In an increasingly globalised economy, multinational enterprises (MNEs) must navigate complex taxation and customs regulations to ensure compliance with various national frameworks. Customs valuation (CV) and transfer pricing (TP) are two key aspects of this regulatory environment, particularly in the UK, where the interaction between these domains can significantly impact both the tax obligations of businesses and the correct valuation of goods for import duties. The World Trade Organisation (WTO) has developed a set of guidelines for customs valuation that are widely followed globally, including in the UK. This guide will explore both customs valuation and transfer pricing and with particular emphasis on the six WTO valuation methods that are used to determine the customs value of goods.
WTO Valuation Methods for Customs
The WTO’s Customs Valuation Agreement (CVA) outlines six primary methods for determining the customs value of goods. These methods are designed to ensure that the value of imported goods is assessed in a fair and consistent manner, reflecting the true price paid or payable for the goods in an international transaction.
Under UK law, customs valuation is primarily regulated by The Customs (Import Duty) (UK) Regulations 2018. The main method used to value goods is the transaction value method, which is based on the price paid or payable for the goods when sold for export to the UK. This method includes the cost of the goods, freight, insurance, and other charges related to the importation. It is notable that whereas customs valuation is based upon the cost of freight to the UK border, VAT is chargeable on the inland proportion of the transport also.
- Transaction Value Method
The transaction value method is the most commonly used method under WTO rules and is based on the price actually paid or payable for the goods when sold for export to the importing country. This price includes all costs related to the goods, such as shipping, insurance, and any associated charges. The transaction value is considered the most reliable and direct way to assess the value of goods, assuming there is no significant influence on the price between related parties.
Guidance: Ensure that the price declared for the goods reflects the true sale price between the seller and buyer, and include all costs (freight, insurance, etc.). In cases where the buyer and seller are related parties, customs authorities may scrutinise the price to ensure it aligns with market conditions.
- Transaction Value of Identical Goods
This method applies when the transaction value of the goods being imported cannot be determined or when the goods are sold to related parties. In such cases, the value of identical goods sold in the same country can be used as the basis for determining the value. Identical goods are those that are the same in all respects, including physical characteristics, quality, and reputation. The lowest price at the greatest aggregate quantity may be used.
Guidance: When using this method, the comparison should be made with goods that are identical in every aspect. They must have also have entered the UK market at the price declared during the most recent 30 day period, and supporting evidence must be provided to demonstrate this. The transaction value of the identical goods should be adjusted for any differences in conditions of sale, quantities, and any other factors that may affect the price.
- Transaction Value of Similar Goods
If the goods cannot be considered identical, then the transaction value of similar goods can be used. Similar goods are those that, although not identical, have similar characteristics and are commercially interchangeable. This method can be applied when no identical goods are available but similar goods are readily identifiable. The lowest price at the greatest aggregate quantity may be used.
Guidance: The customs authorities will assess whether the goods have sufficient similarity to be used for valuation purposes. The transaction value of similar goods must be adjusted for any differences in terms of quality, quantity, and commercial conditions. Similar goods must have also have entered the UK market at the price declared during the most recent 30 day period, and supporting evidence must be provided to demonstrate this.
- Deductive Value Method
The deductive value method is used when the transaction value method or the value of identical or similar goods cannot be determined. This method is based on the price at which the imported goods are sold to unrelated buyers in the importing country, adjusted for certain factors such as commissions, transport costs, and taxes.
Method 4(b) The organisation must give a reasonable estimate of the final sales value for deposit purposes. This estimate must be supported by a pro-forma invoice, statement of value or other evidence. For importations of fresh fruit and vegetables and cut flowers, the trader does not have to wait until all the goods are sold to establish the Customs value. Once the trader has sold enough to arrive at the unit price the trader must send copies of the sales invoices and a copy of the calculations to the National Import Duty Adjustment Centre (NIDAC). Unless an overall percentage deduction has been agreed with HMRC, HMRC will also need details of the actual deductions claimed. Duty will either be taken to account, refunded or called for.
In the fresh fruit and vegetable and cut flowers trade the account sales procedure may be used as a basis for arriving at the duty payable.
Guidance: This method is often applied when goods are sold in the domestic market of the importing country. The valuation is determined based on the resale price of the goods, adjusting for any additional costs incurred in the resale process. This method can be particularly useful for goods that are widely traded.
- Computed Value Method
The computed value method is based on the cost of production of the goods, including the materials, labour, and overheads used in the manufacturing process. This method is used when the transaction value or the values under the previous methods cannot be determined. The computed value must also take into account a reasonable profit margin and general expenses incurred by the producer.
Guidance: When applying this method, the customs authorities will need to assess the cost structure of the manufacturer, including all costs related to the production of the goods, and add an appropriate profit margin. This method is typically used for intercompany transfers of factory-made goods, custom-made or specialised goods.
- Fallback Method
The fallback method is the last resort and is used when none of the above methods can be applied. This method allows customs authorities to determine the value using a reasonable method, based on available information, provided it is consistent with the principles of the CVA.
Guidance: The fallback method provides flexibility when no other method is applicable. However, the approach must still be based on the general principles of the CVA and should aim to approximate the customs value as closely as possible to the actual transaction price.
Transfer Pricing (TP)
Transfer pricing refers to the pricing of transactions between related entities within an MNE, such as the sale of goods, services, or intellectual property (IP). The primary objective of transfer pricing regulations is to ensure that these transactions are conducted at arm’s length, meaning that the terms and conditions of such transactions reflect what would occur between unrelated parties under similar circumstances. In the UK, transfer pricing rules are based on the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, which provide a framework for determining appropriate pricing and preventing the manipulation of intercompany transactions to shift profits to low-tax jurisdictions.
The UK’s domestic transfer pricing rules, found in Part 4 of the Taxation (International and Other Provisions) Act 2010 (TIOPA 2010), mirror the OECD guidelines, requiring that MNEs use arm’s length principles when allocating income and expenses across their global operations. The arm’s length principle is typically tested through a series of methods, including:
- Comparable Uncontrolled Price (CUP) Method: This method compares the price charged in a controlled transaction (between related parties) with the price charged in an uncontrolled transaction (between unrelated parties) for the same or similar goods or services. The CUP method is often considered the most reliable, particularly when there are truly comparable transactions.
- Resale Price Method (RPM): This method is used when goods are resold by the buyer to an independent party. The resale price method subtracts the gross margin from the resale price to determine the arm’s length price, with the assumption that the related-party transaction’s profit margin should be consistent with that of independent resellers.
- Cost Plus Method: This approach is typically applied when the seller provides goods or services to a related party and does not resell the goods. It involves adding a reasonable profit margin to the costs incurred in the production or provision of the goods or services. This method is often used in manufacturing and service industries.
- Transactional Net Margin Method (TNMM): The TNMM compares the net profit margin achieved in a controlled transaction with the net profit margin of similar uncontrolled transactions. It is often applied when other methods are difficult to use or when comparability data is scarce.
- Profit Split Method: The profit split method divides the combined profits (or losses) of related entities in a way that reflects the relative contributions of each party to the overall transaction. It is particularly useful when transactions involve complex intangibles or when multiple parties contribute to the value of a product or service.
- Comparable Profit Method (CPM): This method is similar to the TNMM but focuses on the profit levels of comparable companies rather than the profit margins from individual transactions. It assesses the overall profitability of the company to ensure that the intercompany pricing reflects market conditions.
These methods allow tax authorities to evaluate whether intercompany pricing is reasonable and reflects market conditions, thus preventing base erosion and profit shifting (BEPS).
For UK businesses, failure to comply with transfer pricing rules can lead to significant tax adjustments, penalties, and the imposition of interest charges on unpaid taxes. Consequently, businesses must maintain detailed documentation to support their transfer pricing arrangements, including analysis of the comparability of transactions, selection of appropriate pricing methods, and the economic analysis underpinning the intercompany transactions.
The Intersection of Customs Valuation and Transfer Pricing
A critical issue in customs valuation is the determination of the correct “transaction value” for goods imported from related parties. If goods are transferred between related companies, customs authorities may question whether the price paid is reflective of market conditions. In such cases, the arm’s length price under transfer pricing rules may be scrutinised to ensure that the customs value is accurate and not artificially low to reduce customs duties. This creates a clear intersection between transfer pricing and customs valuation.
The relationship between transfer pricing and customs valuation is particularly important in MNEs with international supply chains. Goods transferred between related parties are subject to both transfer pricing and customs valuation rules. When these related party transactions involve cross-border goods movements, there is a potential for discrepancies between the value used for transfer pricing purposes and the value declared for customs purposes.
For example, if a company uses a low transfer price in a related-party transaction to reduce its taxable income in the UK, this could lead to an undervaluation of the goods for customs purposes, potentially resulting in lower import duties. Conversely, a high transfer price could increase the customs value and lead to higher duties. Consequently, UK tax and customs authorities may closely scrutinise these intercompany transactions to ensure that the customs value is consistent with the arm’s length price determined under transfer pricing principles.
The UK HM Revenue and Customs (HMRC) is vigilant in ensuring that MNEs comply with both transfer pricing and customs valuation rules. HMRC may conduct audits to verify that the correct values are declared and that transfer pricing arrangements are aligned with the arm’s length principle. Any inconsistencies between the customs value and transfer pricing positions may trigger further investigation and potential penalties.
Practical Implications for Multinational Enterprises
For MNEs operating in the UK, the need to comply with both transfer pricing and customs valuation regulations requires careful planning and documentation. To avoid complications, businesses should ensure that their transfer pricing documentation aligns with their customs declarations. This includes maintaining consistent pricing structures for related-party transactions across both tax and customs reporting.
Furthermore, businesses must be aware of the risk of double taxation, where differing valuations are used for transfer pricing and customs purposes, resulting in the payment of additional duties without the corresponding offset against tax liabilities. MNEs should seek to mitigate this risk through advance pricing agreements (APAs) or customs rulings, which can provide certainty on the appropriate transfer pricing methodology and customs valuation approach.
Additionally, the increasing digitalisation of global trade and the push for more transparency in international tax and customs practices underscore the importance of robust compliance measures. Businesses that can demonstrate a consistent, arm’s length approach to both transfer pricing and customs valuation are better positioned to navigate these regulatory challenges and avoid costly disputes with tax and customs authorities.
Conclusion
Customs valuation and transfer pricing are closely intertwined in the regulatory framework governing multinational enterprises. For businesses operating in the UK, it is essential to ensure that both tax and customs declarations are consistent with the arm’s length principle to avoid potential penalties and double taxation. By understanding the principles and methods used in both domains, and maintaining comprehensive documentation, MNEs can effectively manage their compliance obligations and reduce the risks associated with cross-border transactions. The increasing scrutiny of related-party transactions underscores the importance of careful planning, transparent reporting, and proactive engagement with tax and customs authorities.
For assistance in determining customs valuation for interbranch transfers of goods, please contact Alinea Customs’ consultancy department, customs@alineacustoms.com.
