Release date: June 29, 2010
Guest: Alastair Moran
Running time: 11:42 minutes
When importing goods into Canada from related foreign parties, Canadian companies often do not understand the important intersection between transfer pricing and customs valuations. In this episode, Alastair Moran discusses the various methods for customs valuation and how these are impacted by transfer pricing in so far as the customs value of a particular good may be different from its transfer price. He also discusses unbundling royalty payments, the effect of management fees on customs valuations and implications on the final selling price.
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You’re listening to another episode of PwC’s Tax Tracks at www.pwc.com/ca/taxtracks. This series looks at the most pressing technical and management issues affecting today’s busiest tax directors.
Gerry Lewandowski: Hi, I’m Gerry Lewandowski. Here with us today is Alastair Moran, a senior member of PwC’s trade management practice based in Toronto. Alastair started his career with Canada Customs in the Valuation Directorate and has been with PwC for over ten years. He is experienced in providing advice and assistance to Canadian companies on customs and trade issues. Alastair is with us today to discuss the intersection of transfer pricing and customs in terms of the value of imported goods and how these valuations can be significantly different.
Thanks for joining us Alastair.
Alastair: Thank you, Gerry. Pleasure to be here.
Gerry: Alastair, could you begin by explaining to us what customs valuation is all about?
Alastair: Well, here in Canada, Gerry, the Customs Act sets out a hierarchy of methods for determining the customs value – what the act calls the value for duty.
The primary method for determining the value for duty is the transaction value method. Under this method, the value for duty is based on the price actually paid or payable for the goods in a sale for export to a purchaser in Canada. The actual price may have to be adjusted by adding or deducting certain prescribed amounts which would mean that, in some cases, the selling price or transfer price of goods could be different from the value used to calculate the amount of duties and taxes owing.
Now, if the transaction value method cannot be used because, for example, the goods are not actually sold, there are five alternative methods that the importer would proceed, though in sequential order, until a value for duty could be determined.
Gerry: You mentioned that the transfer price and the value for duty purposes might end up being different amounts. Can you expand on this?
Alastair: What’s important to understand, firstly, that there is no single piece of legislation that deals with the value of imported goods for both customs and income tax purposes. The Canada Border Services Agency and the Canada Revenue Agency each go their separate ways, as it were.
Now, you may remember that I said that the actual price of the goods may have to be adjusted for customs purposes by adding or deducting certain prescribed amounts. Royalty payments, for example, may have to be added to the price in order to arrive at the value for duty. This is one reason why the transfer price and value for duty could differ.
It’s also possible that the value for duty could be based on a selling price to a person outside Canada while for income tax purposes, of course, we're always looking at the price to a Canadian taxpayer.
Remember too that I said that there may be cases where the value has to be determined using a method other than the transaction value method. So, this could result in the transfer price and the customs value being different.
Gerry: Let’s talk about a couple of interesting points….more particularly, you mentioned that the customs price could possibly be based on the selling price to a non-resident and that certain amounts had to be added to the selling price for customs purpose. How would that work?
Alastair: Yes, this in an interesting distinction between customs valuation and transfer pricing. You may remember that I said that the transaction value had to be based on the price in a sale for export to a purchaser in Canada. Oddly enough, someone who is not in Canada can be a purchaser in Canada.
Let’s say that a US company buys goods in the Far East and has those goods shipped directly to a Canadian distribution centre. The US company then fills orders received from Canadian customers from the inventory in the Canadian DC.
This is, perhaps, the simplest example of a situation where a non-resident can be a purchaser in Canada. There are two elements in this example that are key.
Firstly, when the US company purchased the goods in the Far East, it had not already agreed to sell them to a Canadian resident; in other words, the US company purchased and imported the goods on spec.
Secondly, the goods were shipped directly to Canada; that is, the sale to the US company was a sale for export to Canada.
Allow me, Gerry, to take a little more time on these two points. We've often found US companies that export goods to Canada and which have declared their purchase cost or their landed cost as the basis of the Canadian customs value. This would only be correct in very specific circumstances, as we’ve just outlined. Companies need to very careful on this point as an error here could result in retroactive duty adjustments and penalties. And … if you were about to ask, Customs can go back four years.
Gerry: Now, if royalties are one of the items that have been added to selling price, how does this work if a royalty payment has to be unbundled from the transfer price?
Alastair: If the royalty payment is actually included in the transfer price, then it will be regarded as part of the value for duty and subject to duties and taxes. There isn’t much we can do.
On the other hand, royalties and license fees that are paid separately from the transfer price are not included in the value for duty unless they are paid as a condition of the sale of the goods. The expression “condition of sale” has been interpreted by Canadian courts to mean that the contract of sale must expressly state that the seller has the right to refuse to sell the goods if the royalties or license fees are not paid.
So, careful attention to the wording of the royalty agreement, and how the royalty is charged, will go a long towards ensuring that these amounts do not have to be included in the value for duty. Of course, royalties that are charged separately from the price of imported goods may be subject to withholding tax in Canada, so one needs to take both corporate income tax and customs duty impact into account when deciding how to go forward.
Gerry: What about management fees, Alastair, these are typically charged separately from the transfer price…do they have to be added back for duty valuation purposes?
Alastair: Basically Gerry, the Canada Border Services Agency is going to look very closely at any amounts paid by the buyer to the seller over and above the invoiced selling price. The Agency’s default position will be that any separate payments are part of the value for duty unless the importer can show why they should not be, so it’s important for importers to make sure that they can defend a decision to exclude any separate payments from the value for duty.
In the case of management fees paid by the buyer to the seller, the importer is going to have to demonstrate that, firstly, the buyer actually received bona fide services, and, secondly, that those services are of a type that the buyer would legitimately require to operate its business, and, finally, that the amount of the charges were consistent with an arm’s length relationship. On this last point, having a transfer pricing study which supports the arm’s length nature of the management fee will go a long way towards making this a non-issue in the event of a customs audit.
Gerry: When the importer is determining the value for duty, are there any amounts that can be deducted from the selling price?
Alastair: Well, the opportunities for deductions are fewer Gerry, but they are there. For example, certain freight, insurance and related costs – those that arise after the place in the country of export from which the goods were shipped to Canada – are a potential deduction. And companies that are importing goods on an installed basis should be aware that costs incurred for the construction, assembly, or maintenance of the goods that is provided after the goods have been imported are not regarded as part of the value for duty.
Gerry: Are transfer pricing adjustments an issue for importers? Is the importer obliged to report the transfer pricing adjustments if the goods are duty free?
Alastair: Very good point Gerry and thanks for bringing it up because this is something that importers buying from related companies often overlook.
Firstly, if the value for duty is based on the transfer price – that is, the transaction value method has been used – then the Canada Border Services Agency expects importers to report any increase in that price that occurs after the goods have been imported … even if the goods are duty-free.
You should know that there is a provision in the Customs Act which requires the importer to correct any error in the declared value of imported goods within 90 days of having reason to believe that the error occurred. As far as the Agency is concerned, a post-importation increase in the transfer price means that the value for duty originally declared is no longer correct. Failure to make corrections within the prescribed time limit can result in financial penalties under the Administrative Monetary Penalty Systems or AMPS.
On the other hand, post-importation reductions in the transfer price do not have to be reported because there is another provision in the Act which says that any rebate or reduction in the selling price that is affected after importation is to be disregarded when determining the value for duty. That’s the upside: the downside is that the reduction in the transfer price cannot be used as the basis of a claim for a duty refund.
Gerry: And finally, Alastair, you have worked with your Transfer Pricing colleagues at PwC on issues like this before….what are the types of things that PwC can assist clients with in terms of attempting to deal with this issue?
Alastair: We’ve touched on a couple of the most common issues that we help our clients with, Gerry. For example, filling refund claims or adjustment requests relating to amounts that were incorrectly included or excluded from the declared value for duty. Or, helping clients with reporting transfer pricing adjustments – sometimes helping them to prepare voluntary disclosures to avoid penalties for failing to report these adjustments within the time limits set in the law.
We’re also helping a number of clients, particularly clients new to Canada, with planning their whole import process to make it compliant and cost effective.
One final comment, Gerry, and this is for any clients that already have value for duty rulings from the Canada Border Services Agency. We’d love to have a look at your ruling; we’ve had some real success in challenging rulings and obtaining refunds for our clients – into the millions of dollars. And yes, just like Customs, we can go back four years too.
Gerry: Thank you for sharing your perspectives with us, Alastair. For additional customs information, please visit the PwC website at pwc.com/ca/customs.
Thank you for tuning into Tax Tracks at www.pwc.com/ca/taxtracks.
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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.