“This case is pivotal,” said Claire Reichstein, international trade attorney for Ford Motor Company, at the American Association of Exporters and Importers (AAEI) conference in Baltimore in June. “It’s going to be a game changer. It stands for the proposition that transfer pricing is not relevant for customs value.”
The European Court of Justice (ECJ) on Oct. 17, 2016, received for referral a case heard by the Finance Court in Munich, Germany (Finanzgericht München) examining the refusal of the German Principal Customs Office to partially refund customs duties declared and paid by a German subsidiary of Japan-based Hamamatsu Photonics, which distributes optoelectronic devices, systems and accessories, among other things.
The nine-page, Dec. 20 ruling is publicly available for review on ECJ’s website under the name Hamamatsu Photonics Deutschland.
The German court asked the ECJ to clarify whether the [European] Union Customs Code allows, for customs valuation purposes, an agreed transfer price composed of two parts — an amount initially invoiced and declared, and a flat-rate adjustment made after the end of the accounting period — without it being possible to know at the end of the accounting period whether the adjustment would be made up or down.
Stated in its ruling, the ECJ determined that European customs law must be interpreted to not permit the use of such transaction values for customs valuation purposes.
“In the version in force, the Customs Code does not impose any obligation on importer companies to apply for adjustment of the transaction value where it is adjusted subsequently upwards and it does not contain any provision enabling the customs authorities to safeguard against the risk that those undertakings only apply for downward adjustments,” the ruling states. “In those circumstances, it must be held that the Customs Code, in the version in force, does not allow account to be taken of a subsequent adjustment of the transaction value, such as that at issue in the main proceedings.”
Hamamatsu bought imported goods from its parent company, which charged intra-group prices in accordance with an advance pricing agreement concluded between that group of companies and German tax authorities, according to the ruling.
The total of the amounts charged to the German subsidiary, Hamamatsu Photonics Deutschland GmbH, were regularly checked and, if necessary, adjusted in accordance with the Organization for Economic Cooperation and Development’s (OECD’s) “arm’s-length principle,” regarded as the international standard on transfer pricing for multinational businesses.
That principle aims, in part, to prevent multinational companies’ taxable profits from being artificially shifted out of tax jurisdictions, according to OECD’s website, and under the principle, the pricing of such transactions must reflect the pricing that would have occurred between two nonrelated parties, according to an EY background paper on the case.
Between Oct. 7, 2009, and Sept. 30, 2010, the German subsidiary imported goods from more than 1,000 consignments from the parent company, and tariffs ranging from 1.4 percent to 6.7 percent were levied on the taxable goods, the ruling states.
The German subsidiary’s operating margin during that period was lower than expected, and transfer prices were reduced as a result, and the subsidiary thus received a credit of €3,858,345.46, the ECJ ruling states.
Hamamatsu Photonics Deutschland then applied to German customs to recoup €42,942.14 in duties, but customs rejected the request, saying the action would be incompatible with Article 29(1) of the Community Customs Code, “which refers to the transaction value of individual goods, not that of mixed consignments,” the ruling states.
The question remains whether the Hamamatsu case was fact-specific and therefore isn’t applicable to other situations or whether it will apply to transfer pricing for customs valuation more broadly, Jeroen Scholten, an international director in EY’s global trade practice, said in an interview with American Shipper.
Those who claim the case is very fact-specific include some European authorities familiar with the case who told Scholten that the Japanese parent company didn’t have an agreement with German customs, for instance, Scholten said during a panel at the AAEI conference.
But if the ruling is determined to have broad application and companies don’t conduct business in alignment with the court’s interpretation, they “may end up at a serious compliance risk” and could ultimately pay too much or too little in duties for cross-border transactions in which value is declared for profits-based pricing (e.g., transfer pricing), Scholten said.
Almost all multinational companies set intracompany transfer prices for cross-border transactions, and commonly adjust those prices up or down at the end of quarter or year, as various circumstances may impact the ability of different company divisions across a supply chain to meet expected profit margins forecasted before the start of an accounting period, he said.
In the case of Hamamatsu, the Japanese parent company gave its related German importer/distributor a retroactive discount so the German subsidiary fit within the range the parent company had set for it, Scholten said.
Another example would be a car company’s import/distribution arm that was forecast to earn 5 percent profit during a quarter but only ends up making 3 percent after it had to make deals with buyers or paid more expenses than anticipated, he said.
The only way, then, to meet the expected 5 percent profit is for the intercompany seller, such as the exporting arm, to give that importer/distributor a retroactive intracompany discount on the initial car purchase by crediting the importer/distributor, he said.
In practice, many countries allow transfer pricing corrections for upward adjustments to customs value resulting in additional payment of customs duties, but not always for downward adjustments resulting in a refund of customs duties, Scholten said.
In the context of transfer pricing, customs administrations generally tell importers, “‘If you’ve got a post-importation adjustment, and the value goes up, you better tell us about it, and pay us. And if it goes down, you better tell us about it, but we’re not going to pay you,’” Reichstein said during the AAEI conference. “That’s how it mostly works. ...This case is saying transfer pricing isn’t even relevant.”
It is now the responsibility of EU member states to consider how to respond to the ECJ ruling through their respective policy mechanisms.
The EU Customs Expert Group is responsible for crafting recommendations to implement customs policy, but it is unclear when a batch of suggestions regarding the ECJ decision might emerge.
But time is of the essence in terms of developing an EU-wide approach to the ECJ ruling, as differences of interpretation between different member states’ customs authorities are starting to emerge, Martijn Schippers, a tax lawyer in EY’s Rotterdam office and researcher at the Erasmus University Rotterdam, told American Shipper.
Dutch customs authorities are telling importers of multinational entities that they must have a pre-approved agreements with customs on how to address transfer pricing adjustments, and Belgium is taking a similar approach according to a local guidance document, he said.
But Swedish and Italian customs authorities seem to operate under the interpretation that the ECJ ruled customs valuation and transfer pricing have nothing to do with each other and may see the ECJ ruling as confirmation of rulings of their local courts, and as such, transfer prices can never be used as the basis for determining customs value, Schippers said.
At this point, the EU Customs Expert Group could be the best entity to provide clarity on the issue, he said.
“The problem is, with this, you cannot tell importers worldwide, ‘OK, you have to do A, B, C, and you’re good,’” Scholten said. “The challenge for companies is that something that may have been a practice … in the past, and you paid them the duties or got refunds, has become more uncertain as to whether you can actually do it.”
He continued, “You really have to wonder about the appropriate way to file your imports, and that makes it, for a lot of companies, uncertain to understand what the appropriate value is, and if you can declare it. And that’s uncomfortable, because you want to know on the day of shipment what you’re doing, not a year later when you’re filing a correction.”
EY is advising its clients to revisit their transfer pricing methods, as well as any agreements with European customs authorities addressing how upward or downward pricing adjustments should be handled, including whether traditional mechanisms allowing for retroactive adjustments to customs valuations are still allowed, or whether alternatives might be available, Scholten said.
If the Hamamatsu ruling is to be interpreted as setting restrictions or limitations in using transfer pricing as a basis for transaction value, importers could be forced to use alternative customs valuation methods, and thereby assume a heavier administrative burden, Scholten wrote in an email.
Transfer pricing analysis is one way companies can corroborate transaction value, which is the price actually paid or payable for goods when sold for export into a customs territory, and which, in principle, is the customs value of imported goods.
The preamble to the World Trade Organization Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994 instructs that transaction value should form the basis for customs valuations to the greatest extent possible, and many countries have reported transaction value is used in 90 percent to 95 percent of all importations, according to the World Customs Organization Guide to Customs Valuation and Transfer Pricing.
To use the transaction value method, it should be proved to the satisfaction of customs authorities that the buyer and seller aren’t related or that their relationship didn’t influence the price, Scholten wrote.
It is common practice by multinational companies to use the transfer pricing analysis included in transfer pricing documentation to prove that the transfer price hasn’t been influenced by the relationship between buyer and seller, he wrote.
But whenever the customs value can’t be determined by imports’ transaction value, alternative valuation methods come into play, Scholten wrote.
So, the Hamamatsu ruling could impact a “great part” of the international trade community, especially since an estimated 60 percent of world trade occurs within multinational entities, Scholten wrote, citing OECD data.