SEPTEMBER 15, 2015

By Siddartha Bhatt S, Advocate

ON 24^th June 2015, the World Customs Organization (hereinafter referred to as "WCO") has published "WCO Guide to Customs Valuation and Transfer Pricing". This article examines the interplay of relationship between transfer pricing and customs valuation in a related party import transaction.

1. Customs Valuation

1.1. In terms of Section 14 of the Customs Act, 1962, value of imported goods shall be transaction value, that is the price actually paid or payable for the goods when sold for export to India for delivery at the time and place of importation, where the buyer and seller of the goods are not related and price is the sole consideration for the sale.

1.2. The second proviso to Section 14 provides that the Central Government may make rules to determine the circumstances in which the buyer and seller are related and the manner of determination of value in respect of imported goods when the buyer and seller are related.

Customs Valuation Rules

1.3. The Central Government vide Notification No. 94/2007-Cus (N.T.) dated 13.09.2007 as amended, notified Customs Valuation (Determination of Value of Imported Goods) Rules, 2007 (for brevity "Valuation Rules").

1.4. The said Rules provide that because the parties are related, the value declared need not be rejected. If the Customs Officer finds that the value has been influenced by the relationship of parties, then, the Rule requires one to move on to the subsequent rules.

1.5. In summary, the Valuation Rules provide four tools for valuation of goods imported from related parties. They are transaction value of identical goods, transaction value of similar goods, deductive value method and computed value method. A residual method is also provided which is not specifically defined. A rule also guides that the cost and services towards certain expenses like free supply of goods, cost of moulds, tools, dies etc., charges towards engineering development, designs, drawings etc., payments made towards royalties, technical know-how fee, trademark fee etc., shall be added to the extent they are not added in the transaction value.

2. The Special Valuation Branch

2.1. Circular No. 11/2001-Cus ., dated 23-2-2001 was issued by the Central Board of Excise and Customs (CBEC) establishing a specialized arm of Customs Department called the Special Valuation Branch (SVB) inorder to examine the values of goods imported from related parties.

2.2. The SVB Circular requires the Customs Department to recognize the related party imports and examine their relationship from the angle of Valuation Rules. The Circular also requires a series of documents to be submitted to the authorities for examination of relationship and resultant influence on the value of imported goods.

2.3. The Circular also requires the importer to fill up a long questionnairethat includes a question "what is the basis of arriving at the price in the invoice? Is it (a) Price list with discount, (b) Net discounted price (c) Quotation, (d) Transfer price; or (e) Other (please specify)?" Therefore, the Circular contemplates a situation wherein the imported goods value is based on transfer prices between the related parties.

3. What is Transfer Pricing?

3.1. The WCO Valuation Guide, vide Chapter 3 states that Transfer Pricing is a neutral concept that simply refers to the determination of transfer prices for transaction between related parties.

3.2. In other words, in principle a transfer price has to match what the seller would charge an independent, arm's length customer, or what the buyer would pay an independent, arm's length supplier.

3.3. The transfer pricing study undertakes a detailed analysis of determination of arm's length price. It takes into account of various similarly placed companies, in terms of operations, relations, market structure, product profile, assets, risks etc., which are comparable with the company on hand, whose transfer prices are under study.

3.4. On a thorough study of such comparables, the transfer pricing study provides a benchmark profit which needs to be achieved by the company under study. The bench marking is nothing but, if the company under study operates under the arm' length, in respect of import and export of goods and services, then it has to earn the benchmark profit.

3.5. Therefore, as indicated in the WCO Valuation Guide, extracted from Tax Justice Network, "transfer pricing is not, in itself, illegal or abusive. What is illegal or abusive is transfer mispricing, also known as transfer pricing manipulation or abusive transfer pricing".

3.6. Considering both, the customs valuation and transfer pricing, WCO has very interestingly narrated the divergent interests in both the scenarios in the form of following picture:

4. Transfer Pricing and Customs Valuation - What is WCO's Guideline?

4.1. At least from 2009-10, the SVB has been seeking the details of information regarding transfer pricing study of companies whose imports are under scrutiny. However, none of the Orders passed by the SVB relied on the transfer pricing and held that as the company has achieved the same amount of profit as indicated in the transfer pricing study and hence the imports are at arm's length.

4.2. At this juncture, it is necessary to understand how a transfer pricing study can help to establish the arm's length pricing in customs valuation.

4.3. Let us take a simple example of an importer and trader. If the transfer pricing study specifies that similarly placed companies are earning 10% profit in India and he also has to achieve the same benchmark, and on study of the financials of the trader it is found that he has earned same amount of profit, it is evident that the trader neither overvalued the imports nor undervalued the imports. In terms of WCO Valuation Guidelines, in such a scenario, the SVB can accept the imported goods value without any further investigation.

4.4. Fundamentally, it is to be understood that when an importer undervalues the imported goods, the profit that he will retain in India would be high. If an importer overvalues the imported goods, the profit he retains in India would be less. Therefore, a study of transfer pricing benchmark profit and the actual profits earned by an importer for a period of time coupled with foreign exchange payments, if any, would reveal the real picture of value of imported goods.

4.5. Therefore, in terms of the WCO Valuation Guidelines, customs valuation of related party imports can be evaluated by the help of transfer pricing study of the importer.

5. Conclusion

In the light of the aforesaid discussions, I am of the view that the trade community should give high priority on providing all the transfer pricing information to SVB in order to convince the arm's length price of imported goods which would ease SVB to pass the Orders at the earliest and the import valuation would not be suspected. Caution should be exercised that the same transfer pricing study may affect the customs valuation where a huge difference exists between the transfer pricing benchmark and the profit earned in India.

(The author is associated with Lakshmikumaran & Sridharan, Bangalore.)