Related party transactions involving imported merchandise are subject to regulation by United States Customs and Border Protection (CBP) as well as the United States Internal Revenue Service (IRS). For this reason affiliated companies engaged in the sale and importation of merchandise to the United States should consider the impact of pricing determinations from the perspective of both taxing agencies when structuring these types of transactions.
Although CBP and IRS look to apply an “arms-length” test in evaluating related party transactions, each agency approaches its task from a different perspective and with diametrically opposed objectives. Because both authorities seek to maximize their own revenue collection, a multi-national importer/taxpayer may find itself disadvantaged in the absence of advance planning.
CBP is authorized by statue to examine whether import prices have been influenced by the relationship between an affiliated importer and exporter (i.e. whether the prices are at “arms-length”). In examining the transaction, CBP will consider the circumstances of sale and examine whether the declared value approximates one or more so called “test values”. If CBP concludes that the import price is too low, the goods will be reappraised at higher values and increased duties and fees collected. Conversely, the IRS will reallocate income to achieve an “arms-length” profit margin in the United States if it believes that the transfer price in the “controlled” export transaction is too high and that profit had therefore been shifted to the offshore vendor.
Companies are often more sensitive to revenue tax matters than to Customs import duties. International sales transactions and domestically prepared transfer pricing studies are typically structured with an eye towards satisfying the IRS or other local taxing authority, often by seeking to establish that the domestic margin substantially exceeds margins of “comparable” companies. In the not uncommon belief that more is always better, such reports often “gild the lily” as they hunt for comparable companies with the lowest possible margins for comparison to provide a “cushion” in case of IRS audit or inquiry, with little or no recognition of the potential Customs consequences.
Related party transactions are subject to heightened CBP scrutiny, and transfer pricing inquiries are likely to occur at some point in time. Care should be taken by the parties, their tax advisors and counsel in structuring related party sales and drafting transfer pricing and economic analysis reports.