Transfer pricing and customs law: Crucial interdependencies

A large part of the cross-border world trade takes place among group companies. Therefore, transfer prices and customs duties play a very important role within a group, not only considered separately, but also the connection between transfer prices and customs. Especially against the background of the different objectives of tax administration and customs administration, it is advisable to include the influence of transfer prices on customs values in the planning process at an early stage, i.e. at the time of transfer price determination and conclusion of contracts.

The judgment of the Court of Justice 20.12.2017 Hamamatsu Photononics Germany in case C-529/16 also shows very recently that transfer prices can have a crucial impact in determining the customs value and that in this context regulations which are quite common in the area of transfer pricing can offer potential for conflict in the field of customs. In the following, the main differences and connections between transfer pricing and customs law will be discussed.

Tax administration vs. customs administration

Different objectives, rules and procedures of tax administration and customs administration can be decisive for the handling of situations that affect transfer pricing as well as customs law. Such situations are deliveries of goods from third countries to the customs territory of the EU, between affiliated entities. While tax revenues are of advantage for the state itself, state governments or municipalities, approx. 80 percent of the customs revenues are to be transferred from Germany as the collecting member state to the EU to Brussels. The remaining 20 percent are intended to cover the administrative costs incurred. The German tax administration can use the German tax revenues for its own purposes in Germany, but most of the customs revenues have to be paid to the EU. As a result, the tax administration has a much greater interest in generating tax revenues, while customs duties take a back seat as a source of revenue from the perspective of the member states.

If a German group company purchases goods from a third country affiliated company, an arm's length price has to be paid from a tax perspective. From a German tax perspective, a transfer price as low as possible would be desirable, since the transfer price leads to a reduction in German tax revenues. As a consequence, the lower the transfer price, the higher the German tax revenue. From a customs perspective, the point of view should be reversed: the higher the customs value, the higher the revenues for the customs administration and for the EU. In addition, the member states have to deal with severe penalties if customs duties are not collected in the correct amount.

Transfer price vs. customs value

The fundamental principle to be observed in connection with transfer prices is the so-called arm's length principle, regulated in Germany in § 1 (1) sentence 1 AStG. According to Article 9 of the OECD Model Tax Convention it says: where ”conditions are made or imposed between the two enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly”. Consequently, the transfer price serves, inter alia, to create a balance of interests between the tax burden of the group, i.e. to take advantage of tax reductions by calculating a high transfer price for the received goods of the foreign company, which has a lower tax rate, and to maximize national tax revenues by calculating the lowest possible transfer prices for the received goods of foreign companies in order to keep the profit and thus the basis for tax revenues in Germany high. In addition, transfer prices also fulfil a protective function against double taxation.

The customs value, on the other hand, is generally based on the real value of the goods, the so-called transaction value, i.e. the price actually paid or payable for the goods when sold for export to the customs territory of the Union, which must be adjusted if necessary, see Article 70(1) UCC.

In the case of deliveries of goods between associated companies from a third country into the customs territory of the EU, the transfer price is often used as the basis for determining the customs value. As a consequence, different conflicts can arise, since the customs value is not always automatically the transfer price or the final transfer price. As described above, the customs value is determined concretely at the time of clearance, whereas the final transfer price is often not fixed until the end of the fiscal year, for example, when adjustments are made, e.g. planned costs are adapted to actual costs. In addition, transfer prices are often determined on a common basis for a large number of transactions, and customs values refer to a specific transaction. The year-end adjustments which are possible according to transfer pricing regulations can lead to the issue that adjustments in respect to the customs value and in this connection customs refunds are no longer possible for the company because subsequent price adjustments are only accepted by the customs administration in Germany if they lead to post-clearance collection of customs duties.

Implications

As explained above, the transfer price can in principle be used to determine the customs value. Problems arise if the transfer price is adapted after clearance of goods. When determining transfer prices and in the context of ”price setting”, it is therefore advisable to take future interdependencies with customs law into account and to make arrangements such as additional passages in intra-group contracts. Consequently, the interests of the group as well as those of the tax and customs authorities can be considered.