Quarterly retail review Q3 2021

Transfer pricing is typically the start point for calculating transaction value of goods, and the customs duties paid on them. But, an agreed transfer price isn't always acceptable for customs purposes. Sometimes, tension between the agreed transfer price and the customs valuation rules means that there's a risk that any price used for these purposes could be challenged by the customs authorities.

So, how can retailers manage transfer pricing risk and avoid unnecessarily high customs duties? From the outset it's important to understand the fundamental differences between transfer pricing and customs valuation regulations.

A very low transfer price on an imported product is likely to generate a correspondingly low customs duty. Conversely, very high transfer prices can effectively move profits to the selling company, but this can lead to a high level of customs duty to be paid by the recipient group company.

Transfer pricing rules are designed to stop the manipulation of prices within a group by requiring that all goods, services, intellectual property, and loans are priced on arm's length terms.

Customs regulations include a similar requirement that goods are imported at a fair market value, as if the transaction was made between unrelated parties. These rules seek to avoid distorting both the profitability of the buying and selling companies, and the customs duty applied on the importation of goods.

It's less well known by retailers that any retrospective transfer pricing adjustments will impact on the declared customs value, meaning the business may also have to revise its customs duty payments and declarations. Failure to do so can lead to additional customs payments, and potential penalties.

Adjusting transfer pricing upwards

Many retail businesses have to adjust their transfer prices throughout the year. These adjustments may include changes to the transfer price on the purchase of certain goods for the recipient company to earn a targeted operating margin in line with the benchmarking of independent comparable companies. In such cases, the business has to go back and revise its customs duty payments and paperwork.

Likewise, the charging of intragroup royalty may have a similar effect, where that royalty relates to the provision of say, an arms length brand name, maybe embedded into the importation price of the goods themselves. The charging of a brand royalty can effectively be another charge for the product and, as a result, the customs valuation of the goods should be increased to reflect the royalty charge that is levied in addition but separately.

Adjusting transfer prices downward

Not all transfer pricing adjustments increase the price of goods. A transfer price may need to be reduced when the recipient company is making less profit  compared with independent ones. In such cases, the import price upon which customs duties are paid is higher than the arm’s length price. However, not all customs authorities accept such downward price adjustments, and may not repay the overpaid customs duties.

Mitigating risks arising from customs duties/transfer pricing interaction

It's vitally important that retailers enable efficient communication between teams responsible for these matters. Early review of the impact of transfer pricing, royalties or additional payments relating to the goods may be beneficial as it can have a positive impact on customs values.

To help you achieve this, we've identified three practical steps you can take to make sharing information between your people responsible for setting transfer prices and those controlling customs valuations quicker and more responsive to each other.

Three things you can do to efficiently manage transfer pricing risk

1 Don’t leave your transfer pricing adjustments to the year end

Some retailers leave all their transfer pricing adjustments to either the year end (for inclusion in the statutory accounts) or when preparing their tax returns (up to 12 months after year-end).

The consequence of this timing is that transfer pricing adjustments on goods requiring a customs duty rebate or additional payment sometimes occur up to two years after the products were imported into the country.

This not only places an administrative burden on teams making these claims or duty payments, but also means that the value of the goods is only known in hindsight; in some cases many months after they've been sold. This complicates the budgeting process, has a knock-on impact on the level of commission paid to sales teams, and causes short-term difficulties in calculating the gross margin of different products. This can affect buying decisions in later periods.

2 Share knowledge via price change committee

Traditionally, the team responsible for reporting and paying customs duties were part of the buying or supply chain planning teams, while those in charge of transfer pricing adjustments were typically in the tax department.  This segregation of duties made it difficult for either group to know when to make a transfer pricing adjustment, and the value of it.

A price change committee enables both groups to undergo joint training to better understand the legal frameworks of these taxes, and identify timing issues and opportunities for tax reclaims. If you can't form a committee, finding an alternative way to increase communication between your operational or commercial teams and the tax team should improve efficiency.

3 Know where you can reclaim overpaid customs duties

In some territories the tax authorities do permit a rebate on customs duties where it's agreed that the transfer pricing adjustment is acceptable. Not every territory does, so understanding this distinction is very helpful for your cashflow modelling. You should consider:

which countries will accept both upwards and downwards adjustments to goods value for customs purposes, and grant a rebate to the retailer

whether prior approval or a customs valuation ruling is required to access this refund

Putting them into practice

The traditional separation of responsibilities between the supply chain planning team and the tax department makes the relationship between transfer pricing and customs duties even harder for retailers. And, this problem may be exacerbated by hybrid working.

Retailers must become more purposeful in bringing together accountability to reduce tax risk to the business and increase opportunities for receiving rebates.

For more practical guidance on managing transfer pricing risk get in touch with Liz Hughes.

VAT is embedded in everything you do: from paying suppliers, moving stock, selling in-store and online to invoicing rebates and collecting cash, but compliance is becoming increasingly complex. Tax authorities around the world are expanding reporting requirements and capturing more real time data and in-depth analytics. In the UK HMRC is using Making Tax Digital with the aim of becoming one of the most technically advanced tax administrations in the world. At the same time, retailers are using technology themselves to streamline and scale their business.

To prepare accurate VAT returns you need to focus on the tax configuration of all the end to end IT systems used in your day to day operations, rather than just the return itself.

Emerging VAT touchpoint risks

Retailers are embracing new technology to improve their efficiency and enhance customers' experience of their products and services, but implementing new systems brings risks as well as rewards.

We have seen an increasing number of retailers partner with other businesses to enter new markets or offer new services.  Deliveroo is a prime example of this, but we have also seen a diverse range of partnerships: from photo products to healthcare services. The need to be quick to market makes full integration of the data flows from the third party into your accounting processes more complex, which introduces a risk for VAT accounting. This is especially true if the third party may be receiving payments on your behalf.

Many retailers are also looking to enhance their customers' experience by adopting mobile checkouts, or even virtual checkouts and automated payment processes, and activating omnichannel strategies to integrate customer experience across all sales platforms. Internal processes and systems are being enhanced with technological solutions that will introduce efficiencies and cost savings. This ranges from completely new ERP and EPOS systems, through to the automation of reporting, utilising robotics and artificial Intelligence. However, the rapid rate of change introduces risks to the control framework, so it's vital to future-proof your tax and VAT processes.

Developing your systems around VAT risk management

To stay on top of these challenges, tax functions are upskilling and recruiting tax technology specialists to optimise their systems for efficient and accurate VAT compliance requirements.

By bringing VAT configuration into the design stage of all new system developments, you can embed all the information you need within the data flows. This improves the accuracy of VAT returns, reduces the need to make VAT adjustments, enriches data quality, and future-proofs your processes.

Richer data enhances the data analytics available to you for implementing efficient and robust VAT controls. You can also develop internal VAT reporting to inform decisions on how it will impact new products, promotions, and service offerings.

Ultimately, by ensuring the VAT function works closely with developers to embed VAT controls across end-to-end systems, you can manage them more efficiently. This enables the tax function to look beyond compliance and focus on adding value to your business.

For more information on using technology to help you adhere to VAT compliance requirements, get in touch with Rob Outram.