Merging of Transfer Pricing and Customs Valuation

28 Feb 2013

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Comptroller-General of Customs, Inde Dikko Abdullahi

Two worlds to tax as one

Johnson Ngila Mutuku

What is it all about?

Transfer pricing adjustments are currently the news dominating the tax world. Last year, Vodafone was hit with a $2 billion transfer pricing assessment. Shell India is facing a $2.7 billion transfer pricing bill from the tax man, even before the dust has settled. The list goes on and on. Given the replication of strategies and more specific tax planning strategies by multi-national enterprises (MNEs), most of the local (Nigerian) subsidiaries of these MNEs will potentially face transfer pricing adjustments. The tax authorities do not need to reinvent the wheel!

Majority of global cross-border movement of goods are transacted between related parties.  Related importers/exporters would be shocked if they were advised that the bargained price in the contract of sale was prima facie not able to form the basis of the customs valuation in the country of importation because the parties were related. Nevertheless, this is the essence of the new customs administration change which is focused on the non-conventional customs duty assessment mechanisms. Customs administrators no longer rely solely on importers/exporters supporting documentation for customs valuation. More specifically, many customs administrations throughout the world are now reviewing all related-party contractual prices to determine whether those prices have been affected by the relationship.  It therefore follows that the countries in the West Africa region will have no choice but to go down the same road.

Transfer pricing in West Africa

As many tax practitioners and MNEs (including local groups in the case of Nigeria) might be aware, tax authorities in the West African region have shifted their focus to tax revenue leakages allegedly brought about by transfer of profits.  This is accentuated by the rising budget deficits across the region.  According to the Central Intelligence Agency World Factbook , the 2011 budget deficits of Nigeria and Ghana were 3.30% and 5.40% of gross domestic product, respectively.

Nigeria, the largest economy in the West African region and second largest in Africa, published its Transfer Pricing Regulations with effective date of 2 August 2012.  Ghana, another West African economic giant, who recently joined the league of oil producing countries, also published its Transfer Pricing rules in September of the same year. It is expected that other countries in the region will follow swiftly.

The Conflict

With transfer pricing in place in Nigeria, the immediate focus of the MNEs in the country (the ones without global transfer pricing policies) will be shifted to transfer pricing planning, policy documentation and compliance.  MNEs with global transfer pricing policies will seek to domesticate the global policies to conform to the specific provisions of the Nigerian Transfer Pricing Regulations. It is therefore imperative that such companies pay attention to the interplay between transfer pricing and customs valuation.  

The prices charged among related parties may be adjusted in line with the Transfer Pricing Regulations. The resulting price differential might satisfy one arm of the Revenue authorities (either Customs Department or Tax Revenue Authority), but rub the other the wrong way.  This, no doubt, fulfils an old adage that ‘one man’s meat is another man’s poison’.

For example, when a Nigerian manufacturer imports its raw materials from a related party in a different tax jurisdiction, the Federal Inland Revenue Service (FIRS) would want the prices charged to the local manufacturer to be as low as possible, in order to reduce their cost of goods sold and increase the attendant taxable profits of the manufacturer. On the other hand, the Nigeria Custom Service would tend to hike the valuation of the raw materials in order to guarantee higher customs duty.

A major point of reference for customs valuation is the World Trade Organisation (WTO) customs valuation agreement. The WTO deals with the global rules of trade between nations.  Its main function is to ensure that trade flows as smoothly, predictably and freely as possible. The WTO customs valuation agreement sets out a fair, uniform and neutral system for determining the value of imported goods on which customs officials levy duties. On the other hand, Transfer Pricing Regulations in most countries are fashioned after the Organisation for Economic Cooperation and Development (OECD) Transfer Pricing Guidelines for MNEs and Tax Administrators (herein referred to as OECD TP Guidelines).

The primary difference between customs valuation based on WTO customs valuation agreement and transfer pricing rules based on the OECD TP Guidelines is the evaluation requirements for the methods. WTO customs valuation agreement dictates a hierarchy of six customs valuation methods that companies must use sequentially. On the other hand, OECD TP Guidelines prescribe non-sequential evaluation of all the available transfer pricing methods to determine which gives the most appropriate simulation of what unrelated third parties would pay in a similar transaction.

In a situation where the two authorities use the same method, say Comparable Uncontrolled Price method to determine the transfer price, the outcome can satisfy both arm’s length pricing and customs valuation.  However, where there is variance in the preferred method, it is most likely that each authority will arrive at different prices for the same transaction. The tax payer (and possibly the final consumers) invariably bears the brunt of such a variance.

Indeed, the issue of customs value of imported goods has sometimes resulted in a contentious push and pull between the importers and the Revenue Authorities.

The OECD TP Guidelines give customs valuation as a guidance for applying the arm’s length principle.  However, it does not envisage the divergent interests of the parties involved in implementation and enforcement of transfer pricing and customs valuation legislation.

International conferences in the more established tax jurisdictions in Europe and Asia have been conducted to foster understanding of the relationship of the two, without much success. Thus, transfer pricing and customs valuation will continue to remain contentious as these are two worlds to tax as one.

The compromise

To help reduce the conflict between the customs service and the tax authority, countries such as the US, Canada, the UK and Australia have merged the two government agencies into one.

Both transfer pricing and customs valuation have recommended methods, though not exclusively limited to these methods, to determine prices/value of international transactions. There are fundamental comparability requirements that ought to be met prior to use of any method to determine either the customs value or arm’s length price. Factors like the characteristics of the goods/services, time, volume and country production/origin are important.

For the transfer price and the customs value of a transaction between related entities to be acceptable, there is need for the related entities to demonstrate that unrelated parties would have transacted in the same manner or in a similar manner, which is not materially different for a similar transaction.


There have been efforts by the OECD and World Customs Organisation (WCO) to resolve this conflict. Discussions have been held on how the methodologies of transfer pricing and customs valuation can perhaps converge. Convergence is attainable given the fact that transfer pricing and customs valuation seem to use similar methodologies in establishing whether the prices/value of transactions between related entities are at arm's length.

However, this convergence seems unlikely for a number of reasons, including the fact that transfer pricing is focused on profit allocation while customs valuation deals with valuation of transactions. Nevertheless, many now reckon that there is much in common between the two systems. In particular, customs administrations have recognised the energy which revenue authorities direct at transfer pricing between related parties. After a review of the relevant customs international agreement and their domestic laws, many customs administrations now recognise that more resources should be directed at reviewing related-party contracts for the sale of goods from a customs perspective.

Way to go

As depicted above, transfer pricing strategies can profoundly impact the customs valuation strategies of a company and vice versa. It has become important to coordinate the two to create the desired synergy. It is, therefore, imperative that MNEs proactively review their transfer pricing policies vis-à-vis their customs valuation to ensure that they are not exposed to additional customs duty and/or income tax.

Johnson Mutuku is a Senior Adviser in Tax, Regulatory and People Services of KPMG Advisory Services.

Tags: Business, Nigeria, Featured, Merging, Transfer Pricing and Customs Valuation

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