Customs valuation and tax transfer pricing
INSIGHT ARTICLE |
Companies importing goods into Canada often face duties, tariffs, and other compliance items driven by the imported goods value. However, how do you determine this value when the imported goods are purchased from a related party?
Two tax worlds collide
Most companies that have cross border related party transactions are likely familiar with transfer pricing. These companies may also charge management service fees, royalties, and may commonly have year-end true-ups to align with their transfer pricing policies.
When reviewing or establishing transfer pricing policies, companies should also consider how these decisions will impact their customs valuation.
CBSA and CRA: The same goals?
In Canada, the Canada Border Services Agency (CBSA) is responsible for administering the Custom Act which includes ensuring the correct value is declared on a transactional basis for imported goods.
While both the Canada Revenue Agency (CRA) and the CBSA administer aspects of Canadian taxation, the two have competing tasks when determining / assessing the price of imported tangible goods. The CRA is looking to fairly apply rules concerning income taxation to maximize income tax payable by a company, while the CBSA looks to ensure the value of goods is not depressed through transfer pricing and that duties paid are maximized. These concepts compete as higher import values generally result in lower taxable income.
In 2006, the CRA released a circular where the very first paragraph addressed a question commonly asked by importers/taxpayers. The purpose of this information circular is to address taxpayers' question: "Why can't the same transfer price used for income tax purposes be used for customs purposes?"
While the government does address in this circular the similarities between transfer prices for income tax purposes and valuation for customs purposes, much of the circular outlines the differences.
Companies who import tangible goods from related companies should conduct regular reviews of their valuation for customs purposes to ensure they are compliant with regulations under the Customs Act. One of the reasons why it is so important to conduct these reviews is that the CBSA has been very aggressive in conducting valuation audits, especially between related parties. The CBSA is more frequently taking the position that all post-importation payments between related parties are subject to duty unless the importer can provide sufficient proof to demonstrate the payments in question are not dutiable.
Specific considerations with respect to customs valuation
It is the view of most customs authorities around the world that importers should be declaring the price paid or payable (i.e. the invoice price) when reporting the value of goods to customs. This is known as the Transaction Value method for customs valuation purposes. Companies who use this method of valuation still must consider specific statutory additions and deductions, even when not purchasing from a related party, these include:
- Commissions and brokerage
- Royalties and licence fees
- Post-importation payments or fees (subsequent proceeds)
- Certain transportation and associated costs
- Costs arising after the goods have been imported
- Import duties and taxes
Note to importers:
If you are an importer who is paying any of the above costs to a foreign supplier (whether related or not), you could be at risk during a customs valuation audit if the costs are note being included in the import value. Contact your RSM professional if you have questions or concerns.
However, when purchasing from a related company, an importer may not use the transaction value unless they can substantiate that the sale is taking place at arm’s length in accordance with Organisation for Economic Co-operation and Development (OECD) principles. The transfer price selected by companies is the starting point of the transaction value for customs purposes. However, the additions and deductions outlined above also need to be considered. It is CBSA policy to accept a price paid, or payable, which is derived from one of the methods set out by the OECD, unless there is information on prices available that is more directly related to the specific importations.
The transaction value method for customs is comparable to the comparable uncontrolled price (CUP) method of transfer pricing. If you are using another transfer pricing method for income tax purposes, you may fall outside of transaction value for customs purposes. Importers using a method other than CUP for transfer pricing should review their customs valuation methodology to ensure there are no specific risks related to how they are determining the customs value. For customs valuation purposes, the methods other than transaction value have some of the most complex rules and create the most instances of non-compliance.
Preparing for a CBSA valuation audit
As stated, one of the area’s most often audited by the CBSA, is customs valuation. The CBSA uses data analytics to compare importers of similar goods, identify importers purchasing from related parties and identify importers of high risk/value commodities for targeting. CBSA will primarily target importers purchasing from related parties, and then look to other factors for determining whom to audit.
During these audits, the CBSA not only looks at the invoice price declared for goods to ensure they are being valued correctly, but also looks to all other agreements and amounts paid between the related parties to determine if goods have been correctly declared. Some of these agreements will cover not only the price payable for goods but also cover the agreement to provide services. As per CBSA policy, payments for services in respect of imported goods are to be considered in the price declared to customs. Failure to declare the price at the time of import requires importers to adjust the import value to ensure they are included.
During a valuation audit, an importer will also be required to demonstrate the payment for services is calculated at arm’s length, that the service was required for the Canadian operation, and was actually delivered. Other areas such as royalties, commission, and design work will need analysis to document and determine the dutiable status. The analysis is important to demonstrate to customs that careful planning has taken place and the importer is serious about compliance. This planning is similar to what is required for transfer pricing purposes and is necessary to ensure compliance with both tax authorities. During an audit, the CBSA will review any transfer pricing documentation, as well as other intercompany agreements to determine if the correct values have been declared to customs.
Some of the documentation that the CBSA will examine, includes:
- Any payments based on the resale of the goods that cannot be related by the importer to services received
- Management or administration fees, subject to certain exceptions
- Contributions to research and development
- Form T106 – Information Return of Non-Arm’s Length Transactions with Non-Residents
- Payments for materials used in production of imported goods
- Contributions for marketing or promotion not related to goods sold in Canada
- Overhead expenses related to the manufacturing of the goods but not captured in the selling price and recovered after the importation of goods
- Interest on deferred payments
- Any written agreements in place between the parties
- Other payments made after importation
If the CBSA identifies issues, and an importer is found to be non-compliant, the CBSA can assess penalties and interest and typically require the importer to correct retroactively for four years, which can be very costly. This action will be taken regardless of whether the goods are duty free or subject to duty. The CBSA’s decision can be appealed but it can be a long, and often is a costly process.
Retroactive changes to achieve target margins
Many companies purchasing from related vendors use transfer pricing policies that target specific operating margins. As such, companies will often make adjustments at year-end, with corresponding debit/credit notes, to ensure related companies meet these margins. From a customs perspective these are called retroactive price adjustments.
With respect to retroactive price adjustments, it is important to note that if the adjustment results in an increase to the import value to Canada then the importer must report this adjustment within 90 days. This applies whether or not the goods are free of duty or dutiable. Failure to make the corrections timely can result in penalties and assessments as mentioned above.
If the transfer price adjustment results in a decrease to the import value, the importer may be entitled to a refund of duty. The time limit to file a refund is four years from the date of import. Companies who have not been filing these adjustments on a regular basis should conduct an in-depth review to identify fiscal years that represent a compliance risk, and consider a voluntary disclosure to the CBSA.
RSM can help you assess the risks involved in filing a disclosure and look to offset costs through refunds for downward adjustments or identifying allowable deductions.
What should importers do?
On a yearly basis, importers should be reviewing their valuation for customs purposes, and where applicable review their transfer pricing policies with customs valuation, to identify potential risks in their imports. Further, specific attention should be paid when preparing income tax filings to determine if adjustments being made could trigger requirements for adjustments to customs authorities as well.
Our combined approach
Our trade advisory and transfer pricing teams take a unique approach to ensuring businesses comply with all taxation requirements in Canada. As part of this approach we will review intercompany payments to identify those which can be considered to create part of the price paid or payable for reporting values to the CBSA. RSM can also coordinate transfer pricing policy development to identify risks, and mitigate costs.
How can RSM help?
We can assist you in understanding the requirements for correctly valuing imported goods, whether you are purchasing from related or non-related parties. Being proactive in this area can assist in mitigating potential risks during a CBSA valuation audit and reduce the burden of regular compliance activities in order to stay compliant.
When engaged to provide transfer pricing documentation, RSM can provide further customs analysis for various payment streams, and determine if they are to be included, or not, in the value for customs purposes. Finally, RSM can assist in setting up compliance plans to ensure your company can meet the regulations and requirements of a CBSA valuation in a timely manner.
If you have questions on how we can assist your business, contact us today.