Transfer Pricing And Customs Valuation

Published Date: 02 Nov 2017

Any international transaction is subjected to indirect tax through customs, sales or value added tax to determine the duty payable on the goods imported. If the goods are transferred between related parties, then the transfer price should be determined giving consideration to both: corporate income tax-recompressions and customs implications.

In India, while customs duty is determined by valuing the good under Section 14 of Customs Act, 1962, the income tax is decided by valuing the good under Section 92 of Income Tax Act, 1961. The founding principle for income tax and customs valuation in determining the transfer price is the same: the price established for the goods should be the same had the transaction taken place between unrelated parties but there are certain differences which stand out when we compare arm’s length valuation of the good under Income Tax Act and Customs Act. The Income Tax Act prescribes determination of the arm’s length price by first determining the most appropriate method between the following: comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method or any such other method as may be prescribed by the Board. If more than one method can be considered appropriate, then the arithmetic sum of the price found by each method will be chosen to be the arm’s length price. The Customs Act, contrastingly follows a sequential process in determining the arm’s length price. Under Customs Act, the arm’s length is determined by the method which is appropriate in the following sequence: transaction value of identical goods, transaction value of similar goods, deductive value, computed value and residual value. So, if the arm’s length price of goods is determined under transaction value of identical goods, it will not be subjected to deductive, computed and residual valuation. Under Income Tax Act, even if the price of good is identified under comparable uncontrolled price method (which is identical to transaction value of identical goods), if a different valuation is found under cost plus or profit split method, then the arithmetic mean of the prices will be determined as the transaction price. Additionally, under Income Tax Act, if the arm’s length price so determined is within 5% of the actual international transaction price, then the transaction value will be used to determine the taxable income. There is no such provision under Customs Act. Also, owing to the above factors, the valuation of the imported good by custom officials and income tax officials might vary significantly. To increase the revenues of their departments, while custom officials would like the arm’s length price to be as high as possible, income tax officials would prefer it to be as low as possible. Also, companies are put at a significant risk as custom valuation takes place when goods are imported while income tax officials asses the company around 2-3 years after the end of a financial year. If on account of transfer pricing adjustments, the value of the imported good is altered, then there is likely hood of proceedings from the customs special valuation or special investigation branch proceedings being triggered. Recently, in September 2012, the Finance Ministry notified the "Advance Pricing Agreement (APA) Scheme" under which any party could get into an agreement with Central Board of Direct Taxes (CBDT) which would fix the transfer price well in advance. So, the problem of customs special valuation and special investigation branch proceedings being triggered may well be a thing of the past.

Furthermore, the database used for zeroing in on arm’s length price differs for both the central level bodies. Directorate General of Valuation, under the Central Board of Excise & Customs has developed its own database: National Imports Database (NIDB), Export Community Database (ECB) and Central Excise Database (CEDB). Income tax officials use ‘Prowess’ database to arrive at an arm’s length price. Though, fundamentally the values obtained via both the databases should be same, more often than not there is a likely hood of discrepancies between the two values.

Government Action

The Government of India, through an order in May, 2007 implemented a recommendation of a Joint Working Group which was formed for better co-ordination between customs and income tax officials while arriving at an arm’s length price. The committee was of the opinion that co-operation and co-ordination between the two departments on transfer pricing is extremely essential. They proposed that there be bi-monthly meetings at regional level in metro cities between income tax and customs departments. In addition, there will be a meeting every 6 months between Director General of Transfer Pricing, Director General of Valuation and the Chief Commissioners of Customs. In these meetings, the two departments will exchange of information in specific cases. In addition, the Joint Working Committee proposed that National Academy of Direct Taxes (NADT) and National Academy of Customs, Excise and Narcotics (NACEN) shall develop and organize training programmes on transfer pricing. This can be considered as the first step towards addressing transfer pricing issues between the two departments in a harmonious manner. Even though the two departments have agreed for joint meetings and have shown intent to arrive at a consensus for transfer pricing, they are no legally bound to co-operate with each other and fix on a particular arm’s length price. Transfer pricing officers, in past have expressed a view that price accepted by other officers may not be conclusive in determining the arm’s length price for a particular transaction.

Recommendation

As we have seen that customs and income tax officers differ on their valuation guidelines for determining the arm’s length price. In order to counter the same, Indian entities have to undertake separate paperwork for customs and income tax to determine the transfer price. In case there is difference between the same, the entity might end up paying either additional income tax or customs duty on importing a particular good. The newly introduced APA’s have legal validation only for income tax officials and the customs officers may only use it as a guideline to determine the appropriate transfer price. Since, both the bodies report to the revenue department, we propose that there be a central body for valuation under the revenue department which consists of officers from Special Valuation Branch (SVB), Customs and Directorate of Transfer Pricing (DTP) to establish the arm’s length price. Instead of APA’s with CBDT, there could be APA’s with this central body for valuation which would be legally binding on the income tax officials as well as customs officials. The streamlining of process will be a big benefit for the companies towards a single window to fix the transfer price.