Indirect Tax Retroactive TP adjustments & customs value of imported goods By Kayn Woolmer The South African Revenue Services (SARS) is clearly on a compliance mission with its increasing requests for verification of compliance being sent to tax payers for many different tax types.
In recent weeks, we have noted an increase in the requests for tax payers to confirm whether an appropriate adjustment to the customs value or any imported goods is made following from retroactive transfer pricing adjustments being made. This indicates a heightened awareness at SARS of the potential interaction between transfer pricing and customs valuations (below). The approach being taken smells of a fishing expedition as the queries are being raised across the board, without any apparent knowledge whether the entity has made any transfer pricing adjustments, or in some cases, even that the entity imports goods.
Interestingly, this is not a new issue at all, as this potential has always existed. . However, with limited knowledge of customs compliance processes within many businesses, the required customs value adjustments are often overlooked.
The current South African customs and excise legislation defines a customs value as the “transaction value” which is further defined as “the price actually paid or payable for goods when sold for export to the Republic.” Therefore, where the transfer price of any imported goods is changed in terms of a group transfer pricing policy after the goods have been imported into South Africa (for example, because group profit targets have been missed), you will more than likely be required to make a corresponding customs value adjustment. But it’s not necessarily as clear-cut as that.
Generally, SARS questions transaction values of goods where the seller and the buyer are related to each other within the meaning of the Customs and Excise Act, 91 of 1964 (Customs Act). But the fact that a buyer and a seller are related will not in itself disqualify a transfer price from being accepted as a customs value, unless the relationship influenced the price actually paid or payable for the exported goods. Therefore, where a transfer pricing policy exists between two related parties, the argument that the relationship between the seller and the buyer has not influenced the price payable is unlikely to be defensible.
In such circumstances, the buyer should declare the status of its relationship with the seller on its customs clearance documentation, and should also indicate which valuation method was used to arrive at the customs value used for customs duty and import VAT purposes. In our experience, this compliance requirement is often not attended to and comprises a risk for the imposition of penalties. This declaration is required on the customs clearance document (SAD500).
The customs legislation provides for importers to request a ruling from the Commissioner for the SARS on their customs values. While these rulings are not mandatory, the SARS may instruct an importer to apply for one where any potential to dispute the customs value of imported goods exists. These rulings are referred to as “value determinations” (VDNs).
The customs legislation provides for five additional valuation methods to be applied where the price actually paid or payable is influenced by the relationship between the buyer and the seller or does not meet the customs valuation criteria discussed herein for any reason. These methods include ascertaining whether: - The transaction value is based on the value of identical goods imported by non-related parties at the same commercial level, in the same quantities and at the same time as the goods; or
- The transaction value is based on the value of similar goods for sale for export to South Africa, at the same commercial level, in the same quantity and at the same time; or
- The transaction value is based on the unit price of the goods when sold in South Africa to parties unrelated to the importer(s), provided still in the same condition as at the time of importation, but subject to certain adjustments for:
- commissions, profits and general expenses (including direct and indirect costs of marketing),
- the costs of transportation as well as loading, unloading, handling, insurance and other costs associated with transportation, and
- deductions for duties and taxes paid or payable in South Africa; or
- The transaction value is based on a computed value supplied by the producer, being:
- The sum of the costs of the manufacturing process, including materials, the cost of packing and packaging and
- the value of other materials or components and engineering, development, planning and similar services, transportation and associated costs and
- an amount for profit and general expenses
Should none of the above provide a relevant method for arriving at an appropriate customs value, the importer may request that the Commissioner for the SARS issues a VDM based on a combination of them.
There are some similarities between these methods and the five recognised transfer pricing methods. For instance, the transactional value is very close to that of the Comparable Uncontrolled Price method. Thus, there is merit in the view that an adjustment to a transfer price between related persons would result in an adjustment to the valuation for customs purposes.
What is important for both customs valuation matters and transfer pricing alike, is that the import value represents an arm’s length value upon which the appropriate, income tax, customs duty and import VAT liabilities will be based. This is what a VDN aims to ensure. Should the SARS opine that a transfer price has been influenced to the extent that the transaction value is under-valued for customs duty purposes, it will require that the transfer price is appropriately uplifted. Where such an upliftment or adjustment to the customs value results in an under declaration of a customs duty liability, the SARS may impose penalties and interest based on the extent of the underpayment of both customs duties and VAT.
Herein lies the anomaly in this entire line of investigation. An increase in the transfer price will give the desired increase in customs duty but will inevitably lead to a reduction in the resulting profitability and hence the income tax liability. Thus, in this regard, customs officials and income tax officials are fighting one another for a share of the cake.
Retroactive adjustments to transfer prices are common where the pricing policy is established by reference to a profit margin. This applies to four of the five transfer pricing methods. Two methods focus on the gross margin being achieved and a further one on the net margin. The forth is a split of profit at either the gross or net level. It is not uncommon for a group transfer price to be set to ensure that one party achieves a certain level of profitability. In the event this is not realised, the price is adjusted to ensure this. In the event the level of profit is exceeded, the price may also be adjusted. These adjustments are often effected retrospectively.
Thus if such a query is received, clients need to consider the following: - Do you import goods from international connected persons?
- If yes, what is your pricing policy for the goods? And
- Do you understand the implications of your transfer pricing policy on the customs value of goods that you import?
If the answer to 1 is “Yes” and the pricing method adopted is designed to achieve a certain profitability and/or is subject to retrospective adjustments, then this letter needs to be carefully responded to. |
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