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Getting income tax and customs to see eye-to-eye
December, 10th 2012

While there is an increase in foreign direct investment, transnational corporates struggle to reconcile customs and transfer pricing regulations when arriving at an import price that is acceptable to both authorities. Although both authorities operate at the Central level and examine an assessees submissions there still appears to be a disharmony in the methodology used to arrive at an acceptable arms length price.

A catch-22 situation is not uncommon when a corporate imports goods from overseas related parties. If, on account of transfer pricing adjustment, the value of the imported goods is altered, the customs special valuation or special investigation branch proceedings are triggered.

The trouble lies in the application of two systems of valuation to the same transaction one applied sequentially, and the other offering a choice of methods. What is desired is a common valuation methodology for both customs and income tax. Many of the elements used to determine the taxable income, such as sales price, cost of goods sold, adjusted cost base, inventory cost and so on, may also be relevant for customs. When associated enterprises deal with each other, the presumption is that the relationship has influenced the import price. The onus for establishing otherwise rests with the importer, and the process is time-consuming, involving extensive documentation.

Owing to this, tax and customs duty outflow is higher than warranted in most cases and seen as an inhibitor for investment in India. Every industry, from consumer goods to heavy equipment, is affected by this issue.

Any corporates objective is to arrive at the most-favourable income tax and customs treatment. The factors influencing this typically includes the customs duty rate in the country of import; and statutory or treaty relief for underlying foreign taxes in the country of import or export (such as tax credits, exempt dividends) among others. A combination of these factors, together with a harmonised methodology for arriving at the import price is warranted. Typically, the value of the imported goods is established first, as it is required for customs.

Accordingly, transfer pricing for tax and customs should be based on a single determination of the arms length conditions, using criteria that are acceptable under both rules. The recently introduced advance pricing arrangement (APA) mechanism could be utilised to declare the import value. Though this is not statutorily binding on customs authorities, it could be useful for simultaneous determination of import price under both legislations.

Alternatively, one could examine the possibility of declaring the related party transaction values, subject to an eventual transfer pricing compensatory adjustment through pricing formulas or price review clauses. Such formulas or review clauses should be declared to customs authorities at the time of entry of goods. This would logically imply a likely delay in the final determination of customs value, but it could help harmonise customs valuation and transfer pricing.

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