TP Adjustments and Customs

In a preliminary ruling of 20 December 2017 (case C-529/16) the European Court of Justice decided on a customs issue caused by a price adjustment for transfer pricing and corporate income purposes.

The decision was requested in proceedings between a German subsidiary of a Japanese corporate and the Principal Customs Office in Munich, Germany, following the refusal of the Principal Customs Office to partially refund customs duties declared and paid by the German subsidiary.

In short, the following happened:

The Germany subsidiary 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 the group and the German tax authorities. The total of the amounts charged for the imported goods were regularly checked and, if necessary, adjusted, in order to ensure the conformity of the sale price with the arms length principle laid down in the OECD Transfer Pricing Guidelines.

The checks were carried out in a number of stages, based on the Residual Profit Split Method. In the first stage, each participant was allocated a profit to produce a minimum rate of return. The residual profit was then allocated in accordance with specific factors. In the second stage, the operating margin range for the German subsidiary was established. If the operating profit actually generated would fall outside the range of margins, the operating profit would be adjusted to the upper or lower limit of the margin, and subsequent credit or debit charges were made.

Between 7 October 2009 and 30 September 2010 the German subsidiary released for free circulation various goods from more than 1,000 consignments from its parent company, declaring a customs value corresponding to the prices charged.

Because the operating margin of the German subsidiary fell below the arm’s length range for its operating margin, the transfer prices were adjusted. The German subsidiary thus received a credit of approximately EUR 4 million, thereby lowering its cost of imported goods and increasing its operating profit.

Now, the Germany subsidiary applied for the repayment of customs duties for the imported goods. There was no allocation of the adjustment amount to the individually imported goods.

The Principal Customs Office in Munich rejected the application on the ground that the method applied by the German subsidiary was incompatible with Article 29(1) of the Customs Code which refers to the transaction value of individual goods, not that of mixed consignments.

The European Court of Justice held that the Customs Code does not allow account to be taken of a subsequent adjustment of the transaction value and further pointed out that the cases in which the Court has allowed a subsequent adjustment of the transaction value is limited to specific situations such as quality defects or faulty workmanship in the goods discovered after their release for free circulation.

The decision highlights the conflict between two sets of rules with different objectives in terms of tax revenues and time of application and which are typically administered by different teams within tax administrations. This is not new but again stresses the need to apply a proper price adjustment policy for transfer pricing, VAT and customs purposes.