. However, US Customs Regulations do require importers to include the cost of royalties or license fees that are a condition of a sale when calculating the dutiable value, among other specified costs.
In other words, the legal form of a royalty transaction and inter-company pricing policies in place may be an important consideration when calculating dutiable values. For instance, a customs ruling issued in 2014 (HQ H242894) established that the amounts paid by an automotive importer to be the exclusive distributor of branded automobile parts in the US market are excluded from the dutiable value of imported goods. Keep in mind that customs rulings are subject to change and can be highly facts-and-circumstances driven.
Are There Opportunities to Save?
While companies are cringing with trade war fears, multinationals should revisit the form, valuation approach and the results of inter-company transactions from both a customs and income tax perspective. Increasing customs duty rates have driven the need for more sophisticated transfer pricing and customs planning. Some companies have benefited from:
- 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
- Assessing a company’s cross-border service charge policy
Uncertainties over trade policies have the potential to wreak havoc on the global economy, and multinational companies face significant disruptions in their well-established supply chains. Since customs has not necessarily been at the top of the agenda while duty rates have fallen globally, revisiting both customs and transfer pricing strategies could lead to tangible savings for companies adapting to new cost structures.
For more information on these and other transfer pricing topics, contact Clayton & McKervey.
¹ Clayton & McKervey does not offer Customs consulting services, and readers should consult with experienced Customs practitioners before implementing Customs planning strategies.