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Bridging the gap between transfer pricing issue and customs valuation
Multinational corporations that import merchandise from related parties continue to face potentially inconsistent treatment by the internal Revenue Department service on transfer pricing and the Customs Department on custom valuation issues. The Revenue Department could decide that the transfer price between related parties was too high, resulting in an underpayment of corporate income tax; for the same set of transactions the Customs Department could determine that the valuation was too low, resulting in an underpayment of import duties. This inconsistent treatment has existed for decades, but it is now becoming increasingly difficult to ignore. Taxand Thailand explains the key differences between transfer pricing and customs valuation and the opportunities to achieve a consistent result. We also attempt to explore the potential for bridging the gap between transfer pricing and customs valuation regimes.
In Thailand the Revenue Department and the Customs Department lack coordination of customs valuation and transfer pricing and documentation requirements. Businesses continue to treat 'Customs' and 'Tax' as separate departments. Many importers misunderstand that transfer pricing studies will protect importers for customs purposes. These perceptions lead to an increasing volume of controversies.
Different in purposes
Although both referenced as 'taxes', customs and transfer pricing are each rooted in entirely distinct disciplines. One belongs to the area of indirect taxation and the other to the area of direct taxation.
The Revenue Department focuses on the ultimate impact of any underpayments and overpayments for goods on the taxable income. The Customs Department applies duties based on the value of specific imported goods, seeking to attach the correct dutiable value to those goods.
Different in applications
The taxpayer generally is required to finalise its transfer pricing at the time of filing its income tax return. Because it may be impractical to analyse every individual transaction, taxpayers are allowed to apply the transfer pricing methods to overall results for product lines or other grouping. The Revenue Department's goal of clear reflection of income does not require that the valuation be correct for each transaction, but only that it achieves an appropriate income result in the aggregate. This difference allows for aggregation of transactions and offsetting adjustments for tax purposes.
Customs imposes a duty at the goods classification level, and requires a detailed transaction-by-transaction approach with a value determination at the goods classification level. These substantial differences in application of transfer pricing and customs valuation rules open the door to conflicting results.
Differences in treatments
The Revenue Department may determine amount paid was too high, and income and tax were artificially too low. The Customs Departments may determine amount paid was too low and customs duties were artificially too low.
Differences in enforcement
Customs penalties regimes typically are more severe than income taxes. In Thailand, Thai Customs can seek a maximum fine of 4 times the duty value of the goods. Thai Revenue Department can recover the underpayment of income tax and a place a fine of two times the short paid tax.
Among the question to be addressed is the consequence of a transfer pricing adjustment to a value previously accepted by Customs and vice versa. The usefulness of transfer pricing documentation for customs purposes is also important to explore. Furthermore, the possible development of a joint advanced customs and transfer pricing agreement is perceived as promising, despite limited and contrasting experiences in countries so far. In addition, the development of joint customs and transfer pricing audits is being discussed, the objectives of which would be to reduce the time and efforts spent in audits by the tax payer and the authorities and to arrive to a possible common determination of the valuation of related party transactions that would be acceptable for both customs and tax authorities.
Thai Customs Department has introduced the Advance Customs Valuation Ruling regime in order to reduce the under-declared value issue and to facilitate importers to seek for a confirmation on customs value of the goods especially in the event there are changes in transfer pricing structure among the group of companies, or any payments will be made after importation which they may relate to the imported goods, or other circumstances which may affect to the customs value. However, this ruling is not binding. Importers can use it only to protect the customs penalties in the event the value is re-determined by customs officials.
To minimise exposures and maximise tax saving efficiencies, it is critical for importers to manage risks in determination of transfer price and customs value as well as carefully apply existing tax and customs rules. The tax payer should manage risk by setting up a strategic plan to reduce the grey area of customs and transfer pricing issue and potential conflict in enforcement of tax and customs rules.
Transfer pricing leads to different import prices. Companies should consider both regimes to balance the financial costs (duties and taxes) and benefits of various methods. "Tax" and "Customs" should not be separately functioned. These following key considerations should be taken into account:
- Consider both sets of rules when setting prices and creating documentation
- Develop common and / or reconcilable methods for pricing, with common and / or reconcilable documentation, to avoid disparate results including penalties
- Taxpayeres should share information and coordinate audits Transfer pricing normally causes a customs valuation issue. Customs penalties are much higher in Thailand, so it's critical to focus on a detailed review of customs issues which may exist.
- Taxpayers should use APAs to i) substantiate Revenue ii) substantiate customs. Although this is not yet the norm as an APA or other ruling has precedent value elsewhere
- Don't assume that transfer pricing studies will protect you for customs purposes
- Make sure the foreign related affiliate is part of the team because it will be part of an investigation or audit
- Understand that the impacts on tax, duty, loss of revenue and deductions, penalties and defences are different
- Internal communications are essential in setting price and customs value
- Managing the risks to taxpayers is necessary to bridge the gap between transfer pricing and customs valuation
The joint dispute resolution mechanism between OECD and WTO or the Revenue Department and The Customs Department is the only one practical area to bring the two administrations together. The joint guidance and rules between Transfer Pricing Guidelines and Customs Valuation Rules seem unlikely to be happening any time soon because of major determinative distinctions resulting from key differences in rules, purposes, applications, treatments and enforcements. So in summary, the most important essence in bridging the gap between and harmonising Transfer Pricing and Customs Valuation is to bring 'customs' and 'tax' together for risk management purposes for taxpayers . It is not necessary to produce a single document that can be used for both tax and customs authorities but at least the prices should be justified under separate rules and be reconciled.
Your Taxand contacts for further queries are:
Hatasakdi Na Pombejra
T. +66 262 1800 ext. 111
T. +66 262 1800 ext. 180
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