The treatment of transfer pricing adjustments for the purpose of customs valuation

By: MSc, M, Friedhoff, European customs law, 2017

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1 Table of contents

1 Table of contents.................................................................................................. 1

2 List of abbreviations ............................................................................................. 2

3 Introduction .......................................................................................................... 3

4 Transfer pricing .................................................................................................... 4

4.1 The arm’s length principle ....................................................................................... 4

4.2 Transfer pricing methods ......................................................................................... 4

4.2.1 The CUP method ............................................................................................. 5

4.2.2 The resale price method ................................................................................... 5

4.2.3 The cost plus method ....................................................................................... 5

4.2.4 The TNMM ....................................................................................................... 5

4.2.5 The transactional profit split method ................................................................. 5

4.2.6 Transfer pricing adjustments ............................................................................ 6

5 Customs valuation................................................................................................ 7

5.1 Customs valuation methods .................................................................................... 7

5.1.1 The transaction value of the imported goods .................................................... 7

5.1.2 The transaction value of identical or similar goods. .......................................... 8

5.1.3 The deductive value method ............................................................................ 8

5.1.4 The computed value method ............................................................................ 8

5.1.5 The reasonable means method ........................................................................ 8

5.2 Transactions between related parties ...................................................................... 8

5.2.1 Examining the circumstanced surrounding the sale .......................................... 9

5.2.2 Examining test values provided by the importer ..............................................10

6 Linkages and differences between transfer pricing and customs valuation ........ 11

7 Court of Justice case C-529/16 Hamamatsu Photonics Deutschland GmbH ..... 12

7.1 Introduction ............................................................................................................12

7.2 Summary of the case .............................................................................................12

8 Analysis .............................................................................................................. 15

8.1 Order for reference .................................................................................................15

8.2 Decision of the ECJ ................................................................................................15

8.2.1 Adjusting the customs value ............................................................................15

8.2.2 Obligation upward adjustment .........................................................................16

8.2.3 Misuse of customs value adjustments .............................................................16

8.2.4 Transfer pricing adjustments and the customs value .......................................16

8.2.5 The transaction value without transfer pricing adjustments..............................16

8.2.6 Simplified procedures ......................................................................................17

8.3 Potential solutions ..................................................................................................17

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8.4 Impact UCC............................................................................................................18

9 Conclusion ......................................................................................................... 19

10 Literature list ................................................................................................... 20

2 List of abbreviations

CCC Community Customs Code

CUP method Comparable Unit Price method

EU European Union

Hamamatsu Hamamatsu Photonics Deutschland GmbH

ECJ European Court of Justice

OECD Organisation for Economic Co-operation and

Development

OECD Guidelines OECD Transfer Pricing Guidelines for Multinational

Enterprises and Tax Administrations

The Court The European Court of Justice

TNMM Transactional net margin method

UCC Union Customs Code

WCO World Customs Organisation

WTO World Trade Organisation

Customs Valuation Agreement Agreement on the implementation of article VII of the

general agreement on tariffs and trade 1994

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3 Introduction On December 20, 2017 the highly anticipated Hamamatsu case was published by the European Court of Justice (hereafter ECJ or the Court). The main issue in this case relates to the treatment of transfer pricing adjustments for the purpose of customs valuation. This judgement of the ECJ has left companies which import into the European Union (hereafter EU) and customs authorities wondering how to act in accordance with the law when dealing with transfer pricing adjustments. The majority of global trade consists of intercompany transactions of Multinational companies. Multinational companies can use their intercompany relations to e.g. shift profits from high tax jurisdictions to low tax jurisdictions. In order to prevent this multinational companies have to comply with transfer pricing rules. The principles governing transfer pricing are established in the OECD Guidelines1 which are governed by the Organisation for Economic Co-operation and Development (hereafter OECD). These rules aim to make sure that related companies act similarly to unrelated companies. By doing so these relates companies comply with the ‘arm’s length principle’. One important aspect of transfer pricing are so called adjustments. These adjustments are made to assure that any deviations from the arm’s length principle are corrected. The treatment of transfer pricing adjustments for the purpose of customs valuation has been a matter of much discussion for years. The treatment of these adjustments differs significantly between various member states of the EU Customs Union. This may be considered remarkable since all member states aim to comply with the same European customs legislation. Up to the moment the Hamamatsu case was released no guidance had been provided by either the European legislator or the ECJ. Therefore, more guidance by the ECJ on this subject was welcomed by the stakeholders. Taking into account among others the increasing importance of transfer pricing for international trade it was expected that the ECJ would take a practical approach when dealing with transfer pricing adjustments for customs valuation purposes. This would be in line with (recent) guidance from the World Customs Organization (hereafter WCO). However, at first sight this does not seem to be the case. In addition, the ECJ has not provided much guidance in the Hamamatsu case on how companies should deal with transfer prancing adjustments in general. This has created uncertainty for both businesses and customs authorities alike. This thesis aims to provide as much insight as possible into the implications of the Hamamatsu case. To provide more insight into the consequences of transfer pricing adjustments for the purpose of customs valuation following the Hamamatsu court case the research question of this thesis is: “What is the impact of the Hamamatsu case of the ECJ relating to the treatment of transfer pricing adjustments for the purpose of customs valuation?”

1 The OECD guidelines are formally known as the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations.

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4 Transfer pricing

4.1 The arm’s length principle The conditions of transactions between independent parties are established by market forces. One party will not enter into a transaction if it feels that it will not sufficiently benefit. This may however be different with transactions between related parties. In this case a party may enter into a transaction which harms its interests but which is beneficial for related entities. The conditions of transactions between related parties does not influence the overall profitability of the multinational enterprise. It does however influence the profit of a specific entity. This in turn plays an important role in among others how much corporate income tax can be levied by the tax authorities of the relevant country. To prevent that multinational enterprises shift profit from high tax jurisdictions to low tax jurisdictions related entities must act in accordance with the arm’s length principle. The arm’s length principle is found in Article 9 (1) of the OECD Tax Convention: “ [Where] conditions are made or imposed between the two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.” According to the arm’s length principle the conditions of related party transactions should be compared to comparable transactions between independent parties. When the conditions of the related party transaction are not in accordance with the arm’s length principle they must be adjusted. The arm’s length principle and how it should be used under different circumstances is further established in the OECD guidelines2. For purposes of arm’s length principle, an “associated enterprise” is an enterprise that satisfies the conditions set forth in Article 9, sub-paragraphs 1a) and 1b) of the OECD Model Tax Convention. Under these conditions, two enterprises are associated if one of the enterprises participates directly or indirectly in the management, control, or capital of the other or if “the same persons participate directly or indirectly in the management, control, or capital” of both enterprises.3

4.2 Transfer pricing methods To determine whether the transactions between related parties are in accordance with the arm’s length principle various transfer pricing methods may be used. The OECD Guidelines differentiates between traditional transaction methods and transactional methods. Traditional transaction methods are the comparable uncontrolled price method (hereafter CUP method), the resale price method, and the cost plus method. Transactional profit methods are the transactional net margin method (hereafter TNMM) and the transactional profit split method. When a traditional transaction method and a transactional profit method can be applied in an equally reliable manner, the traditional transaction method (especially the CUP method) is preferable to the transactional profit method4. In addition, multinational enterprises retain the

2 OECD guidelines 2017. 3 Paragraph 11, OECD Guidelines 2017. 4 Paragraph 2.3 OECD Guidelines 2017.

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freedom to apply methods not described the OECD Guidelines to establish an arm’s length remuneration5.

4.2.1 The CUP method The CUP method compares the price charged for property or services transferred between related parties to the price charged for property or services transferred between independent parties in comparable circumstances6.

4.2.2 The resale price method The resale price method begins with the price at which a product that has been purchased from a related party is resold to an independent party. This price (the resale price) is then reduced by an appropriate gross margin on this price (the “resale price margin”) representing the amount out of which the reseller would seek to cover its selling and other operating expenses and, in the light of the functions performed (taking into account assets used and risks assumed), make an appropriate profit. What is left after subtracting the gross margin can be regarded, after adjustment for other costs associated with the purchase of the product (e.g. customs duties), as an arm’s length price for the original transfer of property between the associated enterprises. This method is probably most useful where it is applied to marketing operations7.

4.2.3 The cost plus method The cost plus method begins with the costs incurred by the supplier of property (or services) in a transaction between related parties for property transferred or services provided to a related purchaser. An appropriate cost plus mark-up is then added to these costs, to make an appropriate profit in light of the functions performed and the market conditions. What is arrived at after adding the cost plus mark up to the above costs may be regarded as an arm's length price of the original controlled transaction. This method probably is most useful where semi-finished goods are sold between related parties, where related parties have concluded joint facility agreements or long-term buy-and-supply arrangements, or where the related party transaction is the provision of services.8

4.2.4 The TNMM The TNMM examines the net profit relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction. The net profit indicator of the taxpayer from the controlled transaction should ideally be established by reference to the net profit indicator that the same taxpayer earns in comparable uncontrolled transactions, i.e. by reference to “internal comparables” Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise (“external comparables”) may serve as a guide.9

4.2.5 The transactional profit split method The transactional profit split method first identifies the profits to be split for the associated enterprises from the controlled transactions in which the associated enterprises are engaged.

5 Paragraph 2.9 OECD Guidelines 2017. 6 Paragraph 2.14 OECD Guidelines 2017. 7 Paragraph 2.27 OECD Guidelines 2017. 8 Paragraph 2.45 OECD Guidelines 2017. 9 Paragraph 2.64 OECD Guidelines 2017.

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It then splits those combined profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm’s length.10 The transactional profit split method can be based on a contribution analysis11 or on a residual analysis.12

4.2.6 Transfer pricing adjustments Using a transfer pricing method an arm’s length remuneration for related parties is established. When it turns out that the remuneration of a party involved in a related party transaction is not according the arm’s length principle this must be adjusted. The purpose of this adjustment is to set the remuneration of the tested parties in accordance with the arm’s length principle. This adjustment may be made by the involved parties themselves or by tax authorities. In case one tested party makes an adjustment the other involved party should preferably make a corresponding adjustment to prevent double taxation. Transfer pricing adjustments are a common feature of multinational enterprises’ pricing strategies.13

10 Paragraph 2.114 OECD Guidelines 2017, p.133. 11 Paragraph 2.124 OECD Guidelines 2017, p. 136. 12 Paragraph 2.127 OECD Guidelines 2017, p. 137. 13 Paragraph 5.3.1 WCO guide to customs valuation and transfer pricing.

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5 Customs valuation The European customs legislation before May 1, 2016 was laid down in the Community Customs Code14 (hereafter CCC). As of May 1, 2016 the CCC has been replaced by the Union Customs Code15 (hereafter UCC) as European customs legislation. The provisions of the CCC and the UCC relating to customs value are “a cut and paste” of article VII of the Customs Valuation Agreement of the World Trade Organisation (hereafter WTO).1617 Determination of the customs value is an important component to determine the amount of import duties which are payable related to a transaction. More specifically it provides the dutiable base. In addition, the classification and origin of goods provide the duty rate in case of an ad valorem rate (i.e. a duty rate specified as a percentage over the value of the goods).

5.1 Customs valuation methods The CCC and the UCC contains the following 6 customs valuation methods18:

1. the transaction value of the imported goods;

2. the transaction value of identical goods;

3. the transaction value of similar goods;

4. the deductive value method;

5. the computed value method; and

6. the reasonable means method.

These customs valuation methods have to be applied in sequential order. The only exception to this rule relates to the deductive value method and the computed value method. The order of applying these methods may be reversed if the declarant so requests.

5.1.1 The transaction value of the imported goods In accordance with article 29 CCC (70 UCC) the primary basis of the customs value of goods shall be the transaction value which is the price paid or payable for the goods when sold for export from a third country (i.e. not inside the EU) to the customs territory of the EU. This is in accordance with the preamble of the Customs Valuation Agreement which states: Many countries have reported that the transaction value is used in 90 – 95% of all importations.19 In order to use the transaction value of the imported goods several conditions needs to be fulfilled. An important condition in this regard is that the buyer and seller are not be related, or if these parties are related, this relationship did not influence the price (see paragraph 5.2 for more information). Where necessary this transaction value shall be adjusted in accordance with articles 32 and 33 CCC (71 and 72 UCC) (for among others royalties and license fees related to the imported good).

14 Council regulation (EEC) No 2913/92 of 12 October 1992 establishing the Community Customs Code. 15 Regulation (EU) No 952/2013 of the European parliament and of the council of 9 October 2013 laying down the Union Customs Code. 16 Bakker and Obuoforibo 2009, p. 115. 17 Customs Valuation Agreement, formally known as agreement on the implementation of article VII of the general agreement on tariffs and trade 1994. 18 Article 29 through 31, CCC (70 and 74 UCC). 19 Paragraph 2.1 WCO guide to customs valuation and transfer pricing, WCO 2015.

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5.1.2 The transaction value of identical or similar goods. If it is not possible to determine the customs value based on the transaction value of the imported goods the sequential customs valuation method is the transaction value of identical goods. If this is also not possible the transaction value of similar goods should be considered. These identical or similar goods should be imported into the EU customs territory at or around the same time as the goods being valued.

5.1.3 The deductive value method If the previous methods have not resulted in an acceptable customs value the deductive value method, or if the declarant so requests the computed value method, may be used. The deductive value method is based on the price of the imported goods, or identical or similar imported goods (imported within ultimately 90 days after the goods being valued) sold to persons not related to the seller.20 To determine the dutiable base various (but not all) expenses incurred in the EU (among others direct and indirect costs of marketing related to the goods) may be subtracted.21

5.1.4 The computed value method If the previous methods have not resulted in an acceptable customs value the computed value method may be used. In addition, the applicant may request to use the computed value method instead of the deductive value method. The computed value method is based on various costs related to the imported product before it is imported into the European Union. The computed value consists of the sum of the costs or value of materials and processing, profit and general expenses which are usually reflected in the sales of goods and transport costs.22

5.1.5 The reasonable means method Where the customs value cannot be determined based on any of the previous customs valuation methods the reasonable means method (also referred to as the fall-back method) should be applied.23 When using this method the previous customs valuation methods are applied sequentially with a reasonable flexibility.24

5.2 Transactions between related parties As was mentioned in paragraph 5.1.1 the transaction value of the imported goods may only be used to determine the customs value where the buyer and seller are not related or where the relation between the buyer and the seller did not influence the price. The definition of related parties for customs purposes is laid down in article 143 of the CCC implementing act25 (127(1)(d) UCC implementing act26). For multinational enterprises dealing

20 Article 30, section 2, sub c, CCC (Article 74, section 2, sub c, UCC). 21 Article 152, CCC implementing act (Article 142, UCC implementing act). 22 Article 30, section 2, sub d, CCC and article 153, CCC implementing act (Article 72, section 2, sub d, UCC and article 143, UCC implementing act). 23 Article 31, CCC (Article 74, section 3, UCC). 24 Punt en Van Vliet 2000, p.99., article 144, UCC implementing act. 25 Commission regulation (EEC) No 2454/93 of 2 July 1993 laying down provisions for the implementation of Council Regulation (EEC) No 2913/92 establishing the Community Customs Code 26 Commission implementing regulation (EU) 2015/2447 of 24 November 2015 laying down detailed rules for implementing certain provisions of Regulation (EU) No 952/2013 of the European Parliament and of the Council laying down the Union Customs Code.

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with transfer pricing adjustments section 1 sub d of this article will likely be relevant. Here it is mentioned that parties are deemed related if “a third party directly or indirectly owns or controls or holds 5% or more of the outstanding voting stock or shares of both of them”. At any rate if multinational enterprises are related parties according to the arm’s length principle it is almost certain they are also related for customs purposes. Where the buyer and the seller are related, there are two methods to determine whether such relationship influenced the price (i.e. examining the circumstances surrounding the sale or test values provided by the importer).27

5.2.1 Examining the circumstanced surrounding the sale Annex 23 of the CCC implementing act provides additional information on how the circumstances surrounding the sale should be examined (this guidance no longer exists in the UCC nor its implementing or delegated act. It is stated that in order to determine whether the relationship influenced the price several factors should be taken into consideration. This includes the way in which the buyer and seller organize their commercial relations and the way in which the price in question was arrived at. The flowing examples are given which would demonstrate that the price had not been influenced by the relationship:

1. The price has been settled in a manner consistent with the normal pricing practices of the industry in question;

2. The price has been settled in a manner consistent with the way the seller settles prices for sales to buyers who are not related to the seller;

3. It is shown that the price is adequate to ensure recovery of all costs plus a profit which is representative of the firm's overall profit realized over a representative period of time (e.g. on an annual basis) in sales of goods of the same class or kind?28

This guidance is based on the third paragraph of the Interpretative Note to article 1 section 2 of the Customs Valuation Agreement. With regard to the first and third matter mentioned above the WCO guide to customs valuation and transfer pricing recommends that customs should (at least initially) consider information contained in available transfer pricing documentation.29 In addition to the Interpretative Note, the technical committee on customs valuation has provided several case studies and a commentary relating to examining the circumstanced surrounding the sale. It should be noted that guidance from the WCO does not have direct effect in Europe. However, it is a valuable source for the interpretation of customs legislation.30 Case study 10.1 considers two cases. In the first case a product is sold by the seller to both a related and an unrelated buyer in the country of import. The product is sold to the unrelated buyer at a higher price than to the related buyer while the costs for the seller are the same. In the case the relationship between the seller and the related buyer was deemed to have influenced the price. In the second case a product was sold only between related parties.

27 Article 29, section 2 under a and b, CCC (Article 134, section 1 and 2, UCC implementing act). 28 Paragraph 2.3 WCO guide to customs valuation and transfer pricing. 29 Paragraph 5.2.2. WCO guide to customs valuation and transfer pricing. 30 The Customs Code Committee refers to WCO guidance in the European customs valuation compendium e.g. in commentary 3.

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The prices charged to the buyer were sufficient to recover all the seller’s costs including a profit that was representative to the firm’s overall profit over a representative period of time. In this case the relationship between the seller and the buyer was not deemed to have influenced the price.31 In commentary 23.1 the use of transfer pricing documentation to examine the circumstances surrounding the sale is examined. The commentary concludes that any relevant information and documents provided by an importer may be utilized for examining the circumstances of the sale. A transfer pricing study could be one source of such information.32 In case study 14.1 the circumstances of the sale between two related parties is examined. In this case customs took into account a transfer pricing study based on the TNMM (for more information on the TNMM please see paragraph 4.2.4) to determine whether the price had been settled in a manner consistent with the normal industry pricing practices under the Interpretative Note 1.2. The transfer pricing study confirms that the remuneration of the buyer was within the arm’s length range based on an analysis of the remuneration of comparable companies from the industry. Accordingly the case study concludes that the transfer pricing study supports that the price between the seller and the buyer was settled in a manner consistent with the normal pricing practices of the industry. Therefore the relationship between the related parties did not influence the price.33 Case study 14.2 also examines the circumstances of the sale between two related parties. However, in this case a transfer pricing study based on the resale price method was taken into account (for more information on the resale price method please see paragraph 4.2.2) to determine whether the price had been settled in a manner consistent with the normal industry pricing practices under the Interpretative Note 1.2. As opposed to case study 14.1 the transfer pricing documentation in this case shows that the remuneration of the buyer was outside the arm’s length range based on an analysis of the remuneration of comparable companies from the industry. The remuneration of the buyer far exceeded the estimated income since more products were sold at full price, and fewer at a discounted price, than anticipated. The buyer had not made any compensating transfer pricing adjustment to mitigate the exceeded income. This case concludes that the import price was not settled in a manner consistent with the normal pricing practices of the industry in question. Therefore, the relationship between the seller and the buyer is deemed to have influenced the price. The customs value of goods imported in 2012 had been declared at a lower price and should be re-determined accordingly by application of the alternative methods of valuation in a sequential order.34

5.2.2 Examining test values provided by the importer The declarant (likely the importer) is also given the option to demonstrate that the declared transaction value closely approximates to one of three defined test values. In this case the relationship between the seller and the buyer is not deemed to have influenced the price. The test values are based either on the transaction value, the deductive value or the computed value for identical or similar goods.35 This is not a substitution for the regular customs valuation determination.

31 Case study 10.1 of the WCO technical committee on customs valuation. 32 Commentary 23.1 of the WCO technical committee on customs valuation. 33 Case study 14.1 of the WCO technical committee on customs valuation. 34 Case study 14.2 of the WCO technical committee on customs valuation. 35 Article 29, section 2, sub 2, CCC (Article 134, UCC implementing act).

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Based on the above criteria the declarant should access and produce relevant data relating to identical or similar goods. However, manufactured goods often contain technology or intellectual property unique to the multinational enterprises so such comparison prices are typically not available. Furthermore, goods sold by multinational enterprises within their own group are often not sold to unrelated parties. Hence, this option is rarely used in practice.36

6 Linkages and differences between transfer pricing and customs valuation

The aim of both customs valuation and transfer pricing methodologies is very similar: whereas Customs are establishing whether or not a price has been ‘influenced’ by the relationship between the parties, the transfer pricing objective is to seek an ‘arm’s length price”. Each is ensuring that the price is set as if the parties were not related and had been negotiated under normal business conditions.37 In addition, various customs valuation and transfer pricing methods exhibit similarities. For example both the deductive method and the resale price method are based on a value built up from materials and manufacturing costs etc. However, as opposed to the transfer pricing methods, the customs valuation methods are hierarchical and should be applied sequentially. Therefore, customs will use information from transfer pricing reports primarily to substantiate the transaction value method and to establish whether the relationship between the seller and the buyer influenced the transaction value.38 While transfer pricing and customs valuation have similar methodologies the objectives when applying the rules are opposite. From the perspective of the tax authorities, the price paid by the buyer should be reasonably low, in order to prevent profits from being transferred to countries with preferential tax regimes and not to adversely affect the determination of the taxable base for the purposes of direct taxation. However, from the perspective of the customs authorities, the customs value should be reasonably high, in order to determine a higher dutiable base to which the relevant rate applies.39 The perspective of the declarant is likely exactly opposite to perspective of either the tax or customs authorities. An important challenge when using transfer pricing data for customs valuation purposes relates to the level of detail. Customs valuation focuses on specific products at the moment of import. However, transfer pricing reports often use aggregated data of various products over a long period of time. It is important to establish that transfer pricing data relates to the imported products at the time of import. The WCO is working with the OECD and World Bank Group to encourage customs and tax administrations to exchange knowledge, skills and data, which will help ensure that each authority has the broadest picture of a multinational enterprises business, its compliance record and can make informed decisions on the correct revenue liability. Greater understanding of this the usefulness of transfer pricing data for customs valuation purposes and a sharing of ideas and solutions will provide more certainty for governments and business and will lead to a more consistent approach and accurate determination of duty

36 Paragraph 2.2 WCO guide to customs valuation and transfer pricing. 37 Paragraph 4.1 WCO guide to customs valuation and transfer pricing. 38 Paragraph 4.1 WCO guide to customs valuation and transfer pricing. 39 Bakker and Obuoforibo 2009, p. 116.

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liabilities. Burdens on business can also be reduced by taking a more joined-up approach, which can be seen as an important trade facilitation measure.40 In this regard the WCO and OECD have met on multiple occasions to help gain a better understanding of further alignment and other technical aspects. This has already resulted in the adoption of commentary 23.1 and case studies 14.1 and 14.2 by the WCO technical committee on customs valuation.41

7 Court of Justice case C-529/16 Hamamatsu Photonics Deutschland GmbH

7.1 Introduction On 20 December, 2017 the ECJ published the judgement in the case of Hamamatsu Photonics Deutschland GmbH (hereafter Hamamatsu). The judgement followed upon a request for a preliminary ruling from the Finanzgericht München (hereafter the referring court). It is customary for ECJ cases to publish the opinion of the Advocate General prior to the final judgement. It is important to notice that although this judgement potentially has a significant impact for a great number of companies it was published without an opinion of the Advocate General. This is may be an indication that the ECJ did not consider this case to be technically complicated.

7.2 Summary of the case Hamamatsu Photonics Deutschland GmbH is a company established in Germany, which belongs to a group of companies active globally whose parent company, Hamamatsu Photonics, is established in Japan. Hamamatsu purchased imported goods from its parent company which charged it for those goods intra-group prices in accordance with the advance pricing agreement concluded between that group of companies and the German tax authorities. The total of the amounts charged to Hamamatsu in the main proceedings by the parent company were regularly checked and, if necessary, adjusted, in order to ensure the conformity of the sale price with the ‘arms-length’ principle. The intra-group prices including the adjustments were based on the residual profit split method (for more information see paragraph 4.2.5). Hamamatsu received an arm’s length remuneration which is expected to result in sufficient profit. If the profit actually generated falls outside that margin, the result is adjusted to the upper or lower limit of the margin and credits or subsequent debit charges are made. During the period in question Hamamatsu released more than 1000 consignments purchased from the parent company. The customs value was determined according to the intra-group pricing methodology. These consignments contained multiple goods with a duty rate between 1.4% and 6.7%. The profits of Hamamatsu fell below the established arm’s length range during this period. As a result the intra-group transfer prices were lowered and a transfer pricing adjustment was

40 Paragraph 1.2 WCO guide to customs valuation and transfer pricing. 41 Paragraphs 4.3 and 4.4 WCO guide to customs valuation and transfer pricing.

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made. Hamamatsu received a credit payment from its parent company. Hamamatsu subsequently argued that the customs value on which the customs duties of the imported products were based was too high. The company then applied for a repayment of customs duties for the amount which it considered was over charged. There was no allocation of the adjusted amount to the individual imported products. The German customs authorities Munich rejected that application on the ground that the method adopted by the Hamamatsu was incompatible with Article 29 section 1 of the Community Customs Code (hereafter CCC) which refers to the transaction value of individual goods, not that of mixed consignments. The applicant in the main proceedings lodged an appeal against that decision in German court. The German court subsequently referred 2 questions to the ECJ.

1. By its first question, the referring court asks essentially whether Articles 28 to 31 of the CCC must be interpreted as meaning that they permit the adoption, as the customs value, of an agreed transaction value which consists partly of an amount initially invoiced and declared and partly of a flat-rate adjustment made after the end of the accounting period, without it being possible to know at the end of the accounting period whether that adjustment would be made up or down (resulting in additional payable duties or a possible refund).

2. If so: may the customs value be reviewed and/or determined using simplified approaches where the effects of subsequent transfer pricing adjustments (both upward and downward) can be recognized?’

The ECJ starts with addressing the first question by referring to principles based on previous case-law of the ECJ.

The objective of EU law on customs valuation is to introduce a fair, uniform and neutral system excluding the use of arbitrary or fictitious customs values. The customs value must thus reflect the real economic value of an imported good and take into account all of the elements of that good that have economic value.

Furthermore, the ECJ has already stated that the customs value had to be determined primarily according to the ‘transaction value’ method under Article 29 of the Customs Code. It is only if the price actually paid or payable for the goods when they are sold for export cannot be determined that it is appropriate to use the alternative methods laid down in Articles 30 and 31 thereof.

The ECJ has also stated that, if as a general rule the price actually paid or payable for the goods forms the basis for calculating the customs value, that price is a factor that potentially must be adjusted where necessary in order to avoid the setting of an arbitrary or fictitious customs value.

Article 78 of the Customs code permits the customs authorities, on their own initiative or at the request of the declarant, to amend the declaration. However, it must be recalled that the cases in which the ECJ has allowed a subsequent adjustment of the transaction value is limited to specific situations relating, inter alia, to quality defects or faulty workmanship in the goods discovered after their release for free circulation.

The ECJ then states that, in the version in force, the CCC does not impose any obligation on importer companies to apply for adjustment of the transaction value where it is adjusted subsequently upwards and it does not contain any provision enabling the customs authorities to safeguard against the risk that those undertakings only apply for downward adjustments.

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The ECJ continues that in those circumstances, it must be held that the Customs Code, in the version in force, does not allow account to be taken of a subsequent adjustment of the transaction value, such as that at issue in the main proceedings. This results in the conclusion that the answer to the first question is that Articles 28 to 31 of the Customs Code, in the version in force, must be interpreted as meaning that they do not permit an agreed transaction value, composed of an amount initially invoiced and declared and a flat-rate adjustment made after the end of the accounting period, to form the basis for the customs value, without it being possible to know at the end of the accounting period whether that adjustment would be made up or down. Lastly, according to the ECJ the second question expressly applies only if the first question is answered in the affirmative, there is no need to answer it.

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8 Analysis

8.1 Order for reference In the order for reference the referring court sets forth its own interpretation of the law in this case. This provides an additional insight the questions of the referring court. The referring court starts of by establishing that in order to use the transaction value the price of the individual goods should be determined unambiguously in the relevant commercial contracts. Since the transfer pricing adjustment does not relate to individual goods this condition is not met. Therefore, in the case the transaction value is not applicable.42 It should be noted that it is likely difficult to sufficiently relate a single transfer pricing adjustment to the commercial contracts of individual goods. Subsequently the referring court considers that the transaction value may also not be based solely on the amount initially invoiced where the later transfer pricing adjustments are not taken into consideration. This would lead to a fictitious price43. The referring court then considers the possibility that in this case none of the customs valuation methods mentioned in articles 29 and 30 are applicable in this case due to legal and factual reasons. This would only leave the reasonable means method to determine the customs value. The referring court considers that the definitive payable price by the buyer (i.e. including transfer pricing adjustments) would lead to an acceptable customs value based on the reasonable means method. The referring court states that this results in the question how the transfer pricing adjustment should be allocated to the relevant import transaction when using the reasonable means method. This is essentially the second question asked by the referring court.44 The above implies that the questions of the referring court does not only relate to the application of the transaction value method based on article 29 CCC. The referring court seems to be sure that in this case the transaction value is not applicable. However, the referring court seems to be of the opinion that in this case the reasonable means method should be implied. In this regard the referred questions seem especially aimed at establishing whether this opinion is correct, and if so, how the transfer pricing adjustments should be taken into consideration.

8.2 Decision of the ECJ

8.2.1 Adjusting the customs value The ECJ states that the customs value must reflect the economic value and all elements of that good that have value. In addition the ECJ has decided that where necessary the price potentially must be adjusted to avoid the setting of an arbitrary or fictitious customs value. However, there must be a basis in the law to adjust a declaration. In this regard the ECJ examines Article 78 CCC. According to the ECJ it has limited a subsequent adjustment of the transaction value to specific situations. Subsequently two of these situations are discussed relating to goods which were damaged or with a hidden defect present before they were released for free circulation. In both these cases the customs value was adjusted downwards. The ECJ does not explicitly discusses whether transfer pricing adjustments are comparable to these situations (i.e. whether transfer pricing adjustments could result in a lowered transaction value).

42 Order of reference ECJ case C-529/16 Hamamatsu, p. 11. 43 Order of reference ECJ case C-529/16 Hamamatsu, p. 13. 44 Order of reference ECJ case C-529/16 Hamamatsu, pp. 13-14.

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8.2.2 Obligation upward adjustment However, the ECJ does state that the CCC does not impose an obligation to apply an upward adjustment of the transaction value. For the sake of completeness the ECJ case relating to GE Healthcare45 will shortly be discussed. In this case the ECJ decided that royalty payments which cannot yet be determined at the moment of import should be included in the transaction value. The future inclusion of royalty payments could among other be based on article 156 a CCC implementing act.46 However this article strictly relates to article 32 section 2 and article 33 CCC. Since these articles do not relate to any transfer pricing adjustments they are not relevant in this case.

8.2.3 Misuse of customs value adjustments According to the ECJ, the CCC does not safeguard against the risk that declarants only apply for a downward adjustment if this were to be allowed based on article 78 CCC. If this were to be allowed this would create possibilities for potential abuse. First, it would be possible to request a refund in case of a downward pricing adjustment while no additional duties would be paid in case of an upward transfer pricing adjustment. In addition, it would be possible to artificially lower the customs value by way of tax planning. This could be achieved by initially giving an importer a remuneration above the arm’s length range (i.e. based on a low price of the sold goods). This would subsequently lower the customs value of the imported goods. At the end of the year the remuneration of the importer would be corrected by way of an upward transfer pricing adjustment. In this case the additional payment made by the importer to the seller would not be included in the customs value.

8.2.4 Transfer pricing adjustments and the customs value In this regard it makes sense that if upward transfer pricing adjustments are not taken into account when determining the customs value, the same would apply for downward transfer pricing adjustments. In any case, based on the above the ECJ has decided that based on the current version of the CCC any subsequent transfer pricing adjustment may not be taken into consideration to adjust the transaction value. In the Hamamatsu case this means that no refund can be successfully requested relating to the transfer pricing adjustment. In addition, the ECJ states that based on articles 28 to 31 of the CCC (in the version in force) the customs value may not be based upon an amount initially invoiced and declared whereby a flat-rate adjustment is taken into consideration at the end of the accounting period where it is not known if a potential adjustment will be made up or down. This would imply that since under these circumstances the customs value may not be based upon the transaction value a subsequent customs valuation method should be used. However, especially when taking into consideration the opinion of the referring court, this also seems to imply that in this case the reasonable means method based on the transaction value method may not be used.

8.2.5 The transaction value without transfer pricing adjustments In addition, the Hamamatsu case raises the question whether intercompany prices may be used to establish the customs value if no subsequent transfer pricing adjustment (either upward or downward) are taken into consideration. This would imply that no corrective adjustment would be taken into account for customs purposes where the remuneration of the importer falls outside of the arm’s length range established in a transfer pricing study. As was

45 ECJ Case C-173/15 GE Healthcare GmbH. 46 ECJ Case C-173/15 GE Healthcare GmbH, section 44.

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mentioned in paragraph 8.1 the referring court is of the opinion that the customs value may not be based upon intercompany prices without taking into consideration subsequent transfer pricing adjustments. The main question in this regard is whether the relationship between the seller and the buyer influenced the intercompany prices (for more information see paragraph 5.2). The above question has not been answered explicitly by the ECJ in this case. However, there are arguments which support the view that in this situation the relationship between the seller and the buyer should be deemed to have influenced the price. In my opinion this may be inferred from the structure of the ECJ’s consideration in this case. In sections 24 through 28 the Court references to the CCC and its previous judgements. Here it is among others stated that the transaction value should be the price paid or payable, that the customs value must reflect the economic value of the goods (including all its elements) and that where necessary the price potentially must be adjusted to avoid the setting of an arbitrary or fictitious customs value. In sections 29 through 33 the ECJ subsequently deals with the possibilities of adjusting the transaction value due to transfer pricing adjustments. It seems that the ECJ is of the opinion that an adjustment is necessary to avoid an arbitrary or fictitious customs value. In my opinion the ECJ has determined that transfer pricing adjustments should be taken into consideration when determining the customs value to avoid an arbitrary or fictitious customs value. This is in accordance with the position of the Court that royalties or license fees should be included in the customs value even when at the time the customs debt is incurred it is unclear whether the royalties or license fees will be payable.47 Royalties and license fees differ from transfer pricing adjustments. However, this seems to support the view that a timing difference should not influence the customs value of the goods. In order to avoid such an arbitrary or fictitious customs value the transaction value should be adjusted where necessary. However, the CCC does not facilitate to take (upward) transfer pricing adjustments into consideration when determining the customs value. Therefore, the ECJ decided that in this case the customs value may not include transfer pricing adjustments. Following the above reasoning it seems that not taking into consideration any transfer pricing adjustment would lead to an arbitrary or fictitious customs value. In addition, it is likely that under these circumstances the relationship between the seller and the buyer would be deemed to have influenced the customs value.

8.2.6 Simplified procedures In its second question the referring court asks whether the customs value may be determined using simplified procedures where the effects of subsequent transfer pricing adjustments can be recognized. However, this question already assumes that in this case the customs value may be based upon either the transaction value optionally in combination with the reasonable means method. Since the ECJ has ruled that neither of these methods may be used to determine the customs value the second question is no longer relevant. Therefore, the second question is not further addressed.

8.3 Potential solutions This court case may have a significant impact for many multinational enterprises which import goods into the EU. Approximately 70% of the global trade consists of intercompany

47 ECJ Case C-173/15 GE Healthcare GmbH, section 29 and the dictum.

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transaction.48 Many of these companies base their customs valuation on a price which consists of an initial price and a subsequent lump sum transfer pricing adjustment. Under the circumstances of the Hamamatsu case this will be no longer possible. A potential solution may be to submit an incomplete declaration based on a provisional indication of the customs value of the goods based on article 254 of the CCC implementing act. This incomplete declaration should subsequently be completed based on articles 256, 257 and 259 of the CCC implementing act. When properly implemented this may provide a solutions for businesses. However, at the same time it results in an administrative burden for businesses since they potentially need to complete a large number of individual declarations a substantial time after the goods have been imported. It shall be no surprise that this solution is not favored by the International Chamber of Commerce.49 In addition, it might be worthwhile for businesses to consider their transfer pricing model including adjustments. A potential solution might be provided by the continuous monitoring of transfer prices combined with prospective adjustments. Another option might be the implementation of a transfer pricing model based on the price setting (ex-ante) approach instead of the outcome testing (ex-post) approach. Under the price setting approach budget figures based on information of the economic and market conditions including financial projections at the time of the transactions need to be applied to determine intercompany prices. This might render the initial transfer pricing to be binding without the possibility of any retroactive adjustments. The price setting approach is supported by the OECD guidelines and preferred by among others the German tax authorities. It should be considered that the price setting approach may lead to disputes and potential double taxation where tax authorities of different countries prefer a different approach.

8.4 Impact UCC. The Hamamatsu case is based on the CCC. However, as of May 1, 2016 the Union Customs Code (hereafter UCC) has entered into force. This begs the question to which extent this court case is still relevant under the UCC. The UCC does not contain any references to transfer pricing adjustments which may be considered a missed opportunity.50 In addition, the articles relating to customs valuation methods have remained mostly the same as in the CCC as to the extent that it is relevant for transfer pricing adjustments. Therefore, it seems that the Hamamatsu case is still of significant important although the UCC has replaced the CCC. A possible point of attention in this regard may be the rules relating to incomplete and simplified declarations under the UCC.

48 Van Egdom 2011, p.34. 49 Paragraph 5.5.3 WCO guide to customs valuation and transfer pricing, WCO 2015. 50 M.L. Schippers & W. de Wit, ‘BEPS and Transfer Pricing but what about VAT and Customs?’, WFR 2016/63.

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9 Conclusion It seems likely that the Hamamatsu case of the ECJ will have a significant impact for multinational businesses who import into the EU. Under the circumstances of the court’s case it is now clear that the customs value may not be based on an initial price which is later adjusted based on an additional lump sum transfer pricing adjustment (either upward or downward). This impacts both the transaction value and the reasonable means method. Since a large amount of multinational enterprises establish their customs value in a similar way to Hamamatsu this court case has shaken up businesses, advisors and customs authorities alike. Under the circumstances in this case the customs value must likely be established using one of the remaining customs valuation methods. In other cases an incomplete declaration or a different transfer pricing model may provide a solution. However, this should be further explored. It should be noted that this court case was not preceded by a conclusion from the Advocate General of the ECJ. In addition, the elaboration of the considerations of the ECJ are rather limited. Therefore, a lot of uncertainty remains for businesses. As a result of this court case it is likely that the transaction value method will lose importance as a customs valuation method. The majority of all world trade is based on intercompany transactions. For these transactions this court case has made it significantly harder to apply the transaction value. This may be considered remarkable because the Customs Valuation Agreement on which the CCC is based states that “Recognizing that the basis for valuation of goods for Customs purposes should, to the greatest extent possible, be the transaction value of the goods being valued”.51 This court case is also contrary to developments of the past years. The WCO increasingly recognizes the importance of transfer pricing for customs valuation. On multiple occasions in this case the ECJ has stated that the phrase: “in the version in force, the Customs Code (at the time of the facts this was the CCC)”. In my opinion this is likely an indication that the ECJ recognizes that the outcome of this case is not beneficial for either businesses or customs authorities. It may be an appeal to the European Commission to update the customs legislation to explicitly include transfer pricing adjustments. In any case, until more clarity is provided multinational businesses must evaluate their customs value determination and transfer pricing policies to mitigate the potential impact of this important court case.

51 Customs Valuation Agreement, formally known as agreement on the implementation of article VII of the general agreement on tariffs and trade 1994.

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10 Literature list Bakker A. & Obuoforibo B., ‘Transfer Pricing and Customs Valuation. Two worlds to tax as one’, IBFD, Amsterdam, 2009, pp.115-116.

Commission implementing regulation (EU) 2015/2447 of 24 November 2015 laying down detailed rules for implementing certain provisions of Regulation (EU) No 952/2013 of the European Parliament and of the Council laying down the Union Customs Code.

Commission regulation (EEC) No 2454/93 of 2 July 1993 laying down provisions for the implementation of Council Regulation (EEC) No 2913/92establishing the Community Customs Code.

Council regulation (EEC) No 2913/92 of 12 October 1992 establishing the Community Customs Code.

ECJ Case C-173/15 GE Healthcare GmbH.

ECJ GE Healthcare GmbH, C-173/15.

ECJ Hamamatsu, C-529/16.

ECJ Order of reference, Hamamatsu, C-529/16.

laying down the Union Customs Code.

M.L. Schippers & W. de Wit, ‘BEPS and Transfer Pricing but what about VAT and Customs?’, WFR 2016/63.

OECD, Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, OECD Publishing 2017.

Order of reference ECJ case C-529/16 Hamamatsu, p. 11.

Punt, E. N., & Van Vliet, D. G., Douanerechten: inleiding tot het communautair douanerecht, Deventer, Kluwer, 2000, p.99.

Regulation (EU) No 952/2013 of the European parliament and of the council of 9 October 2013.

Van Egdom J.T., Verrekenprijzen; de verdeling van de winst van een multinational, Kluwer, Deventer 2011, p.34.

WCO technical committee on customs valuation, case study 10.1.

WCO technical committee on customs valuation, case study 14.1.

WCO technical committee on customs valuation, case study 14.2.

WCO technical committee on customs valuation, case study commentary 23.1.

WCO, WCO guide to customs valuation and transfer pricing, 2015.

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WTO, Agreement on the implementation of article VII of the general agreement on tariffs and trade 1994.