Harmonizing customs law and transfer pricing provisions

The chase for profits often leads multinational enterprises (MNEs) to make cross-border transactions. According to the 1995 United Nations Conference on Trade and Development World Investment Report, intra-MNE transactions account for as much as 60% of global trade.

MNEs seek to shift profits to lower tax regimes and thereby increase their real (global) profit. Tax cost can be reduced by arranging the transfer of goods, services and intangibles to achieve the minimal corporate tax cost. This practice contradicts the MNEs’ unstated policy of paying the least possible customs duty on the import of goods. Therefore, MNEs have to review the implications of customs duty and transfer pricing regulations on a typical international transaction in goods.

The customs law, including the Customs Valuation (Determination of price of imported goods) Rules, 2007, is modelled on article VII of the General Agreement on Tariffs and Trade 1994. The basic formula for determining customs duty is the transaction value (TV) of the goods, multiplied by the applicable rate of duty. In a transaction between related parties, the parties must demonstrate (using the prescribed methods sequentially) that the TV approximates the value of a transaction between unrelated parties – i.e., parties transacting at arm’s length. Two tests are used to determine this: (1) the “circumstances of sale” test, to determine whether the relationship influenced the price; and (2) the “test values” test, which is used to determine whether the TV closely approximates one of the specified types of “test” values. Importantly, the value of services and intangibles becomes relevant for valuation of the goods when paid in relation to the goods (as a “condition of sale”).

Rohan Shah is the managing partner at full-service law firm Economic Laws Practice, where Ranjeet Mahtani is an associate. The firm is headquartered in Mumbai, and has offices in New Delhi, Pune and Ahmedabad.