Customs Duties and Transfer Pricing

The folks at U.S. Customs recently issued Determining the Acceptability of Transaction Value for Related Party Transactions, which is likely to be seen as another regulatory headache for foreign manufacturers that sell their goods into the U.S. through local distribution affiliates. Here is the key reason why this will be seen as another headache:

Increasingly, importers are asking CBP to rule that a related party transaction value is acceptable under the circumstances of sale test because it meets the arm’s length principle for tax purposes. In some cases, the importer provides evidence that the Internal Revenue Service (IRS) has agreed that the importer’s transfer pricing methodology is the “best method,” as defined in Treasury regulations under IRC section 482, for tax purposes through an Advance Pricing Agreement (APA), or audit. In other cases, the importer provides a transfer pricing study prepared for IRC section 6662 purposes that demonstrates that the transactions are arm’s length under one of the IRS methods … Importers sometimes claim that a related party transaction value is acceptable because it satisfies the Section 482 arm’s length principle as determined using the best transfer pricing method. Sometimes, a copy of an APA or transfer pricing study is submitted along with the claim. In various rulings addressing this issue, CBP has determined that an APA or transfer pricing study by itself is not sufficient to show that a related party transaction value is an acceptable transaction value. CBP has noted that although the broad goal of both the relevant provisions of the customs and the tax law is the same, i.e., to ensure that related party transactions are at arm’s length, there are substantial differences in the legal requirements.

In other words having a reasoned argument that the intercompany pricing is consistent with market pricing (arm’s length) isn’t enough. Now to be fair to Customs, all the IRS cares about is whether the declared price is too high. If the IRS thinks it is too low, then it will not object. But what about the foreign tax authority? If the intercompany pricing is deemed arm’s length by the foreign tax authority, shouldn’t Customs be satisfied?

I was curious how much of our imported goods are considered related party transactions and this source came through. The Census Bureau notes over $1845 billion in imported goods for 2006 with over $982 billion (53.24%) being related party transactions. But then I was wondering how much we collect in customs duties as a percent of imported goods and it turns out to be less than 1.5%. It seems a lot of goods are imported duty free, but some have higher duty rates. Using data from this source, we can graph the customs duty to imported goods ratio from 1929 to 2006. Not surprisingly, this ratio was a lot lower in 2006 than it was during Herbert Hoover’s Administration. Then again – if we eliminated all tariffs, customs would not have to worry about whether intercompany prices were arm’s length. But a few customs attorneys would then have to find alternative ways to make a living.