The Secret Sauce: Blending Customs Valuation & Transfer Pricing - PowerPoint Presentation

1. The Secret Sauce: Blending Customs Valuation & Transfer Pricing Into A Winning Formula Damon V. Pike/Anna Zajac - BDO USA, LLPWendy Everett/Keith Anderson - Schaeffler Group, USA, Inc.

2. AgendaBasics of Transfer PricingCustoms Valuation OverviewRelated Party Pricing – “Circumstances of Sales”Customs Value vs. Transfer PriceAdjustments to Transaction ValuePost-Importation Transfer Pricing AdjustmentsAdministrative Tools to Report Changes in ValueLegally Lowering Customs Value – First Sale Rule and Non-Dutiable FeesQuestions

3. Transfer PricingWhat is Transfer Pricing? Intercompany pricing arrangements relating to transfers of tangible goods, intangibles, etc.Transfer Pricing is utilized to allocate income between related parties in different tax jurisdictions so that, in theory, each jurisdiction receives its fair shares of income tax.Multinational companies can manipulate transfer prices in order to shift profits to low tax regions.To remedy this, regulations enforce an arm's length transaction rule that requires pricing to be based on similar transactions done between unrelated parties.

4. Transfer Pricing - “Best Method Rule”“The arm's length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm's length result. Thus, there is no strict priority of methods, and no method will invariably be considered to be more reliable than others. An arm's length result may be determined under any method without establishing the inapplicability of another method, but if another method subsequently is shown to produce a more reliable measure of an arm's length result, such other method must be used. Similarly, if two or more applications of a single method provide inconsistent results, the arm's length result must be determined under the application that, under the facts and circumstances, provides the most reliable measure of an arm's length result.” 26 C.F.R. § 1.482-1(c)(1). Factors to consider when determining the best method:ComparabilityData and AssumptionsSpecial Circumstances

5. Transfer Pricing - ComparabilityThe factors of comparability discussed in the regulations include:(a) ComparabilityFunctionsContractual termsRisksProperty or ServicesEconomic ConditionsSimilarity of geographic marketsLevel of market, etc.(b) Data and AssumptionsCompleteness and accuracy of dataReliability of assumptionsSensitivity of results to deficiencies in data and assumptionsConfirmation of results by another method(c) Special CircumstancesMarket share strategy, etc.

6. Transfer Pricing MethodsWhat are the methods of Transfer Pricing?Comparable Uncontrolled Price (CUP) Method -- The method most favored by CBP (compares unrelated-party pricing to related-party pricing)Cost-plus (CP) Method – also viewed favorably by CBP because it examines the profit of the seller/manufacturerComparable Profits Method (CPM) -- The most commonly used method by multinational companies (uses function/risk comparability of companies); also called “TNMM” (Transactional Net Margin Method) outside the U.S.Re-sale Price (RP) Method Profit Split Method (PSM)

7. The Transfer Pricing Lifecycle ActivitiesStrategyBuildCalculateInvoice & BookMonitorReportAuditPerform functional/ asset & risk assessmentConduct tax analysis/ benchmarkingEstablish TP policyPrepare implementation roadmapDevelop calculation models (automations if applicable)Define processes and governanceExecute IC agreementsPrepare execution documentation and perform trainingRun and reconcile TP calculationsExecute calculation control frameworkEscalate issues Post journal entriesRaise and execute invoicesSettle and reconcile intercompany amountsCompare YTD results against underlying policyInvestigate inconsistenciesCalculate adjustmentsReviewconsistency in conduct of parties and economic substance in relevant entitiesPerform internal auditsFeed into financial reporting and legal entity / statutory accounts preparation processPrepare tax / TP reportsGlobally coordinate tax audit responsesSupport local accounting auditsPlanningExecuteComplianceControversy

8. Customs Valuation MethodsThe “dutiable value” is a calculation usually based on the “price actually paid or payable” (Transaction Value or “TV”), i.e., the commercial invoice price for the goods when sold for export to the U.S.In general, transfer pricing comes into play only when TV is used as the basis of appraisement.If you cannot use TV, other bases of appraisement must be applied in the statutory sequential order:TV of identical merchandise; TV of similar merchandise; Deductive value; Computed value; and “Fall-back” method

9. Customs Valuation – Related Party TransactionsThe transaction value between related parties is acceptable if examination of the circumstances of the sale (“COS”) of the imported merchandise indicates that the relationship between buyer and seller did not influence the price:Normal pricing practices of the industryAll costs plus a profitSeller settles prices to related buyers in the same manner as it does unrelated onesCBP has broadened its approach to “totality of evidence”EXAMPLE: HQ H029658 (December 8, 2009): Automotive industry’s “Market-Driven” prices and “Advance Pricing Agreement”

10. “Whipsaw” Effect Between IRS and CBPSame overall objective: arm’s length pricing.CBP concerned about transfer prices because of a possibility the seller will charge buyer lower prices for goods that attract lower duty – and charge higher prices for duty-free goods.IRS also concerned about transfer prices because of a possibility seller will manipulate them in an effort to shift profits to countries with lowest tax rates, thus lowering income tax liability.IRS Code Section 1059A: taxpayer can’t claim a higher inventory basis than the declared customs values for the fiscal year period.

11. Customs Valuation vs. Transfer PricingTransfer PricingCustomsItems to be Taxed:Annual Net IncomeSpecific Product PriceRelevant Timeframe:Return Due DatesDate of ImportLevel of Anticipation:Overall Results (Tax Return)Transactional (entry-by-entry)

12. Common Adjustments to Transaction ValueAdditions to TV -- “SCRAPP”Selling Commissions (other than Buying Commissions)RoyaltiesAssistsProceeds from subsequent sales; andPacking CostsDeductions:Transportation/insurance costsCost for services incident to the international shipment of the goodsReasonable cost incurred for post-importation work; andCustoms duties / Federal taxesTotal Cost – All payments made by a buyer to a seller are presumed to be part of TV for imported merchandise. See Generra Sportswear Co. v. United States, 905 F. 2d. 377 (Fed. Cir. 1990).

13. Post-Importation TP AdjustmentsIn the U.S., post-importation price adjustments have to be reported to CBP if the adjustment meets the requirements of the “5-factor” test enumerated in CBP HQ Ruling W548314 (May 16, 2012).In the context of related party transactions, the “5-factor” test requires that the TP policy/formula is in writing and is in place at or before the date of importation of the merchandise covered by policy/formula. Other factors apply as well in order for the adjustment to be considered part of TV.

14. The 5-Factor TestHQ W548314 (May 16, 2012) – the “5 factors” needed to support inclusion of a TP adjustment in TV:A written “Intercompany Transfer Pricing Determination Policy” is in place prior to importation;The U.S. buyer uses its transfer pricing policy, and any TP adjustments are reported to IRS; The company’s transfer pricing policy specifies how the transfer price and adjustments are determined; The company maintains and provides accounting details from its books; andNo other conditions exist that may affect the acceptance of the transfer price by CBP.EXAMPLE – HQ H024857 (Jan. 7, 2014): Contracts showed that the related seller/buyer dealt with each other in the same way that they dealt with unrelated parties. CBP concluded that the intercompany price was arm’s length and thus, that TV applied. Post-importation TP adjustments were part of the transaction value because the TP formula was fixed at or prior to importation.

15. Administrative Tools – Reporting Changes to Custom ValuesReconciliation Program - Importers can “flag” entries and then provide the final customs values after the transfer pricing adjustments are made. Certain entry types cannot be flagged for Reconciliation.“Administrative Letters” - CBP permits importers to use an administrative letter to report the value adjustment and pay additional duty/fees. See HQ H024857 (Jan. 7, 2014). Note that the Prior Disclosure mechanism is not appropriate given that no violation of valuation rules occurred at the time of import.Post Summary Corrections – Unliquidated entriesProtests – Liquidated entries (refunds only)

16. Legally Reducing Customs Values: First Sale RuleU.S. is the only remaining country that recognizes the First Sale Rule (FSR), which permits the first sale price of goods sold for export to the U.S., i.e., the factory invoice price, to be used as the customs value when one or more intermediaries are involved in the import transactions, and all preconditions are met.

17. Legally Reducing Customs Value: Non-Dutiable FeesTerritorial exclusive distribution fees - HQ H242894 (Dec. 4, 2013)Administrative/management fees paid to the seller, not connected to imported merchandise (accounting, finance, planning, management, marketing, etc.) – HQ H239496 (Mar. 13, 2015)Testing/Consulting service fees paid to a third-party service provider – HQ H270670 (Feb. 17, 2016)

18. Questions?

19. Damon leads the Customs and International Trade Services group within the firm’s International Tax Services practice with more than 32 years of experience helping multinational companies navigate the complex rules governing the cross-border movement of goods and services. The goal of the CITS team is to provide end-to-end global consulting services for all aspects of import/export planning and compliance. In addition, Damon advises clients on export compliance and exports controls, often in the context of government contracts under the Trade Agreements Act. He has worked with many companies in filing Voluntary Self Disclosures with, e.g., the Bureau of Industry & Security (Commerce Dept.), the Directorate of Defense Trade Controls (State Dept.), and the Office of Foreign Assets Control (Treasury Dept.).Over his lengthy career, Damon has assisted clients with all aspects of customs and international trade issues. He is especially renowned for his insights in harmonizing transfer pricing policies and customs valuation requirements as part of designing in-house customs and trade compliance programs. While in private law practice, he litigated the first tariff classification case for 3D printers at the US Court of International Trade. Damon’s other areas of expertise include country of origin determinations, free trade agreements qualification, and customs controversy matters (audits, Prior Disclosures, Protests, etc.)Damon is involved in several professional organizations, including the National Customs Brokers and Forwarders Association of America, the International Compliance Professional Association, the U.S.-Mexico Chamber of Commerce and is admitted to the Bars of the District of Columbia, the U.S. Court of International Trade, the U.S. Court of Appeals for the Federal Circuit, and the U.S. Supreme Court. He served as Chair of the Customs Law Committee of the International Law Section of the American Bar Association, 2011-2013, District Export Council, State of Georgia, 2015-2019 (U.S. Department of Commerce), Exporters’ Textile Advisory Committee, 1997-2006 (U.S. Department of Commerce), Georgetown University Law Center International Trade Update, Advisory Board, 2005-2015, and is a licensed U.S. Customhouse Broker.Damon V. PikePRINCIPAL, INTERNATIONAL TAX - CUSTOMS & INTERNATIONAL TRADE SERVICES(561) 207-3205 dpike@bdo.com

20. Anna is a Senior Manager in BDO’s Customs and International Trade Services group within the firm’s International Tax Services Practice. She has more than 20 years of experience working with companies to advise and manage import and export compliance strategy and risk. Her focus is helping clients effectively manage the financial and operational effects of the changing regulatory landscape and remediating compliance risks for international transactions. Anna also helps clients assess tariff management options, determine classification and jurisdiction of goods for export, develop and design compliance documentation and training, and support internal audit programs. Prior to joining BDO, Anna worked for a Big Four Accounting Firm. Her article “Customs duty refunds on transfer-pricing adjustments” was published in AICPA’s The Tax Advisor in 2022 and “The link between transfer pricing and customs duties” was published in AICPA’s Financial Management Magazine in March 2021. Anna has an MBA from the University of Maryland, Robert H. Smith School of Business and is a Certified Public Accountant. During her free time, Anna enjoys working in her garden and mentoring underprivileged students as they prepare for college.Anna ZajacSENIOR MANAGER, INTERNATIONAL TAX - CUSTOMS & INTERNATIONAL TRADE SERVICES(312) 730-1392 azajac@bdo.com

21. 21