Ⅰ. Nationwide Customs Clearance Integration Reform
On 28th June, 2017, the General Administration of Customs of China published the announcement about the Nationwide Customs Clearance Integration Reform, declaring that Guangzhou, Shanghai and Beijing-Tianjin (Jingjin) Tax Collection and Administration Centers (“TCAC”) would start operating since July 1st.
Under the earlier district clearance system, local customs were each responsible for customs administration within their district.This has been changed by the Integration Reform as the three new TCACs are now responsible for customs collection and administration over all the imports nationwide. The Shanghai TCAC is in charge of all mechanical and electrical products (chapters 84-87 and 89-92 in HS CODE), the Guangzhou TCAC of all chemical and metal products (chapters 25-29, 31-40, 68-83 in HS CODE), and the Jingjin TCAC of all the others (chapters 1-24, 30, 41-67, 88, 93-97 in HS CODE).
The three new TCACs possess all the information that was separately stored in local customs before. Some related party transactions, which might have been overlooked previously by local customs due to the lack of information of comparable transactions, have now become the focus of customs investigations. Such a changehas brought new challenges to import companies.
Ⅱ. The Effect of the Integration Reform on Customs Valuation
i. Facts of the Case
M is a company established in the United States which exports medicines globally. The company has two importers in China: related company W and non-related company N. As part of the company’s marketing strategy, all the products imported by W are sold to a specific non-related company.
Before the implementation of the Integration Reform, W and N declared their imports to customs A and B respectively, and the transaction value declared by W had not been challenged by the customs. However, after the reform, all medicine imports must be declared to the Jingjin TCAC. In August, 2017, the Centre found that W imported the same product at a much lower price than N. The centre therefore believed that the special relationship between W and M had an impact on the transaction price and thus challenged the price declared by W.
ii. Case Analysis
It can be seen from the case above that the Integration Reform affects customs valuation of transactions between related parties in two major aspects. Firstly, the value of related party transactions can be more frequently challenged. Before the reform, given that declaration information collected by local customs was not shared between the customs in different districts, the customs could only make decisions and judgments based on the very limited information they each possess. If no similar products were declared to the local customs, namely that the customs did not have information of comparable transactions, it would then be difficult for the customs to become skeptical about the value. The reform breaks this limit by concentrating all the information that was separately stored in local customs into the possession of the three new TCACs. They each have all the declaration information of identical and similar products and the transaction values can be easily compared. Such comparisons make it much easier for customs to have doubts about the transaction values.
Secondly, the reform has made it more difficult to defend the transaction value in related party transactions. Before the reform, given that the information available for local customs was limited, it was difficult for the customs to use the transaction value of identical goods and the transaction value of similar goods to conduct customs valuation. Therefore, even in cases where the transaction value could not be accepted directly by the customs to apply the transaction value method, for example, where the value was deemed to be influenced by the special relationshipor where there were restrictions on the importer’s disposal of the products, the dutiable value could still be negotiated by the deductive value method, the computed value method and other reasonable fallback methods in the hierarchical order. These methods are in fact very similar to the methods adopted by the companies when determining the price in related party transactions: the resale price method, the cost plus method, the transactional net margin method (“TNMM”) and the transactional profit split method (“PSM”) (this will be explained more detailedly later in the article). The result is that there was still a substantial possibility that the transaction value would be accepted by the customs indirectly to be the dutiable value. The situation after the reform, however, is that the declaration information of all the imports across the country provides the basis for the customs to use the transaction value of identical goods and the transaction value of similar goods to conduct valuation. Furthermore, given that these two methods take priority over the deductive value method, the computed value method and other reasonable fallback methods, the prices determined by the resale price method, the cost plus method, TNMM and PSM have become more difficult to be accepted.
The case above also illustrates this point. Company W probably could prove that the transaction value was not affected by the special relationship by the deductive value method before the reform, and thus, not taking into account the fact that all the products imported by company W are sold to a specific non-related company, have its transaction value accepted by the customs to apply the transaction value method directly. However, since the customs now possess the import information of Company N, the difficulty of defending the value by the deductive value method increases. Meanwhile, if the transaction value method cannot be applied and the negotiation is launched, then according to the hierarchy of customs valuation methods, the customs will first try to identify the transaction value of identical goods. Here the declaration information of company N provides the required transaction value and becomes the basis for customs valuation, so company W can no longer rely on other methods to negotiate with the customs.
The fundamental reason behind such effect is the difference between the methods adopted in customs valuation and the methods adopted in price determination in related party transactions (“transfer pricing"). This difference has long been a challenge for related companies and the challenge has now increased after the Integration Reform.
Ⅲ. Comparison of transfer pricing and customs valuation in practice
The determination of transfer prices for transactions between related parties is called transfer pricing. Guoshuifa[2009] No. 2 issued by the State Administration of Taxation has prescribed five specific methods that can be used to decide whether a transfer pricing is in conformity with the arm’s length principle. On the other hand, the General Administration of Customs also published Decree No. 213 to regulate the methods of customs valuation.
A comparison of the customs valuation methods and the transfer pricing methods reveals the difference between the two. The major difference is not in calculation, but in priority (see the table below).
The table shows that if the transaction value is challenged by the customs and the value is determined by the resale price method (deductive value method), the cost plus method (computed value method), the TNMM or the PSM (reasonable fallback methods), it may be accepted by the customs only when the CUP method (transaction value of identical goods method and transaction value of similar goods methods) cannot be applied. The TNMM, which belongs to reasonable fallback methods which have the lowest hierarchy,is relied on almost exclusively, though, by many transfer pricing service providers.[1]
The Integration Reform allows the three new TCACs to apply the transaction value of identical goods method and the transaction value of similar goods method to value almost all imports. Therefore, all transfer prices in related party transactions which are decided by methods other than CUP now face the challenge from the customs and may need to be negotiated. Under such circumstance, companies should take early actions to respond to the emerging challenge.
Ⅳ. Recommended Actions
Companies which import from related parties are encouraged to have documents prepared for customs investigations as early as possible and look to professional advice to decide whether the transfer pricing determined previously still complies with the customs’ regulations after the reform. If the pricing no longer complies with the regulations, companies should prepare documents to demonstrate the company’s distinctiveness in areas such as commercial levels, quantity levels and freight to support the reasonableness of the transaction value, so that a better dutiable value can be achieved in the negotiation with the customs.
Companies are encouraged to look to professional advice to determine the value of future related party transactions as well, taking into account all the imports of similar products nationwide. Companies can negotiate with the customs before the import to obtain prior agreement to avoid unnecessary troubles and misunderstandings.
In fact, customs valuation is only one of the many areas that have been affected by the Integration Reform. The original on-site investigation system has been replaced by a post-clearance review system. What this means is that companies may not realise their long-standing declaration mistakes until the customs actually conduct the investigations, thus increasing the unexpectedness of the customs’ challenges. When a problem actually arises, companies also no longer face any specific or individual customs, but China Customs as a whole. This sometimes requires the companies to communicate and negotiate with TCACs in other regions, so both the difficulty and the cost of solving the problems have increased.
Under such circumstance, companies are encouraged to combine compliance more closely with daily business activities. If necessary, companies can introduce professional third parties to conduct training sessions on compliance, design internal control procedures and implement risk inspections. If the customs are involved, companies are recommended to look to professional lawyers immediately to get advice and guidance to develop effective negotiation and problem-solving strategies.
[1]R. Feinschreiber and M. Kent,“Customs Valuation and Transfer Pricing: Growing Disparity”, Journal of International Taxation, July 2016.
