Home » Across Borders » How MNC set the Price for Exported Goods
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Related Party Transactions. One common issue for Multinational Companies (MNCs) when clearing goods with customs is how to prove that the price paid for the imported article has not been influenced by the relationship between the buyer and supplier. Under current customs laws and procedures, customs may reject the invoice price (price paid) if there is sufficient ground to believe that relationship has influenced the price. In practice, customs can test the acceptability of the declared price by using “test” values of previously imported identical or similar goods.

When confronted with these issues, how can the company prove that the price paid has not been influenced by the fact that the buyer and the supplier are related parties? To address this question, one has to understand that most MNCs, if not all, have internal transfer pricing policies established for setting the prices of goods in cross border transactions. What is the concept of Transfer Pricing? How is it related to customs valuation?

Transfer Pricing. It is roughly estimated that at least 50% of the world’s trade in goods and services are between related parties. With the continuing trend towards mergers, acquisition, consolidation and partnering, it is expected that cross border transactions among member-companies within a group or conglomerate will likely continue to grow at a tremendous rate.

Transfer Pricing is the term used to describe how related parties set the price for goods, services, loans, intangibles (e.g. royalty payments) and property rentals when engaged in transactions among themselves. Obviously, companies want to maximize profits by paying as little tax as possible while on one hand, tax authorities want to maximize revenues by taxing as much profit as possible.

In most developed countries, tax (and customs) authorities review the transfer pricing policies of companies to ensure that companies do not shift as much profit to low tax jurisdictions and that governments are able to collect their fair share from companies conducting cross-border transactions with related companies. In the US, even if the transacting parties are unrelated, tax authorities may apply transfer pricing rules if it can be shown that the parties are controlled directly or indirectly by the same or common interests. Thus, transfer pricing rules apply to companies within a controlled group.

Arms Length Principle. Central to the concept of transfer pricing is the arm’s length principle, which has been used by MNCs for decades. This principle provides that where one company transacts with a related party, the prices and terms of the related party transaction should not differ from the prices and terms which would have prevailed between unrelated parties. Arm’s length pricing simply means that prices should be the same as that between independent parties, under similar set of circumstances. The international application of the arm’s length principle in transfer pricing is coordinated by the Organization for Economic Cooperation and Development (OECD). The OECD has issued guidelines since 1979 to serve as the consensus interpretation of the arm’s length standard and to act as bridge among the various transfer pricing laws of many countries.

Pricing Methods. Under the OECD guidelines, the various methods to determine if the price between related parties is arm’s length can be grouped under the following categories: (a) transactional methods and (b) profit based methods. Based on these guidelines, various countries have individually established their transfer pricing rules. The United States, which has probably the most complex rules on transfer pricing, has different transfers pricing methods depending on the property or service involved (tangible property, intangibles, services and loans and property rentals). For determining the arms’ length pricing of tangible property (in contrast to intangibles), the US has 6 methods, as follows:

  1. Comparable Uncontrolled Price (CUP) method
  2. Resale Price method
  3. Cost Plus method
  4. Comparable Profits method
  5. Profit Split Method
  6. Any unspecified method

The first three methods are quite similar to Methods 2 to 4 of the customs valuation system provided under TCCP Section 201. The CUP method refers to comparison with prices in uncontrolled transactions. Resale Price method refers to comparison with the gross profit margin in an uncontrolled transaction. Cost Plus method normally applies to producer or manufacturers and uses comparison with the gross profit mark up of uncontrolled transactions. The Comparable Profits method refers to the use of objective measures of profitability (e.g. profit level indicators such as capital employed and financial ratios, including ratios of operating profit to sales and gross profit to operating expenses). The Profit Split method is determined by allocating the profit or loss between the controlled parties.

Impact of Transfer Pricing on Customs Valuation. In transfer pricing, certain year end adjustments to inventory sales between a seller and buyer may be made to maintain certain profit levels or gross margins. However, such adjustments may be not allowed by customs. To illustrate, the Philippine subsidiary of a US electronics company was given a huge discount on its last quarter importation of electronic products for year 2002. The discount was given to cover foreign currency exchange losses incurred by the Philippine subsidiary, thereby ensuring its gross margin as a distributor of US products in the Philippines is maintained (ref. Resale Minus method). Using test values of previously imported identical goods, customs rejected the discounted price of the last quarter importation and subsequently, assessed the company for additional taxes and duties.

The author is an international trade and customs specialist, and a licensed customs broker. He is also a partner of the law firm of David Leabres Uvero Gaticales Sto. Tomas. For your comments, he may be contacted at agaton.uvero@wtiphils.com or at (632) 4002145 / 4050021.

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