Year-end price adjustments: aligning corporate tax, transfer pricing and customs. Your bridge to worldwide transfer pricing services

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1 Year-end price adjustments: aligning corporate tax, transfer pricing and customs 2011 Your bridge to worldwide transfer pricing services

2 Agenda The case for adjusting prices/profits and reasons for the adjustment Options available to companies under a tax transfer pricing standpoint Year-end adjustments: corporate tax implications Year-end adjustments: customs value implications Year-end adjustments: VAT implications The interplay between transfer pricing and customs value rules Aligning transfer pricing and customs value and VAT Your bridge to worldwide transfer pricing services 2

3 TPA - Introduction Independent TPA is an independent firm No audit/attest work is carried out - only transfer pricing, customs and valuations services No conflicts of interest or corporate governance issues with TPA Global TPA is present in 30+ countries through own offices and strategic alliances Global teaming/sharing model to allocate best expertise to projects/clients reduce delivery times Globally consistent top quality Specialist Each TPA professional has at least 5 years of dedicated transfer pricing experience in: Big 4 Industry Boutique consulting firms Global knowledge sharing Commitment to technical excellence Competitive pricing Superior client service with quick turnaround Senior involvement throughout projects Consistent global approach and performance One of the leading transfer pricing firms per International Tax Review survey Your bridge to worldwide transfer pricing services 3

4 A common tax issue: adjusting inter-company prices As a general rule, prices in third-party transactions are set when the transaction is first negotiated. Accordingly, transfer pricing rules of many countries focus on the arm s length nature of the price-setting process How to react when actual financial results differ from those predicted under a certain transfer pricing methodology and are outside of arm s length range? OECD Guidelines indicate that prices in transactions between related parties be set at a level that would have occurred in the same transactions had they taken place between unrelated parties Your bridge to worldwide transfer pricing services 4

5 A common tax issue: adjusting inter-company prices Principal/ Trading A RC PS PC Entrepreneur Profit Center Residual profits (unadjusted) Residual profits (adjusted) Production Distributor A RC PS Manufacturing Cost Center Cost Plus A RC Distribution Revenue Center PC Net margin (as a % of costs) PS Resale price minus PC Net margin (as a % of sales) A RC PS PC = Activity = Responsibility Centre = Price Setting = Price/Profit Checking Your bridge to worldwide transfer pricing services 5

6 A common tax issue: adjusting inter-company prices Nevertheless, a number of reasons may explain such deviations from a business reality perspective and eventually support the choice of not to adjust prices, including: the acquisition of a new customer will possibly imply a significant increase in sales without a corresponding increase in operating expenses a global economic downturn may reduce the demand for some products, resulting in lower sales and margins multi-year investments, difficult to assess on a year-by-year basis Your bridge to worldwide transfer pricing services 6

7 Price setting and profit checking Example: price setting (PS) and price profit checking (PC) mechanisms can be used to achieve an arm s length net operating margin for distributors classified as revenue centers Several options are available to taxpayers: - No True-up - 100% True-up - Prospective price adjustments - Retrospective price adjustments Your bridge to worldwide transfer pricing services 7

8 Price setting and profit checking PS = price setting (statutory) PC = profit checking (statutory and/or tax) = prospective adjustments = retrospective adjustments 9 months Budget Q1 Q2 Q3 Q4 PS PS PS PS PS or PC PC Options 1. PS No True-up a. I/Q range (adjustment to lower /higher quartile) 2. PC 100% True-up (US model) b. Economic arguments 3. PS (Q1/Q2/Q3/Q4) c. Retrospective impact analyses on per Q base 4. PS (Q1/Q2/Q3/Q4) + PC ( Q1-Q4) d. Median Your bridge to worldwide transfer pricing services 8

9 Key choices to be made - some comments Prospective or retroactive adjustments? - A company that aims to win market shares and adopts aggressive penetration strategies needs flexibility to manage its contracts with (new) customers. Such a company will likely be in possession of the information/inputs needed for adjusting prices only as the year is coming to the end. - Prospective adjustments only may not lead the company to results targeted; a year-end adjustments will likely be needed. A prospective monthly adjustments system will allow the company less tolerance, but it is administratively more cumbersome. - Year end adjustments pose additional tax issues (as described in the following slides). Bundled or unbundled approach? - Administrative burden: Ø - bundled approach: maximum Ø - unbundled approach: minimum To introduce some flexibility features? - E.g. adjustments system based on corridors of ROS for each category of hardware (e.g. between 1.8% and 3% for networks) rather than targeted ROS (e.g. 2.5% for networks). The adjustments will be made only in case the profitability of the tested companies departs from the corridor. Your bridge to worldwide transfer pricing services 9

10 Year-end adjustments: corporate tax implications Local country rules regarding year-end adjustments can vary considerably. For example, German tax authorities may not allow the adjustment: if it is not operated on the basis of an agreement which is in place at the beginning of the FY concerned, regulating price setting factors and related adjustments, or the company is not otherwise able to show to tax authorities that the same adjustment would have been made by third parties as well ( Administrative principles - Procedures, Chapter ) Many tax authorities may view year-end adjustments as an examination trigger Some tax authorities view adjustments as non-deductible voluntary contribution or distribution of capital (e.g. Japan) double taxation issues Your bridge to worldwide transfer pricing services 10

11 Year-end adjustments : Customs valuation implications Goods moved across borders and imported from one customs jurisdiction into another are potentially subject to customs duties (and other indirect taxes, VAT etc) Customs duties are generally levied ad valorem, and countries have complex regulations for determining the value of imported goods for customs purposes WTO members are bound by the WTO Customs Valuation Agreement, requiring, as a general rule, that customs value to be determined on the basis of the transaction value (i.e. the price paid or payable for the goods when sold for export to the country of importation) subject to certain prescribed adjustments and conditions In a sale between related parties, transaction value eligible only if the price has not been influenced by the relationship between the parties: consistency with arm s length standard Documentation: many countries explicitly stated that a transfer pricing study does not constitute sufficient evidence for validating value of goods for customs purposes Your bridge to worldwide transfer pricing services 11

12 Year-end adjustments: customs value implications WTO Valuation Agreement does not specifically provide for the treatment of adjustments to transaction value; national legislation will determine the behavior of respective customs authorities An apparent contradiction: the transaction value principle states that the price of the goods when sold for export to the country of importation should constitute the customs value Customs Co-operation Council (CCC) Secretariat stated that the expression when sold for export merely indicates the type of transaction involved and made clear the price review clauses alone should not preclude valuation under a transaction value method As a matter of practice, customs authorities tend to view year-end adjustments as directly applicable to the goods imported and part of the price paid for those goods (especially if it is not an occasional adjustment, but a usual practice) Your bridge to worldwide transfer pricing services 12

13 Year-end adjustments: customs value implications Companies are typically in a lose-lose situation: for upward price adjustments, customs authorities will generally require the importer to declare such higher amount and pay duty on the difference for downward adjustments, the importer will face problems having customs administration taking account of such rebates (and possibly get refund of duties). As an example, Canadian Customs Act explicitly prohibits to take into account any rebate or other decrease in the price paid after importation (Article. 48(5)(c) Canadian Customs Act). Your bridge to worldwide transfer pricing services 13

14 Year-end adjustments: customs value implications Particular attention has to be paid to the choice of disclosing (or not) such price adjustments to customs administration These adjustments may be very transparent and customs authorities may easily find such information during a company s audit Exchange of information between direct tax and customs authorities The choice of disclosing the adjustments has the following general advantages: reduces the risk of penalties improves relationship with local customs administration it may reduce duties: only with a prior disclosure the company may be in the position to present its preferred calculations method Your bridge to worldwide transfer pricing services 14

15 Year-end adjustments: VAT implications (Europe) Prospective (monthly or quarterly) adjustments: Invoices have to be issued meeting all the invoice requirements. Retroactive (quarterly or year end) adjustments: 1. Retroactive quarterly adjustments result into the obligation to issue credit notes relating to the previous supplies. 2. When the credited amounts are with VAT (standard/reduced rate), the credited VAT should be claimed back from the local tax authorities. The credited VAT becomes due by the LDR. 3. When the credited amounts are without VAT (in case of intra-community supplies of goods), the credited amounts have to be accounted for as adjustments on the so-called EC Sales Listing (as from January 1, 2010 called EC Transaction Listing). 4. Credited amounts related to intra-community supplies will in principle result into the obligation to make adjustments to previous submitted Intrastat returns. Your bridge to worldwide transfer pricing services 15

16 Bridging the differences? OECD/WCO Joint Conferences Joint Conferences on Transfer Pricing and Customs Valuation (2006, 2007 and onwards) With an ultimate goal of determining if harmonized pricing methodologies can be forged, these Conferences have concluded so far: - more analysis is needed - harmonization will require changes and adjustments on all sides - pilot projects or case studies in harmonization are needed to facilitate consideration Your bridge to worldwide transfer pricing services 16

17 The interplay between Transfer pricing and Customs valuation differences among the two set of rules Direct tax authorities focus on the accuracy of a transfer price as reflected on the tax return (aggregated income across the entire business); customs authorities focus on the determination of the value of goods at the time of entry into their customs territory (transaction-by-transaction, product-by-product) Tax and customs authorities pursue different objectives: a low value for customs purposes will result in lower duties while this same low value will result in a higher income/profit in the country of importation and higher corporate tax Some countries limit the amount a taxpayer can claim as its inventory cost for the imported dutiable merchandise purchased from a related party to its customs value (e.g. USA, IRC 1059A) Specific programs may allow the importer to break the nexus between transfer price and customs value, by selecting the price of an earlier sale (in a series of successive sales) as basis for customs valuation certain conditions to be met (e.g. First Sale Price program, whose acceptability is currently under debate in EU and US) Your bridge to worldwide transfer pricing services 17

18 A roadmap to deal with price adjustments for customs purposes Decision to adjust prices for CIT purposes Prospective adjustments only Retrospective adjustments Customs implications: price consistency No customs implications No customs implications Enhanced exposure to risks NO NO NO Adjustments refer directly or indirectly to goods being imported? YES Is customs assessment based on the value of the transaction now being adjusted? YES Disclosure to customs authority? YES Alignment of transfer price and customs value shortcomings to be dealt with nationally Your bridge to worldwide transfer pricing services 18

19 Procedures for aligning transfer price and customs value For their customs implications, year-end adjustments should be carefully evaluated and, if necessary, reported to customs authorities To avoid lose-lose situations, companies may evaluate whether, based on domestic legislation, specific programs are available to integrate their commercial and invoicing practices (including price adjustments) within their procedures for determining and declaring the customs value of goods imported Generally, no one-size-fits-all solutions A country by country analysis is provided for Asia (Appendix A), whereas for EU and USA the regional procedures are provided in following slides. Your bridge to worldwide transfer pricing services 19

20 Procedures for aligning transfer price and customs value - US In the US, companies may choose among the following options: Post-entry adjustment (shortcoming: limited time) Administrative protests Prior Disclosure (limited sanctions; exposure to Sec. 1059A) Customs Reconciliation program (upon authorization) Post-entry adjustment procedure may be used to amend customs entries before final liquidation date of the entry Prior disclosure allows importers to advise customs authority of violations of customs laws (incl. valuation) in exchange for reduced penalties. However, a prior disclosure filed after the liquidation of the entry has become final does not affect the already liquidated customs value Your bridge to worldwide transfer pricing services 20

21 Procedures for aligning transfer price and customs value - US Preferred method for valuation adjustments seems to be the Reconciliation program, allowing the importer to subsequently provide customs authorities with information (incl. value) not available at the time of entry of the goods Under the program, the importer would: declare a provisional value at the time of entry of the goods complete the declaration at a later date when the information is available, i.e. within 21 months from the date of entry Your bridge to worldwide transfer pricing services 21

22 Procedure for aligning transfer price and customs value - EU Options available to companies: Incomplete declaration at the time of entry (art. 254 IPCC) Ruling on customs valuation (upon satisfaction from customs authorities that price are/are not influenced by the relationship between the parties) Request for review of customs assessment under Article 78 CCC (3 years period) The choice of the procedure for integrating price adjustments into the determination of the customs value will very much depend on the specific situation of each company Your bridge to worldwide transfer pricing services 22

23 Procedure for aligning transfer price and customs value - EU Incomplete declaration under art. 254 IPCC allows the importer to declare a provisional value at the time of entry and correct the declaration in a later date - authorization from competent customs authority required - strict time limits: remaining information to be provided within one month from provisional declaration. Longer time limit may be set by customs authorities where this proves necessary. Different practice across EU member States - lodging of securities required - relevant contract should stipulate that price adjustments may occur after importation and the (objective) conditions and variables influencing such adjustments (should be known already at the moment of importation): formulas, etc. Your bridge to worldwide transfer pricing services 23

24 TPA Global Contacts Europe Steef Huibregtse Amsterdam, The Netherlands T: +31 (0) E: Asia Steven Transfer Pricing Associates (Hong Kong) Limited T: Mobile: E: Zurich, Switzerland & Global, Italy Enrico De Angelis T: E: e.deangelis@tpa-global.com Andre Janssen Rotterdam, The Netherlands T: +31(0) E: atm.jansen@kneppelhout.nl LATAM Antonio Weffer T: +31 (0) E: a.weffer@tpa-global.com Willem Schutte Amsterdam, The Netherlands Tel: +31 (0) E: willem@taxcellent.eu Your bridge to worldwide transfer pricing services 24

25 Appendix A - Year end adjustments in Asia & US - CIT, Customs Duty and VAT implications CIT Customs Duty VAT (other indirect tax) Australia Upward adjustments permitted after year-end. For downward adjustments need to demonstrate there was a binding agreement with foreign supplier acknowledging an adjustment would be made in line with arm s length principle. Some cooperation between ATO and ACS. ACS will consider customs valuation adjustments based on APA or TP audit, although only within approved predetermined range. Taxpayers should consider Valuation Advice (VA) ruling. A VA is valid for five years and indemnifies against customs penalties. GST will be impacted by adjustments in customs value. ATO requires all customs duty adjustments to be processed through the Integrated Cargo System (ICS) so GST is adjusted automatically. China Statutory year end adjustments difficult. Upward adjustments to income tax return allowed; currently no procedures for downward adjustments. Voluntary upward adjustments are possible within three years; downward adjustments not allowed. Customs authorities now beginning to request TP documentation when performing customs audits Year end adjustment to an export value may be deemed to be a domestic sale and caught by 17% VAT Hong Kong Adjustments upwards permitted after year-end. Downward adjustments allowed if binding agreement in place with supplier consistent with arm's length principle. Customs duty limited to liquor, tobacco and other restricted items; Currently no formal voluntary adjustment/disclosure rules in place No VAT applicable Your bridge to worldwide transfer pricing services 25

26 Appendix A - Year end adjustments in Asia & US - CIT, Customs Duty and VAT implications (Cont d) CIT Customs Duty VAT (other indirect tax) India Year end adjustments possible prior to close of accounts; upward adjustment to the income tax return also possible but can be difficult in practice If there is a change in the method of computation or assumptions or if additional facts are brought to light, the Special Valuations Branch of Customs (SVB) can consider a request by the importer for amendment. This could potentially result in a refund of customs duty as well. VAT which is leviable on sale of goods would not have any impact on import of goods into India. GST laws which are currently being drafted will be levied on imported goods, with a valuation/adjusted valuation based on the SVB order. Indonesia No formal procedures for self initiated adjustments Import value can only be adjusted by the customs official during the importation or at the time of customs audit. Therefore, it is not currently possible to adjust customs valuation based on transfer pricing adjustment. VAT adjustments only possible based on customs audits. Japan Written guidelines were issued for selfinitiated adjustments (TP commissioner s directive) on October 22, Voluntary disclosure system is in place for adjustments; refunds of duty are possible through this mechanism. A customs valuation adjustment will trigger a consumption tax adjustment on imports (rate currently 5%). Your bridge to worldwide transfer pricing services 26

27 Appendix A - Year end adjustments in Asia & US - CIT, Customs Duty and VAT implications (Cont d) CIT Customs Duty VAT (other indirect tax) Korea Adjustment permitted to tax return. Three year limitation on downward adjustment to income. Voluntary disclosure system in place for upward adjustments Adjustments based on customs duty revaluations Singapore Adjustments permitted if within range of TP documentation Customs duty applicable to very limited range of goods; voluntary disclosures are possible although no formal procedures in place GST adjusted in line with Customs Duty valuation Taiwan Self-initiated adjustments to the median of the interquartile range are allowed under the comparable profits method. No formal mechanism; however adjustments may be allowed in some cases in practice As for Customs duty Thailand Adjustments permitted if adequate documentation/agreements etc exist. Director-General can make refund based on calculation error, provided that such refund shall not be made after two years from the date of importation or exportation. No formal procedures for adjustment Your bridge to worldwide transfer pricing services 27

28 Appendix A - Year end adjustments in Asia & US - CIT, Customs Duty and VAT implications (Cont d) CIT Customs Duty VAT (other indirect tax) USA Adjustments are the normal procedure (profit split methods privileged) Companies may choose among the following options: 1. Post-entry adjustment (shortcoming: limited time), 2. Administrative protests, 3. Prior Disclosure (limited sanctions; exposure to Sec. 1059A), 4. Customs Reconciliation program (upon authorization). Preferred method for valuation adjustments seems to be the Customs Reconciliation program, allowing the importer to subsequently provide customs authorities with information (incl. value) not available at the time of entry of the goods. Under the Reconciliation program, the importer would: declare a provisional value at the time of entry of the goods, complete the declaration at a later date when the information is available, within 21 months from the date of entry. - Your bridge to worldwide transfer pricing services 28

29 About Transfer Pricing Associates AboutTransferPricing Associates Transfer Pricing Associates is the leading independent provider of global transfer pricing and valuation services and part of the Transfer Pricing Associates Global group. The Transfer Pricing Associates Global group is an independent and specialist provider of expert transfer pricing, tax valuation and customs services, headquartered in Amsterdam and with our own offices and coverage in over 25 countries around the world. Transfer Pricing Associates provides high quality transfer pricing advice and assistance to multinationals of all sizes, wherever they are located. For more details of our innovative services, please visit our website at Your bridge to worldwide transfer pricing services 29