If you are into the importation of goods, what is the basis of the customs duties you pay? If your answer is the invoice price – then I would encourage you to read on, since engaging in such a practice may lead to very interesting implications on the future of your business. To start, it is worth noting that immediately using your invoice value as the basis for customs duties is comparable to levying internal revenue taxes on your gross income. By this, it is very obvious that you are most likely paying the incorrect amount of duties and taxes.
An important point to consider is that, per the World Trade Organization rules (particularly the Agreement Implementing Article VII of the General Agreement on Tariffs and Trade), the basis for customs duties is the Transaction Value. The Transaction Value is not the invoice value. One way to simply describe it is that the Transaction Value is the invoice price plus or minus certain elements listed in Article 8 of the abovementioned Agreement. It is these add-ons and permissible deductions from the invoice value that can increase or decrease the total amount of duties you pay customs. Among these costs, that can either be added or deducted from the invoice price, is the tricky cost item of “royalties.”
In this connection, and as a follow up to the previous questions raised, it would be worthwhile to ask: do you pay royalties on your imported products? This may be made upon importation or by remitting a percentage of your net sales for the same purpose. Now that you’ve checked it, you might want to consider whether those royalties should have been subject to duties or not in the first place. Either way, now may be a good time to check whether you did indeed include the value of your royalty payments as part of the basis for customs duties on your imported items.
Three scenarios would thus be in the offing. First could be that you paid duties on the royalties and that those royalties should indeed be subject to duties– in which case there would be no problem. A second possibility would be you paying duties on royalties when these should not have been dutiable in the first place – which means you made an overpayment. Thirdly, you may not have paid customs duties on those royalties only to find out later that customs rules required you to have done so – meaning you underpaid your customs duties.
It would be erroneous to consider an overpayment of customs duties as having no practical, short or long-term harm to companies. Aside from additional costs, such constitutes a position of disadvantage that could cause more lapses in the level of compliance that a company has vis-à-vis customs rules. It could also be possible that by continuing with this practice unchecked, it may not be before long that the issue confronted by a company transitions from overpayment to underpayment.
The underpayment of duties, whereby certain cost items that should have been added to the dutiable value were omitted upon importation, is certainly to be avoided. An underpayment may be immediately determined by the Bureau of Customs (BoC) at the border, in which case an additional assessment may be made, or it can go on unchecked until that company is hit by a Post-Entry Audit.
Companies importing from related parties may have to take extra precautions in this regard as the BoC may also look at “transfer prices” with greater scrutiny to assess whether such would be acceptable bases for customs duties. A detailed transfer pricing study may have to be presented to the BoC to show that arm’s length principles were followed in setting prices between related parties. Should the BoC be unconvinced of this, then it may altogether reject your declared value and introduce higher values as the basis for duties.
In the event that the BoC rejects a transaction value, it would then follow a hierarchy of other methods to see what value should apply. Briefly these are: a) the transaction value of identical goods, b) the transaction value of similar goods, c) a deducted value (working out a value backwards from the supply chain), d) a computed value (based on a value construction from the beginning of the production chain) and e) a fall back value (or a “reasonable” value assigned by the BoC).
Having your declared value rejected may be hassle enough but at least it imparts lessons to companies (albeit the hard way) upfront. A more risky situation would be if lapses and inaccuracies in a company’s declared values go undetected for an extended period of time. What gives more gravity to a predicament like this are the efforts being made by the BoC in conducting Post-Entry Audits. One focus area of these audits is to check whether importers have indeed followed methodologies consistent with international rules in determining their declared value. This would apply to transactions dating back to as far as three years and back duties and penalties may be assessed on a company. Accumulating back duties obviously may severely affect a company’s state of finances. In case there is a finding of fraud, then more punitive sanctions – including imprisonment, may be imposed.
The valuation of goods for customs purposes is therefore something not to be taken lightly considering the cost saving and risk mitigation a company can get from a proper knowledge of the rules. Companies are encouraged to avail of professional guidance in this respect, particularly on how to extract the most of their opportunities through customs valuation.
It has to be recognized that in today’s world of highly competitive international markets defined by unprecedented peaks in trade volumes and thinning margins, the slightest change in import costs impact tremendously on a company’s financial position. Thus, through a reference to international rules and an analysis of your company’s processes and operations, coupled with expert advice, potential exposures can be kept in check and legitimate reductions to the amount of payable duties can be made.
(Jeremy I. Gatdula is a Principal for International Trade and Customs Services of Manabat & Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. This article is for general information only and is not intended to be, nor is it a substitute for, informed professional advice. While due care was exercised to ensure the quality of the information contained in this article, readers should carefully evaluate its accuracy, completeness and relevance for their purposes, and should obtain any appropriate professional advice relevant to their particular circumstances. For comments or inquiries, please email manila@kpmg.com.ph or jgatdula@kpmg.com).