Customs Value and Transfer Pricing

What Is Customs Value, and What Is Its Basis?

The starting point in customs law is transaction value – the price actually paid or payable for the goods when they are sold for export. The focus here is the specific import transaction: what the price was for the particular goods, under what terms, and at the time of import.

When the transaction is between unrelated parties, it is usually easier to assume that the price reflects market terms. When the transaction is between related parties, the review becomes more sensitive. Not because the relationship itself disqualifies the price, but because the question arises whether the special relationship affected it. This is one of the central questions in the field of customs value.

This creates an important practical difficulty: even a price that was properly determined within the group, and is even anchored in an intercompany agreement, is not necessarily accepted automatically for customs purposes. In some cases, the answer will be yes, while in others the pricing structure itself or the settlement mechanisms may trigger a more in-depth review.

How Does Transfer Pricing Review the Same Transaction?

The world of transfer pricing does not always focus on each shipment separately. In many cases, especially when methods such as the Transactional Net Margin Method (TNMM) are used, the focus of the review is the overall profitability of the local entity over a period, sometimes over an entire tax year. The analysis is based on a functional analysis, the allocation of functions, assets, and risks, and a comparison to comparable companies.

In other words, transfer pricing does not necessarily seek a “perfect” price for each shipment. Sometimes the ongoing price during the year is only part of a broader mechanism, at the end of which an adjustment is made to bring the local entity into an arm’s length profitability range.

This is exactly where the gap is created. While customs seek to determine the transaction value at the time of import, transfer pricing may accept a situation in which the price is truly finalized only at the end of the year. Therefore, a price that may be fully appropriate for transfer pricing purposes will not always provide a complete answer from the customs perspective as well.

Where Does Difficulty Become More Acute in Practice?

Usually, in retroactive adjustment mechanisms. An Israeli importer that operates as part of a multinational group may purchase goods from a related company based on a price set in advance, but at the end of the year undergo a profitability review. If it turns out that the actual profitability is too high or too low relative to the agreed range, the group may make a year-end true-up.

If the Israeli entity is too profitable, it may be required to make a compensating adjustment and pay an additional amount to the related company. If it is less profitable than expected, it may receive a rebate or credit note. In the transfer pricing world, these are recognized mechanisms and are often very natural. In the customs world, each of them raises a different question: is this a correction to the price of the goods, or a broader settlement that does not necessarily translate simply into customs value.

The difficulty increases when the adjustment is based on overall annual profitability, rather than on specific shipments. The harder it is to link the adjustment to specific import transactions, the more complex the dialogue between the two worlds becomes.

What Is Examined in Practice When There Is a Special Relationship?

When a transaction between related parties is examined from a customs perspective, the authorities generally do not look only at the invoice. They may examine how the pricing model works from beginning to end: whether the price at the time of import was final or provisional, whether the adjustment mechanism was set in advance, what the intercompany agreements provide, and how the settlement looks in practice.

Sometimes the key questions are not theoretical, but very practical. Whether a specific adjustment relates to goods, services, or overall profitability. Whether it can be allocated to specific shipments. Whether the transfer pricing report, import documents, and accounting settlement tell the same story. And when they do not, the risk usually increases.

In our experience, it is precisely in places where each function within the company operates well on its own – tax, finance, and Value Added Tax (VAT)/customs – that a gap may arise if there is no integrated view of the same transaction.

Key Tax Risks

Direct Customs Exposure

If a certain adjustment is viewed as an addition to the consideration for the imported goods, the customs authority may argue that the original customs value was understated. In certain cases, the question does not remain at the level of a single transaction only.

Evidentiary and Reporting Risk

A transfer pricing study may be highly professional and well supported, and still not fully answer the question of the precise nature of a particular charge or credit for customs purposes. When the agreements, invoices, and actual settlement do not fully align with one another, the dispute may quickly move from the professional level to the evidentiary level.

Management Risk

Quite often, transfer pricing work is handled through one track, import and customs through another, and VAT implications are examined elsewhere. In such situations, the exposure is not necessarily the result of a major error, but of a lack of coordination between the different pieces of the puzzle.

Example for Illustration Only

Assume that an Israeli importer within multinational group purchases goods from a related company in Europe with an annual volume of 10 million dollars. During the year, each shipment is charged according to an internal price list. At the end of the year, a TNMM review is performed, and it turns out that the Israeli entity is above the profitability range set for it as a limited risk distributor. In accordance with the group policy, it transfers 500 thousand dollars to the related company as a compensating adjustment.

From a transfer pricing perspective, this may be viewed as a natural adjustment intended to bring the result back to an arm’s length level. From a customs perspective, a completely different question may arise whether those 500 thousand dollars are part of the consideration for the goods imported during the year. If so, it may be argued that the original customs value was too low.

The opposite scenario may also be complex. If the Israeli importer receives a rebate because its profitability was below the agreed range, one could argue from an economic perspective that the price of the goods was reduced retroactively. But the question of whether, how, and to what extent this has significance for customs purposes is not always simple.

How Should the “Solution” Be Considered?

In issues of this kind, there is generally no single short and uniform answer. The significance of a particular adjustment may vary depending on the group structure, the role of the local entity, the wording of the agreements, the type of settlement, the manner of documentation, and the way things were implemented in practice.

Therefore, the real question is not only whether the price is “correct” in the economic sense, but whether the overall picture holds together from a customs perspective as well. Sometimes the focus of the discussion will be the nature of the adjustment. Sometimes it will be the degree of its connection to the goods. And sometimes it will be the gap between what is written in the documents and what was actually done in practice.

In our experience, once there is an interface between transfer pricing, customs value, and VAT, it is correct to assume from the outset that the issue requires an integrated review. Not because every case necessarily leads to a dispute, but because in many cases the real implication becomes clear only when the agreements, reports, invoices, and settlement practices are examined together.

To Conclude, not every arm’s length price is necessarily the correct customs value. Likewise, not every pricing mechanism that appears orderly and convincing for direct tax purposes will be accepted automatically in the customs arena as well. The more company imports goods from related parties and operates with year-end adjustments, rebates, or compensating adjustments, the greater the importance of a careful and precise review of all the facts and documents.

Sometimes the difference between a managed risk and unnecessary exposure does not lie in one fundamental question, but in a combination of small details: what the agreement says, how the settlement looks, what is recorded in the import documents, and how each of the different parties within the company understands the transaction.

Nimrod Yaron & Co. specializes in Israeli and international taxation. Our team is comprised of professionals with years of experience at the Israel Tax Authority, alongside experience at leading firms and law offices, bringing a combination of legal and economic insight. We advise private and public companies, Israeli and foreign companies, global venture capital funds, as well as clients seeking focused advice in clear and accessible language. We also work with a professional network of accounting firms and law offices around the world, in order to provide comprehensive support in cross-border matters.

The firm also has a dedicated transfer pricing department, which advises companies on issues of intercompany pricing, documentation, the review of operating models, and dealing with the points of interface between transfer pricing, customs, and VAT. When an intercompany transaction also involves the import of goods, the interface between these worlds may be more significant than it appears at first glance.