Transfer pricing and customs duty; are they two sides of the same coin?
Transfer pricing and customs duty constitute integral components within the expansive world of international taxation. Whereas transfer pricing assesses the prices for goods and services issued between related entities, revenue authorities around the world are keen on ensuring that prices established between related parties adhere to the arm's length principle and do not significantly deviate from prices charged between unrelated parties.
On the other hand, customs, assesses the prices of goods charged in a transaction to ascertain customs value for duty determination purposes. Custom officials will ordinarily scrutinize the import and export transactions between two distinct and legally separate entities of a multinational group to evaluate whether the value declared on imported goods was ‘influenced’ by the relationship between the entities. The customs duty division of the revenue authority on the other hand is committed to ensuring that the customs value encompasses all relevant elements and is accurately represented without any understatement. All this is done to ensure there are no profits shift and that related entities are taxed appropriately.
An intriguing perspective to consider is that the transfer price for goods imported between related parties serves as the foundation for applying custom duties. Therefore, transfer pricing not only influences the valuation of goods from the custom duty standpoint but also establishes a close and interconnected relationship between transfer pricing and customs duty.
This link evidently influences the manner with which revenue authorities conduct audits on taxpayers under either part of taxation. Under transfer pricing, transactions are reviewed to ensure that the prices are set as though parties are unrelated (that is at arm’s length) whilst customs duty reviews are concerned on whether the valuation of goods traded between related parties is done accurately, ensuring that the relationship between the parties does not influence determination of prices and subsequently the customs value. In essence, both parties are focused on the same outcome which enables related parties to transact with each other using prices that reflect the market conditions, without variations due to their existing relationship.
Therefore, taxpayers should be conscious of revenue authorities’ areas of focus during price reviews whether under transfer pricing or customs duty context for related entities. A transfer pricing audit of a typical import transaction between related parts, tests the application of the arm’s length principle and is conducted to ensure that unnecessary cost elements are not included in the transfer price, as this could lead to overpricing. The objective is to secure the most favourable market price, minimizing the outflow of income through payments made by the purchasing taxpayer. This strategy aims to facilitate robust taxable profits within the country.
On the other hand, when revenue authorities conduct post clearance audit in the customs duty context, the value of goods imported from related parties are reviewed to test whether the relationship between the parties influenced the market offering resulting to below the market prices. The objective is to ensure all relevant cost elements are included in the custom value without any understatement. The resultant consequence is that the customs value represents the highest market offering for the imported goods, consequently influencing the customs duty to be collected by the revenue authority.
Whilst it is evident in both reviews that revenue authorities tests whether the relationship between related parties influenced prices, the underlying motives in both reviews stand in contrast to each other. These differences give rise to competing tensions and goal incongruence that could negatively affect total tax liability outcomes for taxpayers. The inevitable question is “what actions should businesses take to stay abreast?”
In my view, businesses must understand the interdependencies of transfer-pricing and customs value rules, to achieve positive outcomes during audits by revenue authorities. Leveraging on a multidisciplinary approach to assess transfer-pricing models alongside custom duty rules is paramount. This ensures policies and contracts are evaluated in a manner that is complimentary and compliance in transfer pricing and customs duty contexts.
Lastly, one of the areas that amazingly demonstrates that transfer pricing and customs duty are two sides of the same coin is that the transfer pricing documentation is used as crucial evidence transfer pricing audit, and a post clearance audit. Hence, it is of paramount that contemporaneous transfer pricing documentations are prepared and maintained by taxpayers. This enables a taxpayer to demonstrate adherence to the arm’s length principle under transfer pricing perspective and at the same time prove that the customs value was not influenced by the relationship between the entities, during a post clearance audit.
Cecilia Otaru (cotaru@kpmg.co.tz), is a Tax Manager at KPMG in Tanzania.
The views expressed here are the author’s and do not necessarily represent the views and opinions of KPMG.
