Who Should Read This Article?
This article opens up the discussion regarding the relationship between customs duties and transfer pricing. Many of our private sector clients have reached out to us with regards to customs duties concerns, as these have a critical impact on intercompany pricing policies and in many cases, their overall pricing strategy. In light of such concerns, we would like to investigate the differences between customs and transfer pricing valuation methodologies as well as explore the possibilities of harmonizing the two practices from both operational and compliance perspectives.
What Is The Issue?
When a multinational enterprise decides to execute a tangible property transaction between controlled affiliates, and in particular, where one of these affiliates is based in the United States, the price of the property transacted is of interest to two primary federal authorities – U.S. Customs and Border Protection (“CBP”) and the U.S. Internal Revenue Service (“IRS”). The CBP and IRS ultimately have different objectives. The CBP’s objective is to ensure all appropriate elements are included in the customs value and that the value of the imported good is not understated. On the other hand, the objective of the IRS is to ensure that the transfer price does not include inappropriate elements and is not overstated. The figures below demonstrate how these two authorities view and analyze these intercompany transactions.
IRS/Taxing Authority Perspective
CBP/Customs Authority Perspective
The customs authority of interest (for example, the customs authority in Country B) perceives the sale of the tangible good as one transaction with various components that cover the totality of the supply/value chain: costs to manufacture the product, research and development (“R&D”) and intellectual property (“IP”) related product costs, freight cost, etc. On the contrary, the transfer pricing structure separates these components into three individual intercompany transactions, certain of which involve transactions between controlled affiliates in jurisdictions that have no interplay, (and thus do not impact) the taxing authority in country B. The tax authority (in Country B) is simply interested in the pricing of the intercompany transaction between Manufacturing, Inc. and Distribution, LLC. to ensure arm’s length price and tax authority (in Country A) ensures that the income earned by Distribution, LLC in Country B is consistent with the arm’s length standard.
Due to such differences, both authorities have their own methodologies when conducting valuations for the related party transaction. The table below shows a brief overview of the primary methodologies and approaches used for transfer pricing and customs valuation purposes.
When closely examined, customs and transfer pricing valuation methodologies have a key difference. Transfer pricing valuations generally place significant emphasis on the overall profitability of the tested party, which is usually the importing party, and compares the tested party with a set of comparable companies in terms of functions performed, assets utilized, and risks assumed. However, customs valuations do not focus on functionality, but rather the actual transaction value of the tangible property transaction. Understanding and handling these key differences are critical to the alignment of transfer pricing and customs valuation outcomes and improving the quality of the documentation that taxpayers maintain in order to demonstrate compliance in these two areas.
What Are The Challenges?
As there are no specific guidelines on how to document customs duties and transfer pricing simultaneously, there are several challenges that taxpayers face. Firstly, as the CBP and IRS have different valuation methodologies, it is difficult to implement intercompany pricing strategies that align tested party profitability targets with transaction-specific unit prices. Secondly, there is uncertainty of the potential impact of ex-post pricing true-ups on import and customs duties. In other words, companies are unsure on how to price transactions accordingly to avoid paying more customs duties than expected. Finally, there is overall ambiguity on how taxpayers should be filing their documentation for both transfer pricing and customs duties. The CBP explicitly states that a transfer pricing study prepared to satisfy the transfer pricing requirements under Section 1.6662(e) of the Internal Revenue Code or a successfully negotiated advance pricing agreement with the IRS are not individually alone sufficient enough to show that a related party transaction value is acceptable for Customs purposes. As such, there can be extensive and oftentimes unnecessary back-and-forth between taxpayers and both the CBP and the IRS.
Our objective is to find the missing link between customs and transfer pricing methodologies. We have examined numerous court rulings by the CBP and understand a general idea of how the CBP assesses a taxpayer’s transfer pricing documentation in the context of customs-related examinations. In further articles, we would like to analyze various cases and present expert advice and potential solutions on how to proceed with customs and transfer pricing documentation.
Brian Vincent, Principal
Samuel Lee, Analyst
 Treas. Reg. §1.482-9
 Part 152 of the CBP Regulations (or Title 19 of the Code of Federal Regulations Part 152)
 CBP, What Every Member of the Trade Community Should Know About: DETERMINING THE ACCEPTABILITY OF TRANSACTION VALUE FOR RELATED PARTY TRANSACTIONS, pg 14