More Holistic Planning Around Custom Valuation and Transfer Pricing
15 November 2013
Posted by: Author: Jed Michaeletos
Author: Jed Michaeletos (Deloitte)
"Companies often have different members of staff or external advisors dealing with transfer pricing and customs duty. Yet, transfer pricing and customs valuation principles are not just linked but, in fact, work in opposites and can result in over pricing and underpricing if dealt with in isolation”, warns professional services firm Deloitte.
Transfer pricing is governed by Section 31 of the Income Tax Act, as well as SARS Practice Note 7, which is based on the Organisation for Economic Co-Operation and Development ("OECD”) guidelines. Customs valuation is governed by sections 65, 66 and 67 of the Customs and Excise Act, which is based on the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (GATT) commonly referred to as the GATT agreement on customs valuation. Of the 148 World Trade Organization ("WTO”) members, all prescribe to the WTO Agreement on Customs Valuation. The agreement establishes that the customs valuation is based on the transaction value of the imported goods, which is the price actually paid or payable for the goods when sold for export, plus certain adjustments. Currently 90% of world trade is valued on the transaction value basis. The WTO Valuation Agreement mandates the World Customs Organisation ("WCO”) to administer the Agreement through its Technical Committee on Customs Valuation. South Africa is a member of the WCO.
One of the instances where the transaction value will be under scrutiny from the South African Revenue Service Customs and Excise ("SARS”) is when the buyer and seller meet the definition of "related parties” in terms of the Customs and Excise Act. In South Africa this definition is very wide and one of the conditions is an equity share holding of 5% or more, which is less than the 20% equity share holding requirement under transfer pricing. says Jed Michaletos, Director, Customs at Taxation Services at Deloitte. Importers need to declare the relationship with their supplier on importation; however, we have found that many companies’ knowledge of the Customs and Excise Act is poor and as a result, in many instances, this declaration is made incorrectly, i.e. buyer and seller are related, however, they declare that they are in fact not related.
It is generally only when the declaration of the relationship is made that SARS will require the importer to complete a customs valuation questionnaire (form DA55). The outcome of this is a value determination from SARS stating whether or not they accept the transaction value (i.e. price paid or payable) as the value for customs duty purposes. If SARS do not accept this, then the alternative methods of valuation need to be consulted and the onus is on the importer to prove that the prices charged by the supplier are the same as for identical or similar goods sold to unrelated partiesin South Africa (effectively the arm’s length price principle). The latter is a costly and time consuming exercise which can be avoided if the importer is more proactive with voluntary disclosures to SARS on the relationships with their suppliers and details of the pricing and other payments (e.g. royalties, commissions, discounts and rebates etc.).
"Having said that, it is also clear that most companies rely on the transfer pricing rules for income tax purposes to drive the prices which are then used as transaction values for customs reporting purposes. Most organisations first and foremost address all of the transfer pricing issues and rules when setting inter-company prices, and only after those prices have been set is any thought or review given to or of the customs valuation rules, if done at all”, says Michaletos.
Companies often have different members of staff (or different external advisors) dealing with transfer pricing and customs duty. Yet the one area very often impacts strongly on the other. For this reason companies should consider a more holistic approach to determining the tax implications of specific transactions. The reality is that there is a significant overlap between transfer pricing and customs duty and a failure to take both kinds of tax into account can often lead to difficulties.
Transfer pricing and customs valuation principles are linked. In fact they work in opposites. From a transfer pricing perspective the Revenue authorities are concerned with over pricing which results in "profit shifting”, whereas from a customs valuation perspective, the Customs authorities are concerned with underpricing which results in underpayment of customs duty and VAT. Consider for example the following set of facts: A South African company (SA Co) is owned by a US Company (US Co) and acts as the distributor in South Africa of goods manufactured by US Co. The group’s transfer pricing policy stipulates that SA Co should earn an operating margin of 2%. The goods supplied by US Co to SA Co are therefore priced with the intention of enabling SA Co to realise this target operating margin.
The policy also provides that, if SA Co’s actual operating margin deviates by more than 0,2% from the targeted margin, the pricing of the goods supplied during the relevant year will be subject to an adjustment at year-end. This adjustment will be calculated in such a way as to achieve the targeted 2% operating margin. The pricing of the goods supplied during the course of the year would, in these circumstances, usually be based on budgeted information. Any possible adjustment which might be necessary at year-end would be as a result of deviations from the budgeted information. In other words, these adjustments would be done by reference to actual figures rather than budgeted figures.
- It is therefore possible that, at year-end, either of the following types of adjustment may be necessary:
- If SA Co has failed to achieve the targeted operating margin then it might receive a rebate in respect of the goods purchased during the course of that year.
- Alternatively, if SA Co exceeds the targeted operation margin it might be required to pay an additional amount for the goods.
Both of these two possible situations have significant customs duty implications. In the event of SA Co receiving a rebate this will amount to a downward adjustment of the amount paid by SA Co for goods. This would effectively mean that the original customs valuation of the goods has been overstated and that customs duty and VAT has, in all likelihood, been overpaid. This means that SA Co would wish to seek a refund of any such overpaid customs duty and VAT.
With the alternative scenario - in other words, where SA Co is required to make an additional payment in respect of the goods, the price actually paid or payable has hence increased and as a result the original transaction value for customs duty purposes needs to be increased. This means that there will have been an underpayment of customs duty and VAT when the goods were imported into the country. This means that an additional payment of customs duty and VAT is required. There are significant practical difficulties with either obtaining a refund of customs duty and VAT paid in these circumstances or with paying the additional amount of customs duty and VAT required. The problem here is that the Customs and Excise Act does not currently cater for such year-end type adjustments. When adjustments are made to the price paid or payable, i.e. the customs value declared on importation, SARS requires that the specific import transactions need to be corrected by means of vouchers of correction.
SARS does not allow for once-off adjustments of this nature. This creates a huge administrative burden on the company. Consider the scenario where a Company imports hundreds of containers per month, they would need to pass vouchers of correction for each entry. Another practical difficulty is that these adjustments are consolidated amounts based on operating margin. If a company has thousands of product line items, some subject to customs duty and others not, the apportionment exercise needed would be a nightmare.
We believe that there is scope for this to be addressed with SARS, the Customs and Excise legislative needs to be changed to cater for these types of adjustments. SARS are currently in the process of re-writing the Customs and Excise Act and this poses an ideal opportunity for SARS to ensure that these changes are made. The biggest risk with respect to these adjustments is that many companies do not notify SARS and therefore the customs value on imports are subsequently not adjusted. This creates exposures to companies that have made debits or lost opportunities with companies passing credits. This is just one factual example of the potential difficulties that can arise in the interaction of customs duty and transfer pricing. Companies are therefore strongly advised to consider both aspects simultaneously when doing their tax planning, concludes Michaletos.
This article was first published in TaxTalk - November/December