This Customs and International Trade Alert is the second in a series examining developments pertaining to the traditional role of U.S. Customs and Border Protection ("CBP") in managing imports, namely determining the classification, value, and country of origin of those imports. With respect to valuation, two specific issues have been the focus of considerable attention at CBP: "First Sale" valuation and related party pricing. "First Sale" valuation, which is the subject of recent CBP proposals and legislative directives, was discussed in our Customs and International Trade Alert, "When it Comes to Imports, Companies Must Remember the Basics: Valuation, Classification, and Country of Origin." Related party pricing, a matter of some enduring concern, is discussed here.
Transaction Value and Related Parties: Transaction value, briefly "the price paid or payable for ... merchandise when sold for exportation to the United States," remains the most common form of valuation for customs purposes. When an import transaction is between related parties, CBP commonly performs a "circumstances of sale" test to ensure that the price was not influenced by the relationship between buyer and seller. In administering this test, CBP has developed several criteria, any one of which may be used to demonstrate that the relationship did not influence the price. The test most frequently used is whether the price is adequate to ensure recovery of all costs plus a profit that is equivalent to the firm's overall profit in sales of the same type of merchandise. While CBP is not proposing to change these criteria, a recent Informed Compliance Publication, Determining The Acceptability of Transaction Value for Related Party Transactions (April 2007), may foretell an increase in agency enforcement efforts, and a greater risk of examination of importer records.
This area of customs valuation presents particular pitfalls for the unwary, even the most sophisticated multinational operations. Particularly problematic are transfer pricing studies, undertaken by multinational companies to satisfy IRS requirements that transfer prices reflect arm's length values, and Advance Pricing Agreements ("APAs"), adopted to ensure that a company's transfer pricing methodology results in sufficient profit in the U.S. entity to avoid domestic tax compliance issues.
The concern with transfer pricing studies and APAs is that, when accepted by IRS, they may be viewed by the importer as assurance that its transfer prices are also satisfactory to CBP. This is not necessarily the case. Because the IRS is concerned with a firm's overall profitability, its focus is much broader than CBP's. Thus, a transfer pricing study or APA that is adequate for IRS purposes may not be acceptable to support a transaction value for a given import entry. Transaction values must be evaluated on a product-by-product basis for individual shipments.
Moreover, since the IRS is concerned with enhancing revenue by expanding the tax base, that agency's interests are biased toward lower transfer prices on imports, thereby creating more taxable profit when the import is resold in the U.S. CBP, on the other hand, is concerned with protecting the revenue by preventing understatement of import values against which duties will be assessed. Thus, CBP's interests are biased toward higher transfer prices on imports.
Indeed, CBP makes clear in its Informed Compliance Publication that there is no reason to expect that the arm's length pricing methodology in an IRS APA will necessarily satisfy CBP. The underlying facts reflected in an APA or transfer pricing study may or may not be relevant to the acceptability tests applicable to transaction value. A bilateral APA (which establishes arm's length pricing acceptable to both the IRS and the taxing authority of the foreign country in which the importer's related party is located) may be more likely to support acceptable customs values, but even with a bilateral APA, it remains the importer's burden to demonstrate that the APA supports one of the specific tests for acceptability of transaction value. Ultimately, the importer must have sufficient information available to demonstrate to CBP how the transfer prices meet the particular test relied upon. An importer who, in declaring customs value, relies on evidence of arm's length pricing developed for tax purposes, but fails to confirm that it independently satisfies CBP requirements, does so at his or her peril. Thus, importers engaged in related party transactions should review carefully the adequacy of their data supporting transfer prices as transaction values for import entries.
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