Trouble ahead? New transfer pricing and customs valuation instruction in Germany

July 18, 2013

In September 2012, the German Federal Ministry of Finance issued a revised internal instruction on customs valuation. Although the document is designed to assist customs officials in their day-to-day work and is not binding for the courts, it is deemed to influence the customs processing of intercompany transactions and how far these transactions are subject to audit.

The implications of the revised instruction are rather contradictory. On the one hand, it reinforces the willingness of the customs authorities to accept the transaction value for related-party transactions and to recognize transfer pricing documentation as valid proof of arm’s-length transactions. On the other, it introduces a range of indicators that signal a possible influence over the price, which implies that a wide acceptance of the transaction value might be difficult to achieve.

In these revised instructions (read the full version of this article in the Ernst & Young Indirect Tax Briefing, issue 7 (pdf, 7.13 MB), the German Federal Ministry of Finance has introduced a range of so-called “indicators, signaling a possible influence over the price.” By doing this, the German authority is effectively seeking to limit the possibilities for reducing the customs duty burden by means of price manipulation.

It is important to note that the list of the indicators was included in the instruction as a part of the body text and not by means of examples, which are used in the instruction in some places. This means that customs officials will almost certainly consider these indicators during any customs clearance procedure or customs audit.

Among the factors that appear on the list are some rather routine transfer pricing exercises undertaken by multinational groups to adjust prices between companies, including retroactive year-end and periodic price adjustments, compensatory payments, and adjustments within a target margin scheme.

Although these mechanisms are considered legitimate from an income tax perspective, they will now prompt a customs official to scrutinize every detail of the transactions involved.

In the end, customs might conclude that the relationship between the parties influenced the price and that the transaction value is no longer applicable. Thus, another method of customs valuation will come into question and, consequently, the calculation might become more complicated and, in the end, lead to higher customs duties.

In this context, it is clear that customs issues should be considered in planning any transfer pricing strategy. A higher customs duty burden often counterbalances income tax reductions achieved through redistribution of the company’s resources.

Involving customs professionals in this process can help companies reconcile these contradictory requirements and find a suitable solution. Moreover, due consideration of the customs issues in designing a transfer pricing program — reflected, for example, in the transfer pricing documentation — can anticipate and exceed the expectations of the customs auditors and smooth the audit process.

Practical implications for business

There is some good news in all of this. Despite the conflicting regulations, it is still possible — with bit of planning — to make it all work. The instruction now regulates price decreases and price increases. Companies can avoid unpleasant surprises by submitting all the documents regarding price adjustments to the customs authorities in advance. It is important to note that price adjustment arrangements should clearly appear in the written contract and should be presented to the customs authority at the time of the importation.

Arguably, it should be possible to get a refund of duties overpaid in Germany arising from price adjustments that reduce the customs value of imported goods, provided written contracts include a respective clause.

Unfortunately, so far there is no formal program for reporting retroactive transfer pricing adjustments in Germany similar to the U.S. Customs and Border Protection Reconciliation Program. In the EU, there is a special regime for incomplete customs declarations, which allows provisional values to be submitted at the time of the importation.

Alternatively, importers can make use of a post-clearance examination of the customs declaration and revise their import entries for the preceding three years.

The German customs instruction also offers another opportunity: an advance non-binding ruling, which assesses prospective price adjustment arrangements by a special valuation division of the German customs authority.

Documents talk

Tax provisions require companies to have transfer pricing studies on hand for relevant related-party transactions. Although such studies might contain information that is useful for customs purposes, the reference points for tax and customs purposes do not fully coincide, so customs will consider these studies merely as an indication of a possible arm’s-length transaction.

While tax authorities compare the economic operator under review with other companies with a similar business function and delve into the books of the local taxpayer, the customs authorities make their comparisons on a product level. They may review comparable imports in their customs clearance databases to determine a reasonable price.

The good thing is that control over the transfer pricing documentation lies entirely in the hands of the company concerned. That means it is possible to reflect both transfer pricing and customs issues in one set of documents. This is especially true, taking into account the next novelty in the customs internal instruction.

One of the most important provisions of the revised instruction is that a company’s transfer pricing documentation will be recognized among the proofs of an arm’s-length transaction.

By implementing this provision, the German Federal Ministry of Finance reinforces the proposals of the International Chamber of Commerce (ICC) and the ICC Committee on Customs and Trade Regulations, as well as Commentary 23.1 of the Technical Committee on Customs Valuation at the World Customs Organization (WCO) to accept the transfer pricing documentation and decrease the pressure on multinational corporations.

Understandably, advance pricing agreements (APAs) or transfer pricing studies alone will not suffice. But it is companies themselves that can highlight the information relevant for customs purposes and can make the transfer pricing documentation talk in their favor before the customs authorities.

Read the full version of this article in the Ernst & Young Indirect Tax Briefing, issue 7 (pdf, 7.13 MB).

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