As the pace and scope of global regulation such as Base Erosion and Profit Shifting (BEPS) continues to increase, transfer-pricing policy is becoming top of mind for multinational companies. Of particular interest is how transfer pricing and customs work together – or sometimes don’t.
Transfer pricing and customs have a lot in common. Both are subject to regulation and oversight. Both have historically depended on manual processes that companies as well as countries are now automating. And both processes are directly linked with substantial tax and duty payments.
On a practical level, the transfer price of a good in a company’s internal supply chain should be closely correlated with the customs valuation on the basis of which customs duties are levied. Creating this alignment can be difficult in practice, however, as both valuations are guided by separate and different valuation principles. In addition, transfer prices are often adjusted retroactively to maintain alignment with the company’s transfer-pricing policy, in which case customs valuations of the related import entries need to be adjusted accordingly to result in the correct duty payment.
These linkages, combined with the fact that governments around the world have recently become more focused on transfer-pricing and customs- valuation declarations than in the past, make both operations a material financial issue for multinational companies.
Transfers pricing in the spotlight
Tax authorities have increased the pace of transfer-pricing regulation and enforcement and will continue to do so.
The number of countries with specific transfer-pricing regulations for direct tax purposes has increased substantially since 1994. Twenty years ago, only Brazil, Mexico, France, Australia and the US had country-specific regulations. By 2011, that number jumped to 65 countries. This has increased the complexity of transfer-pricing processes.
The world’s tax authorities are rapidly moving toward implementation of BEPS, the latest set of global regulatory actions meant to address tax avoidance. Conveniently, BEPS Action 13 will induce both companies and tax authorities to better leverage technology for transfer pricing. Right now, dozens of countries are aligning their cross-border tax and transfer-pricing documentation rules with the OECD’s BEPS framework. This alignment is the first step in automating more of the process.
In contrast to the global transfer-pricing process alignment that BEPS brings, customs authorities still have varying practices for linking transfer prices and customs valuation, although some progress is being made toward harmonization. “There remains a significant variance in the types of evidence customs authorities will consider as supportive of the acceptability of transfer prices as the basis for transaction value,” Deloitte stated in a recent study.
The cost of separating transfer pricing and customs
Ideally, transfer pricing and customs should be in alignment from process and automation perspectives so that both teams can work more efficiently, but this is often not the case. This potentially increases both risks and costs that ultimately impact the company’s trade.
Due to the way most companies organize their compliance operations, decisions regarding transfer pricing are often made in isolation from the trade compliance team. Overall, transfer pricing tends to have a higher level of CFO focus and visibility due to its impact on global effective tax rates. BEPS in particular is causing large companies to further prioritize transfer pricing, accelerating the trend.
From a process standpoint, transfer-pricing policies tend not to reflect how import declarations are made in practice. For example, a transfer-pricing policy may deal with multiple product groups in aggregate, while import declarations are instead made on a SKU-level itemized basis.
For transfer-pricing and customs-valuation alignment to work in practice, the internal processes must be crystal clear and easy to operate so as not to slow down the flow of goods either due to internal processing or the customs valuations being challenged by customs authorities at the border. The tension between supply chain efficiency on one hand and diligent regulatory compliance on the other is at the heart of this matter.
Furthermore, transfer pricing is typically adjusted during or after the fiscal year. This translates into a process challenge for the trade compliance team which has to take the transfer-pricing adjustments and apply them to the individual import declarations made during the year. Accurately prorating the adjustment in most cases is a manual task, and it is further complicated by the difference between how the transfer-pricing policy is implemented and the import declaration process. Failure to reflect changed transfer pricing in customs declaration has inevitable undesirable consequences: either underpayment of customs duties, which can result in penalties, or overpayment of customs duties, which can result in cash leakage. Many countries do not have regulatory mechanisms in place for refunds in the case of duty overpayments, which often creates a hidden cost to downward transfer-pricing adjustments.
Ideally, transfer pricing and customs should be in alignment …
Which begs the question: What barriers prevent customs and transfer pricing from being fully aligned?
The lack of communication between operational transfer-pricing areas and customs leads to an inconsistent process that exposes the company to compliance risks and potential tax and duty overpayments.
Operationally, transfer-pricing decision making tends to be centralized while customs teams work at the borders. The transfer-pricing team’s decision making is typically done on a country entity or line-of-business level while the customs team’s declaration is made at an individual SKU transaction level. Seldom is there an automated link between the higher- level transfer-pricing decision and the lower-level import declaration.
The two departments also tend to report to different areas of the organization. End-of-year reconciliation can therefore be time-consuming and error-prone because the reporting structures of each make it difficult to coordinate customs entry reconciliation processes to match adjusted transfer prices.
So, automated processes and better communication can bridge the gap.
The many benefits of automation
Multinational corporations need to better align customs and transfer-pricing teams because most transfer-pricing policies do not describe the product-level pricing that is required or customs entries, and they need to do so by further automating both.
Their misalignment creates redundant work. Customs compliance teams need to double-check product-level transfer-pricing valuations to ensure they fulfill the criteria set by the customs authorities and the relevant transfer-pricing regulations. The broader trade team must then ensure these valuations are consistently applied across the enterprise.
A company-wide price list for internal transactions is the most straightforward way to accomplish this, and automation can drive it. If a customs authority does challenge any of the assumptions used in valuation for intracompany transactions, automation technology and the documentation created within it can support the company’s case.
Another pain point that could benefit from automation is the year-end reconciliation process. Clearly identifying import declarations which need to be reconciled as a result of retroactive transfer-pricing changes and automating the generation and filing of amended declarations can save hundreds of hours of time by the customs teams and avoid compliance risks arising from duty underpayments.
The right technology can enable trade teams to automate data connection from various global systems and compile information, such as foreign transaction data and supporting documents, in a centralized location. This improves workflow and communication, ensuring that transfer pricing and customs are as aligned as they can be.
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