Transfer Pricing and Customs Valuations: Finding Peace in a Trade War

At a glance

• The main takeaway: Transfer pricing offers a viable tool for offsetting the impact of increasing tariffs, but only when applied strategically.
• Impact on your business: Using a transfer pricing methodology without considering the interplay with customs valuations could do more harm than good.
• Next steps: Schedule a consultation to discuss your multinational company’s transfer pricing and customs valuations strategies.

The full story:

As the largest global trading nation, the U.S. has imposed various tariff measures in recent years, such as the Section 301 “China” tariffs and the Section 232 “Steel and Aluminum” tariffs, signaling a new era of the trade war. The introduction of these tariffs has placed financial burdens on multinational companies actively involved in global manufacturing and the cross-border movement of their goods. Due to the increased tariff costs, many of these companies have been seeking ways to shift these costs among related parties, typically leveraging transfer pricing-based mechanisms to make these adjustments. However, many companies are unaware of the customs consequences associated with this practice.

As the global trade war intensifies, the close correlation between transfer pricing and customs valuation becomes more apparent – and more impactful to a multinational company’s bottom line. If your company engages in transfer pricing practices to help offset the impact of tariff increases, you’ll want to take note of the potential consequences for your customs valuations.

Understanding Transfer Pricing vs. Customs Value

To understand the relationship between transfer pricing and customs valuations, you must first understand them individually. While both can be deeply complex, with intricacies best left to specialized advisors, they can be boiled down into the following key concepts:

Transfer Pricing

Customs Valuations

• An international tax requirement concerning the pricing of transactions between related business entities. • A “transfer price” = the price charged between related entities for goods, services, financial transactions, and the use of intangibles. • U.S. and global regulations require businesses to use a defined methodology to ensure the transaction complies with the “arm’s length principle,” which ensures an equal and independent transaction even among related parties.

• Imported merchandise must be properly appraised under the relevant customs valuation rules. • The “transaction value” method is the most commonly used (of 6 methods outlined by the World Trade Organization (WTO)). • The transaction value determines the value of imported goods as “the price actually paid or payable for the merchandise when sold for export” and encompasses all payments made by the buyer to the seller as a condition of the sale.

In many ways, transfer pricing and customs valuations are inverse of one another. Consider the difference in scope: transfer pricing focuses on the big picture of a company’s financials, while customs valuation focuses on the value of individual imported products. The relationship between the two also works inversely, as a higher customs value means a lower taxable income and vice versa.

Navigating the Mutual Impact

Understanding the difference between the two helps assess the impact that transfer pricing adjustments may have on customs valuations and the influence that customs valuations may have on transfer pricing methodologies. While anticipating customs valuations and selecting a transfer pricing methodology are both incredibly nuanced topics requiring a careful examination of a business’s individual fact patterns, there are a few key concepts to keep in mind:

1. Upward and downward transfer pricing adjustments influence customs valuations.

U.S. Customs & Border Protection (CBP) enforce the arm’s length principle for transfer pricing adjustments by imposing a “five-factor” test [1] that assesses whether an intercompany transfer pricing formula is objective. All five factors must be satisfied for the post-importation price adjustment to be honored.

Satisfying the five-factor test produces a different result depending on whether a company is making an upward or downward transfer pricing adjustment:

• An upward adjustment of a domestic company’s operating profit or taxable income involves decreasing the cost of goods sold in order to increase income, which, in turn, means decreasing the customs value of the imported goods. In this scenario, the importer may be able to claim duty refunds from the CBP.
• A downward adjustment of a domestic company’s operating profit or taxable income involves increasing the cost of goods sold and, thus, the customs value, which requires reporting and paying additional duties to the CBP on the increased portion.

2. Customs valuations are impacted differently by the different transfer pricing methods.

The CBP always considers the transfer pricing methodology when examining the appropriateness of a transaction value. Many businesses utilize the Comparable Profits Method (CPM), which compares the profitability of the related entity to the profitability of comparable, unrelated companies with similar functions, risks, and assets. However, the CBP prioritizes the similarity of the products being imported when performing valuations, meaning the CPM may have little relevance and is unlikely to aid in the shifting of costs that is often desired through transfer pricing. Additionally, the recently increased tariffs can create disparities in the profitability data of the most recent years compared to earlier years, potentially further weakening the CPM for customs valuation purposes.

Companies impacted by rising tariffs may consider using a different transfer pricing methodology, such as the Comparable Uncontrolled Price (CUP) method, which the CBP has acknowledged as being the most relevant for customs valuation purposes.

3. Royalty and license fee payments require separate consideration.

Additional rules apply to payments considered royalty or licensee fees, as determined by criteria outlined in Title 19 of the U.S. Code, which defines royalties and license fees to include direct or indirect additions to product prices as a condition of the sale to the U.S. If the CBP determines that a portion of the payment price is considered a royalty or license fee, additional duty payments are required.

The bottom line

The examples above are only a few of the factors that transfer pricing and customs and tariffs advisors consider when helping multinational companies navigate the complexities of importing and exporting goods. To ensure your multinational company is taking the best approach, working with a highly skilled and specialized team of advisors is imperative.

Aprio’s Transfer Pricing team works hand-in-hand with its Tariffs and Customs team to develop holistic strategies tailored to each client’s needs. When working with our clients, we often perform customs valuation compliance reviews, unit pricing reviews, and reviews of the reportability of pricing adjustments and the dutiability of payments. We can also assist with administrative filings related to such reviews, and we are knowledgeable in First Sale Rule applications. Both teams also function within an expansive international tax practice available to address any need a multinational company may have. Schedule a consultation with Aprio’s Transfer Pricing or Tariffs and Customs service to learn how we can help you navigate today’s trade wars.

Related Resources/Assets/Aprio.com articles/pages

How to Develop the Right Transfer Pricing Strategy for Your Business

An Overview of Aprio’s Tariffs and Customs Services

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[1] As defined by U.S. Customs and Border Protection Ruling W548314.