Transfer pricing is often discussed in the context of corporate income tax, where the main concern is whether profits are allocated appropriately among related entities in different jurisdictions. However, the influence of transfer pricing extends well beyond direct taxation. It can play a crucial role in shaping the treatment of VAT and customs duties in cross-border transactions between related parties.
To date, VAT authorities have not provided much by way of guidance as to the impact of transfer pricing agreements on the value of the supply for VAT. However, a recent spate of cases in the Courts of Justice of the EU have brought the issue sharply into focus. Whilst the UK is not obliged to apply the decisions as it has left the EU, HMRC will undoubtedly be looking at them for alignment.
The HMRC Customs Technical Handbook on Valuation is strangely silent on the matter too. There have been repeated calls from customs specialists for full guidance and maybe the CJEU cases will assist with the process.
Whilst a taxpayer can apply for a binding valuation agreement from HMRC, transfer pricing adjustments are not covered, leaving taxpayers in limbo.
Since VAT and customs regimes rely heavily on the value attributed to goods and services at the point of supply or import, transfer pricing policies that adjust intercompany prices inevitably affect the base on which these indirect taxes are calculated.
This interaction is not always straightforward. Unlike corporate income tax, which permits adjustments at year-end through transfer pricing documentation and reconciliations, VAT and customs regimes tend to require contemporaneous valuations and often do not accept retroactive corrections.
When goods are supplied cross-border between related entities, the invoice value becomes the foundation for both customs declarations and import VAT payable. Customs authorities are particularly sensitive to the issue of under-valuation, since a lower declared value reduces the amount of duty payable.
Conversely, VAT authorities are concerned with ensuring that taxable bases are not understated, as VAT is charged as a percentage of the transaction value. The Organisation for Economic Co-operation and Development (OECD) has developed extensive transfer pricing guidelines for income tax purposes, but these do not always align perfectly with the customs valuation rules established by the World Customs Organisation under the WTO framework.
As a result, businesses can face the challenge of having to reconcile two regulatory regimes that approach the same transaction from different perspectives, potentially leading to double taxation or disputes over values.
The effects of adjustments on VAT and customs
One of the most significant impacts of transfer pricing arises when retrospective adjustments are made to align intercompany charges with the arm’s length principle.
For corporate income tax, these adjustments are commonplace, with entities recording year-end true-ups to ensure profitability falls within acceptable ranges. However, when such adjustments affect goods already imported or services already supplied, they create complications in VAT and customs. A downward adjustment that reduces the transfer price may imply that the original import value was overstated, but most customs regimes do not allow retroactive downward revisions, meaning businesses may have paid more duty than ultimately necessary. The UK does have forms to complete to adjust a downward value, but if there are a number of declarations to be amended, the importer is usually restricted to 20 in a batch and a total email size of less than 4Mb.
Similarly, VAT paid on importation or charged on cross-border supplies may not be reclaimable or adjustable in line with the revised price, leading to stranded costs.
On the other hand, upward adjustments that increase the intercompany price can trigger claims from customs authorities for underpaid duties. In these cases, businesses may face penalties or interest charges if they cannot prove that the adjustment was made for commercial reasons and not to manipulate tax liabilities.
The distinction between income tax and indirect tax systems also emerges in how they view the purpose of the transaction. Transfer pricing seeks to test whether profit allocation is arm’s length, often considering factors such as risk, functions, and assets.
Customs authorities, however, are primarily concerned with the actual invoice value of goods at the time of import, together with the relationship between buyer and seller. If related parties transact, customs authorities may question whether the relationship has influenced the declared value. To satisfy customs requirements, businesses must often provide evidence that the transaction value reflects a price comparable to that between independent entities. This overlap with transfer pricing can create administrative burdens, as documentation must serve multiple purposes but is judged by different standards.
VAT introduces its own layer of complexity. Since VAT is typically a transaction tax on supplies, it is less concerned with profit allocation and more focused on the value on which the tax is levied. Where related parties transact, VAT authorities may apply anti-avoidance rules to ensure that supplies are valued at open-market prices, particularly where the recipient is unable to fully recover input VAT.
For instance, if a subsidiary supplies goods or services at a reduced price to a related company that has limited VAT recovery, tax authorities may seek to revalue the transaction to safeguard revenue. Transfer pricing policies that shift profit into or out of such entities can therefore have direct implications for VAT liabilities. Additionally, the global trend toward increased transparency and reporting, such as through country-by-country reporting and electronic invoicing, means that inconsistencies between transfer pricing documentation and VAT records are more easily detected by tax authorities.
Managing compliance and risk
For multinational groups, managing the interaction between transfer pricing, VAT, and customs duties requires a holistic approach that goes beyond the traditional focus on corporate income tax.
It is not enough to ensure that intercompany charges fall within an acceptable range under the OECD Guidelines; businesses must also consider whether the invoiced values can withstand scrutiny from customs authorities and whether VAT reporting accurately reflects the true economic substance of the transaction. This demands close cooperation between tax, finance, and trade compliance teams, as well as early consideration of indirect tax impacts when designing transfer pricing policies.
One practical strategy is to align transfer pricing methodologies with customs valuation approaches wherever possible. For example, the transaction value method used in customs can sometimes be supported by transfer pricing analyses if evidence is provided that the intercompany price is consistent with comparable uncontrolled transactions. However, this alignment is not always achievable, especially where transfer pricing relies on profit-based methods such as the transactional net margin method, which are not accepted by customs. In such cases, businesses must be prepared to justify differences and document the reasons why valuations diverge.
Another important consideration is the treatment of retrospective adjustments. Companies should assess in advance how such adjustments will be managed from a customs and VAT perspective. Some jurisdictions have mechanisms that permit corrections to customs values when transfer pricing adjustments occur, but many do not. Similarly, VAT adjustments may require careful handling to avoid mismatches between reported outputs and inputs. Implementing robust intercompany pricing policies that minimise the need for significant year-end adjustments can reduce the risk of indirect tax complications.
Ultimately, the impact of transfer pricing on VAT and customs duties highlights the interconnected nature of global tax regimes. While transfer pricing is primarily aimed at ensuring fair profit allocation, its ripple effects extend into every stage of cross-border trade. Failure to anticipate these effects can result in unexpected costs, disputes with tax authorities, and even reputational damage. Conversely, businesses that integrate their transfer pricing and indirect tax strategies can achieve greater efficiency, reduce the risk of double taxation, and enhance compliance across multiple jurisdictions. In an environment where governments are increasingly sharing information and scrutinising multinational supply chains, the ability to manage these overlaps effectively is becoming not only a matter of compliance but also a source of competitive advantage.
If the current Government is looking for taxes that may plug the “black hole”, looking at customs valuation for both transfer pricing and low value imports may help without breaching the sacred “fiscal rules” and pledges not to raise income, corporation or value added tax rates. Import duty will mean a cost-of-living rise but it is income directly to the Treasury.
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