Customs valuation: an emerging issue for auditors and accountants

Over recent months, customs valuation has become an increasingly important part of my work with audit clients. I am seeing more businesses with related-party imports, transfer-pricing adjustments and royalty arrangements where the customs implications have either not been considered or have sat outside the audit conversation.

That experience has convinced me that customs valuation deserves greater awareness among auditors and accountants. Auditors do not need to become customs specialists, but there are some relatively simple triggers that should prompt further questions.

As businesses expand internationally, it is common for groups to establish local entities to import and distribute goods. These entities may operate as limited-risk distributors (LRDs), with their profitability determined under a group transfer-pricing policy.

A common approach is the transactional net margin method (TNMM), under which the local entity is expected to achieve a target operating margin or range. If its results fall outside that range, a year-end debit or credit adjustment may be made.

From a direct-tax perspective, that may be entirely expected. For customs purposes, however, it raises a separate question: does the adjustment change the price paid or payable for imported goods, and therefore their customs value?

A tax-compliant transfer price is not automatically a customs-compliant value.

This distinction matters. A transfer-pricing adjustment should not simply be assumed to relate to imported goods. The underlying agreements, accounting entries and nature of the adjustment need to be understood. It could relate wholly or partly to imported goods, but it could also reflect services, other costs or activities that require different treatment.

I am also seeing more arrangements where an LRD makes both a transfer-pricing adjustment and a separate royalty or licence payment.

Again, the existence of a royalty does not automatically mean additional customs duty is due. In the UK and EU, royalties are generally added to customs value where they relate to the imported goods and are paid as a condition of sale.

Supply, transfer-pricing and licence agreements may therefore need to be considered together. For an auditor, a significant royalty or licence payment to another company is enough to warrant further investigation.

This is where my recent experience has been particularly informative.

Customs valuation can initially appear to be a narrow compliance issue. However, once a potential error is identified, the historic exposure can quickly become relevant to the statutory audit.

In the UK, HMRC can ordinarily notify a customs debt within three years of it arising, although longer periods can apply. A current-year adjustment may look immaterial in isolation, but similar treatment across several years can produce a much larger exposure.

This can bring customs duty, import VAT, interest and penalties into consideration, and require management to assess the appropriate accounting treatment and disclosures.

The point can also work the other way. In the UK, an annual transfer-pricing adjustment that results in a credit being issued may support a customs duty repayment claim, provided the adjustment can be linked to the imported goods and the customs value originally declared.

Nor can it be assumed that a previous auditor considered the issue. Customs valuation can fall between tax, finance, supply-chain and customs teams, particularly in multinational groups.

I find a simple three-stage approach useful.

Start by understanding the business. Does it import from related parties? Are there year-end transfer-pricing adjustments? Does it pay royalties or licence fees?

Where these triggers exist, obtain the relevant transfer-pricing, supply and royalty agreements, year-end calculations, debit and credit notes and customs declaration data.

Understand what the payments and adjustments actually represent and how the business determines its customs values.

The commercial invoice is only the starting point. Where prices are subject to later adjustment, consider whether customs declarations reflect the final price and whether subsequent adjustments have been reported where required.

If there is a potential issue, quantify it. This is where customs declaration data becomes particularly important because it allows the business to identify historic import values, commodity codes and duty paid.

HMRC's Customs Data Report Service can provide UK declaration information, but equivalent data can be harder to obtain elsewhere. For multinational audits, requesting this information early can be critical.

Customs valuation is based on internationally recognised principles under the WTO Customs Valuation Agreement, but the way those principles are administered differs between jurisdictions.

The EU, for example, has important case law concerning retrospective transfer-pricing adjustments. The US has mechanisms, including CBP's Reconciliation programme, that can allow certain elements of customs value to be finalised after import where the appropriate arrangements are in place. China also has specific rules concerning related-party pricing, formula pricing and royalties.

The message for multinational groups is therefore important: a global transfer-pricing policy does not necessarily produce a global customs answer.

This is increasingly leading me to ask whether groups with significant related-party trade should have a customs valuation policy sitting alongside their transfer-pricing policy.

For me, the key lesson from recent audit engagements is awareness.

Auditors and accountants do not need to become customs valuation experts. However, related-party imports, year-end transfer-pricing adjustments and royalty payments should prompt some basic questions about how customs values have been determined.

Customs valuation may historically have sat outside the normal audit conversation, but my recent experience suggests that this is changing. Asking the right questions early can identify an exposure before it becomes a much more difficult year-end audit issue.