Bridging the gap between TP and Customs

In recent years, the business community has acknowledged the relevance of transfer pricing (TP) not only in terms of taxation, but also in relation to customs matters. In these two areas, there is common ground that may be useful to both tax and customs authorities.

At the outset, the customs and tax authorities may have similar objectives when assessing related party transactions. For customs valuation purposes, import transactions between two distinct and legally separate entities belonging to the same multinational group are treated as related party transactions. One of the main objectives of the customs authorities in examining these import transactions between related parties is to determine whether the prices declared for the imported goods are influenced by such relationships.

On the other hand, for taxation purposes, the determination of prices of transactions between related parties is called TP. At the heart of every TP rule is the concept of the arm’s length principle which requires the transfer prices between related parties to be consistent with the prices that independent parties would charge for a similar transaction. Thus, in TP audits, the tax examiner’s main objective is to determine if the taxpayer’s selected TP methods and arrangements are consistent with the arm’s length principle.

The parallel objective of both the customs and tax authorities on related party transactions opens a discussion on what information can be shared between them.

Aside from the above, the customs valuation methods also have striking similarities with the TP methods set out by the OECD TP Guidelines and Philippine TP Guidelines. In terms of customs valuation, the primary method is the transaction value, which is the price that is actually paid or payable when the goods are sold for export, plus any adjustments or cost elements which are not included in the invoice price (e.g., related royalties, commissions, etc.). When the transaction value method cannot be applied, the following alternate methods may be applied:

• Transaction value of identical goods

• Transaction value of similar goods

• Deductive value method

• Computed value method

• Fallback option

In order to apply the transaction value of identical or similar goods, there must be an available comparable shipment to which the transaction value of the identical or similar goods is applied. The criteria for similar goods are less restrictive than for identical goods, hence allowing a larger pool of potential comparable goods/shipment. These methods resemble the comparable uncontrolled price (CUP) method under the OECD and Philippine TP Guidelines.

The deductive value method, on the other hand, is based on the price at which the imported goods are sold on the domestic market, reduced by costs related to post-import activities (e.g., transportation and storage costs) and by profit and general expenses. The deductive value approach is quite similar to the resale price method under TP Guidelines which starts with the price at which the product that is the object of the controlled transaction is resold to an independent enterprise, which is then reduced by an appropriate gross profit margin in order to determine an arm’s length price.

The computed value method, which is based on the manufacturing cost of such imported goods, is akin to the cost-plus method which starts with the costs incurred by the supplier of the property or services that are the object of the controlled transaction plus an appropriate mark-up in order to determine an arm’s length price.

Given the above, one may ask, ‘What if the information available to the customs authorities is made available to the tax authorities, and vice versa?’. For instance, if the customs authorities have access to the transaction value of identical or similar goods, would that information be helpful to tax authorities as well in assessing the arm’s length nature of the import transaction between related parties? On the other hand, what if the information needed by the customs authorities is already included in the transfer pricing documentation of the local entity, would that bring more value to the TP documentation in terms of supporting the position that the pricing between related entities is not influenced by their special relationship?

Another matter worth noting is the impact of TP adjustments to customs duties. In some cases, TP adjustments may be necessary to be consistent with the arm’s length principle. For instance, imagine a limited risk distributor (LRD) that imports goods from its related party supplier (Entrepreneur) which acts as the main entrepreneur and bears majority of the risk. In this scenario, given that the LRD only assumes limited functions and risks, the LRD’s TP policy is to maintain a targeted arm’s length margin. Any difference from the actual and the targeted arm’s length margin of the LRD should be taken into account by both the LRD and the Entrepreneur. If deemed reasonable, there may be an adjustment on the LRD’s purchase price from the Entrepreneur. Such adjustments are usually done at year end before the closing of the books and after importation. As such, these adjustments may also need to be reported to the customs authorities to reflect the correct transaction value of the imported goods. However, there is a possibility that such adjustments may not be accounted for by the customs authorities given that these adjustments usually occur only after the goods have been released from customs custody. In such cases, a clear understanding of the TP policy of the related parties by the customs authorities should be helpful in order to assess whether future adjustments may still be possible to arrive at the final transfer price. Thus, TP documentation should equip the customs authorities in their collection efforts especially on related party transactions.

With rapid globalization, the interplay between TP and customs can no longer be downplayed. The linkages between TP and customs come with a lot of possibilities and discussions as to what can be done to streamline the two practices. This is not an easy task but having an open conversation is a great start.

The views or opinions expressed in this article are solely those of the author and do not necessarily represent those of Isla Lipana & Co. The content is for general information purposes only, and should not be used as a substitute for specific advice.


Leizelyn De Villa is a manager at the Tax Services department of Isla Lipana & Co., the Philippine member firm of the PwC network.

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