Transcript No Slide Title

RELATED PARTY PRICING /
TRANSFER PRICING:
Customs vs. IRS
Presented to the NYSSCPA
International Taxation Committee
June 17, 2008
Alan Goggins
Barnes, Richardson & Colburn
475 Park Avenue South
New York, NY 10016
212-725-0200 Ext 118
[email protected]
Both Customs (or CBP) and the IRS can
scrutinize related party prices to determine if
such prices are “arm’s length”
The tests are similar in theory but
drastically different in the details
Why is this important?
• Any sale from an overseas exporter to a
related U.S. importer implicates both the
CBP and the IRS.
• An overseas version of the IRS in the
country of exportation may also be
involved
Why is this important?
• CBP has recently announced its
intention to step up enforcement
in this area
• Having an APA in place is no
longer sufficient to convince
CBP
Goals for today
• Compare methods employed by CBP and
IRS
• Determine what types of documentation
can satisfy both
Relationship Test
• Control – 5% of voting stock threshold
• Parent – subsidiary and subsidiaries of
subsidiaries
• Sister companies under common control
of a parent company
CBP Valuation Issues
• Value for CBP purposes is almost always
determined under the transaction value
method – 19 U.S.C. § 1401a
• Statute requires use of transaction value
if applicable
• Transaction value = price paid or payable
when sold for export to the U.S.
If parties are related, CBP can
question acceptability of prices
• Circumstances of sales test – 3 variations
• Test values test – 3 variations
• Only need 1 to pass, and any 1 will do
• Pass / Fail – unlike IRS, CBP cannot
adjust prices – must accept or reject
• If rejected – must use alternative
valuation method
First Sale Appraisement
• Method of avoiding CBP inquiry (and
saving duty)
• If unrelated factory sells to exporter, may
be able to use factory or first sale prices
instead of prices from exporter to related
importer
• No duty paid on exporter’s margin
First Sale Appraisement
• Transaction between factory and exporter
must be a sale
• Must be for exportation to the U.S. –
factory must know the goods are destined
to the U.S.
• Labeling, shipping instructions, separate
P.O. for U.S. market goods
Circumstances of Sale Test
• The analysis reveals that the
relationship between the buyer
and the seller did not influence
the prices paid
Circumstance of Sales Test –
Variation 1
• Related party prices settled in a manner
consistent with the normal prices
practices in the industry
• Example – commodities prices tied to
public market quotations
• Documentation – public market quotes
Circumstance of Sales Test –
Variation 2
• Related party prices settled consistent with the
way the seller settles prices to unrelated buyers
• Example – exporter sells same merchandise to
unrelated buyers in U.S. (preferred) or in third
countries at similar prices
• Same pricing formula - related & unrelated
Circumstance of Sales Test –
Variation 2 (Continued)
• Same level of trade
– compare sales to related and unrelated distributors
– OR related and unrelated wholesalers
– OR related and unrelated retailers
• Otherwise, make a level of trade adjustment
• Documentation – Comparative analysis
converting prices to a common currency plus
the invoices
Circumstance of Sales Test –
Variation 3
• Related party price adequate to ensure
recovery of all the exporter’s costs plus a
profit = overall profit in sales of the same
class or kind of merchandise
• Cost of production analysis
• Business segment or product line profit
rather than overall profit
Circumstance of Sales Test –
Variation 3 (Continued)
• Cost of production analysis required for
every product imported
• Documentation – a mountain of paper
required – invoices, ledgers, journals,
cost accounting records, etc.
Test Values
• Related party prices are acceptable to
CBP if such prices closely approximate a
test value or an appraised value if one of
the secondary bases of valuation were
used
• Transaction value of identical or similar
merchandise, deductive value, computed
value
Test Values – Transaction Value
Identical or Similar Goods
• Transaction value identical goods = same
exporter sells same goods to unrelated
buyers in U.S. (? – how is this different
from COS Variation 2?)
• Transaction value similar goods = ask
your competitor what he pays for
imported goods and ask for his customs
entries (do not hold your breath)
Test Values – Deductive Value
• Start with importer’s most common U.S.
resale price and work your way back to a
proxy for the purchase (import) price
• Deduct NDC’s
• Deduct importer’s SG&A
• Deduct importer’s profits in U.S.
• Try to narrow focus to product line costs
Test Values – Computed Value
• This is also an exporter’s cost of
production analysis
• ? How is this different from COS
Variation 3?
Test Values Roadblock
• CBP policy – will
not accept any test
values unless the
secondary
appraisement method
was actually used in
a previous
importation
Test Values Roadblock
• Statute requires use of transaction value
first – only get to secondary methods if
transaction value rejected
• By then, per CBP, too late to use test
values
• CBP policy erases test values from the
statute
IRS Transfer Pricing Tests
• Unlike CBP, IRS can propose
adjustments to prices
• IRS also requires taxpayer to establish
that the method used provides best and
most reliable measure
• Profit-based methods
• Transaction-based methods
IRS Transfer Pricing Tests
Profit-Based Methods
• Comparable profits
• Comparable profit split
• Residual profit split
• Profit comparisons between related parties or
between related parties and competitors
• None acceptable to CBP because must have a
customs value for each imported article
IRS Transfer Pricing Tests
Transaction-Based Methods
• Comparable uncontrolled price (“CUP”)
– Compares related party prices to prices in
sales to unrelated parties
– Similar to COS Variation 2 and can be met
with the same type of documentation
(comparative analysis with invoices and
prices converted to a common currency)
– Here, CBP would likely accept the APA if
given an explanation
IRS Transfer Pricing Tests
Transaction-Based Methods
• Resale price method – used for a reseller
– Compares gross margin in related party
sales to gross margin in unrelated party sales
– Exporter must have sales to related and
unrelated parties
– Would need substantial explanation to
demonstrate an APA here also meets CBP –
possibly COS Variation 2
IRS Transfer Pricing Tests
Transaction-Based Methods
• Cost plus method – used for a
manufacturer and compares gross
margins in sales to related and unrelated
parties
– Somewhat similar to COS variation 3 or
computed value – mountain of documents
– Would again require substantial explanation
to demonstrate APA here also met CBP
CBP vs. IRS
• APA or transfer pricing study alone will
not satisfy CBP
• Must also demonstrate how a CBP
method is met
• Like an APA, importer can apply for a
CBP ruling in advance
CBP vs. IRS
• The only method that
appears to readily
satisfy both CBP and
IRS is
Circumstances of
Sales Variation 2 /
CUP test
CBP vs. IRS
• 26 U.S.C. § 1059A
– Inventory costs of imported merchandise for
a related party importer taken into account
for IRS purposes must not exceed value
declared to CBP
– Does not apply to first sale method
– Example: failure to declare an assist results
in double penalty – CBP underpaid duty and
IRS disallows expense deduction
Concluding Thoughts
• Companies spend significant time and
resources preparing for the day the IRS
knocks on the door
• Comparable effort not made in preparing
for the day CBP questions related prices
• CBP has served notice – be prepared!
Questions?
Alan Goggins, Esq.
Barnes, Richardson & Colburn
475 Park Avenue South
New York, NY 10016
212-725-0200 Ext 118
[email protected]