The Potential Impact of Tariffs on Transfer Pricing …...— New tariffs may not be reflected in...

2019 U.S. Cross-Border Tax ConferenceMay 14 – 16, 2019

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The Potential Impact of Tariffs on Transfer Pricing Issues and Customs Valuation

2© 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 821761

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The following information is not intended to be “written advice concerning one or more Federal tax matters” subject to the requirements of section 10.37(a)(2) of Treasury Department Circular 230.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

Notices

AgendaHigh tariffs potential impact on transfer prices / customs value

Tax Reform – What does BEAT and FDII mean for me?

Looking Ahead – Closing thoughts

Q&A

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Today’s presentersName Title Firm/Company Name Email

Luis (Lou) Abad Principal, Trade and Customs KPMG WNT [email protected]

Brian Cody Principal, Economic and Valuation Services KPMG WNT [email protected]

High tariffs potential impact on transfer prices and customs value


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Accounting for tariffs

Usually included as inventoriable cost, ultimately ending up in cost of goods sold


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Potential impact on transfer pricing

Exposure to tariff risk could affect comparables information used to establish or verify arm’s-length pricing— New tariffs may not be reflected in comparables information, for example,

due to time lag in reporting of financial data— Depending on supply chain, comparables may face similar tariffs or retaliatory tariffs— Supply chains may change — Tariff exemptions may be extended or removed

Tariff impact could trigger need to make transfer pricing adjustment— Quantification is expected to be difficult

Importer of record” initially bears the tariff— Attempt to pass tariff on to customers— No prohibition against allocation of tariff “risk”, but still must be

arm’s length


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Example

Forco sells goods to USco, wholly-owned U.S. distribution subsidiary1

Arm’s length range found to be operating margin (OM) of 2–4% of net sales2

$10 M goods produced in China and subjected to 25% tariff ($2.5M)3

Before tariff, USco earned $3M on sales of $100M goods (3% OM)4

No portion of tariff passed on to third party customers5

Tariff would reduce operating profit from $3M to $0.5M (0.5% OM)6

Assuming no change in the arm’s-length range, USco must make at least a $1.5Mdownward adjustment to its transfer pricing to increase U.S. profits and move results into arm’s length range ($.5M + 1.5M = $2M or 2% OM)

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Impact of tariffs on transfer prices requires a detailed analysis of all facts and

circumstances of the intercompany transactions — no one-size-fits-all

solution.

— Capability of management of U.S. importer to negotiate alternative supply arrangements

— Capability of U.S. exporter (e.g., manufacturer) to negotiate alternative export arrangements, alter customer contracts, etc.

Other TP considerations

— Availability of alternative sources of supply— Ability of U.S. importer to pass tariff impact along

to its customers— Necessity of U.S. exporter to absorb retaliatory

tariffs imposed on its goods in foreign jurisdictions

Industryanalysis

Legal and othercontractual obligations

Functionalanalysis


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Customs impact of transfer pricing adjustmentGenerally, retroactive transfer pricing

adjustments alter the customs value of previously imported goods, and

must be reported

The adjusted transfer price must satisfy CBP’s arm’s-length rules and methods

(which are different than tax/IRC 482 methods)

In addition, if the transfer pricing adjustment results in a retroactive decrease in the

customs value, then the importer must satisfy CBP’s 5-factor criteria in order to be eligible

for a tariff refund

CBP reporting options:— Reconciliation Program

(21 months to adjust)— Post summary corrections (PSCs) — Protests (downward adjustments)— Voluntary “prior disclosure” (violations)

First Sale customs valuation basis? –potential tariff mitigation strategy


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Possible reactions of treaty partners to transfer pricing adjustment

If U.S.-enacted tariffs cause the adjustment, how willing will

other governments be to negotiate with U.S. to eliminate

double tax?

New tariffs could drastically change transfer price on

impacted goods

Mutual Agreement Procedure (MAP) allows treaty partners to

negotiate to alleviate double taxation

Post-year-end adjustments and transfer pricing examinations could result in double taxation


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Potential impact of advance pricing agreement on tariff cost

Restrictive reading of APA critical assumption – new

tariffs may not trigger violation

Same treatment as aboveexample appears to apply


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Overview— Foreign parent / exporter absorbed the impact of high Section 301 tariffs on Chinese-origin

goods, decreasing its OPM and adversely impacting its ability to satisfy customs arm’s length requirements (all costs plus profit)

— KPMG was engaged to evaluate alternative value methods— KPMG gathered the necessary costs and financial data to model the various

customs valuation methodsApproach / Considerations— Alternative value methods (e.g., computed and deductive value) were not operationally feasible— First sale— Moving production outside of ChinaOutcome— Shifting some production outside of China mitigated the compliance impact of the high tariffs on

the customs arm’s length requirements and yielded the largest savings of all the alternatives— Greater coordination between tax and customs functions, on a global basis, with documentation

to potentially support both tax and customs arm’s length requirements.

Case study – Exploring other value methods


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Trade & Customs— Assess applicability of new tariffs (classification and origin)— Consider exclusion process— Mitigate (e.g., first sale valuation; sourcing alternatives etc)— Address potential transfer pricing impact (e.g., arm’s length considerations; report adjustments;

duty refunds?)Transfer Pricing and Dispute Resolution— Tariff impacts on transfer prices will vary substantially by industry and by company – industry and

competitive analyses matter— Comparability analysis requires ever-increased attention on allocation and management of risks

– supply chain, pricing, year of information, etc.— Post-year-end adjustments and transfer pricing examinations could result in double taxation if

adjustments were not to be accepted by foreign tax authorities – consider APAs and other planning to mitigate and resolve transfer pricing risks

Operational Changes/VCM— Companies can change supply chains and discontinue transactions made unprofitable by tariffs

Key takeaways

Tax Reform – What does BEAT and FDII mean for me?


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BEAT— Imposes minimum tax— Imposes 10% tax on certain payments

to foreign related persons

Overview of new international tax framework

U.S.

FDII – 13.125%— Income from sale, leases, licenses, and

dispositions of property to foreign person for foreign use

— Income from services to person outside the U.S.

Distributions –— Mandatory Repatriation— Participation Exemption— 0% on Previously Taxed Income

GILTI – 10.5% (13.125%)— CFC income that is not

exempt or sub F— Current inclusion with 50%

deduction— 80% FTC— Separate basket— No FTC carryforward

Sub F – 21%— Current inclusion at 21%— General and passive baskets— 10 year FTC carryforward

Exempt Income – 0%— 10% QBAI— High Tax sub F

income (elective)

Branch Income – 21%— Current inclusion— Separate basket— 10 year carryforward— Cannot get FDII

Other Income – 21%— U.S. and Foreign source

income that is not FDII or GILTI or eligible for DRDs

163(j) Limit on interest deduction— Related and unrelated party debt— 30% of EBITDA (EBIT in 2026)

CFC2F Branch


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BEAT functions as an alternative minimum tax (i.e., it’s a parallel tax system)BEAT could lead to significant supply chain rationalizations— Different treatment for payments to domestic related parties vs. foreign related parties— Different treatment for payments to third party vs. related parties— Different treatment for reduction in gross receipts vs. deductions – COGS not subject to BEATBEAT SCM services exception is critical for many taxpayers— Statutory and draft regulations provide that the total services costs component of eligible

marked-up services can qualify for that exception— Robust transfer pricing documentation is critical

- White list analysis; and- Low margin covered services analysis

Emerging trends and patterns— Agency arrangements— Disaggregation of SCM services from non-SCM services— Cost sharing arrangements

Key transfer pricing considerations for BEAT


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— Intellectual property ("IP") costs baked into the transfer price (product price) from principal to U.S. importing company, resulting in a higher customs/import value

— Principal is in a low tax jurisdiction- Principal either owns the IP or owns the rights (i.e., pays the IP owner a royalty)- IP, even if developed in the U.S., is owned off-shore

Traditional customs considerations:— Duty-free vs. high tariffs— First Sale for export — R&D (design and development) assists

Example: Integrated supply chain (pre-tax reform)

Contract manufacturer Principal (IP owner) U.S. importer

— Transfer price based on cost-plus, low margin commensurate with routine contract manufacturing

— Entrepreneurial risk-taker— IP provided to contract

manufacturer (assist)

— Transfer price based on resale-minus, low margin commensurate with low-risk distribution


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FDII – foreign-derived intangible income provisions provides incentives for companies to migrate IP back to the U.S (i.e., to act as an IP Hub) if US then licenses IP to foreign parties.New customs considerations:— Reduced customs value

- Lower transfer price/customs basis- Assist exception (19 U.S.C. § 1401a(h)(1)(B)) – R&D undertaken in the U.S. is excludable

— Custom value reduction can be significant for companies with R&D operations in the U.S.

Example: U.S. tax reform structure (FDII)

Contract manufacturer U.S. importing(IP owner)

— Transfer price based on cost-plus, low margin commensurate with routine contract manufacturing

— IP provided to contract manufacturer (assist)


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If companies do not adjust business practice to account for the new legislation, BEAT may raise dutiable customs value for imported products, increasing duty exposure and heightening compliance risk in the area of product valuation.— Restructure supply chain to aggregate the supply of goods with services currently provided by a

related party; “BEATable” costs may potentially be included in the COGS for imported goods — Restructure intercompany arrangements to characterize (and bundle, if appropriate) “BEATable”

license or service costs as included in the COGS for imported goods— Restructure intercompany arrangements or supply chain to unbundle excludable 3rd party service

costs (e.g., 3rd party tolling/assembly services) from intercompany payments for imported goodsU.S. Customs Considerations: — Understanding net financial impact of adjusting valuation / payment arrangements; — Duty increase may be mitigated (e.g. first Sale rule); — Adjustments could belie past “non-dutiable” customs positon; — New arrangement must comply with customs regulations (e.g. bona fide buying agent); — Changes may preclude transaction value (including first Sale), triggering alternative,

more onerous customs value methods.

Base erosion and anti-abuse tax (BEAT)


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Inbound structure: BEAT issues

Trade and Customs Considerations— Understand the customs duty impact and net financial impact of the alternative arrangement – dutiable?— Can a non-dutiable arrangement be implemented? For example, see HQ H242894 (2013), territorial

exclusivity fee under an exclusive distribution agreement.— Understand the customs reporting and compliance requirements.

ID of Potential BEAT Issues— U.S. Co payment of a fee to FP could be considered a base

erosion payment and potentially subject to BEAT.— In many cases the fee could be treated as allocable to

inventory and hence would be treated a reduction in gross receipts. AMCS should be consulted.

FP

U.S. Customers

IP

Intercompany Fee

China CoSuppliers

Potential base-erosion tax on payment of fee paid from U.S. Co to FP

U.S. Co (licensed

distributor)

Sales

Sales Sales

Overview— Foreign-parented multinational corporation (“FP”) is a

multinational manufacturer. — FP operates in the U.S. market via a licensed distributor

(“U.S. Co”)— U.S. Co pays a fee of 5% of sales to FP— U.S. Co purchases goods at cost plus 5% from a foreign

manufacturing affiliate (“China Co”).


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BEAT – Alternative to explore and issues to consider

Further Considerations— Transfer pricing - Conversion costs for U.S. Co?— Trade and customs - Higher customs costs as a result of higher finished goods price under the

new supply chain arrangement? — Trade and customs - Can we mitigate the higher customs cost with “first sale” customs valuation?

If not, does the new transfer price between FP and U.S. Co satisfy customs arm’s length requirements?— Chinese origin goods – Sec. 232 or 301 tariffs?

Potential Alternative Structure— Establish FP as a global principal company whereby U.S. Co

would purchase all its finished goods from FP.— Establish U.S. Co as a limited risk distributor (as opposed to a

licensed distributor). This would have the effect of eliminating the separate royalty. (Note, merely being an “LRD” does not automatically turn off BEAT).

Overview— Foreign-parented multinational corporation (“FP”) is a

multinational manufacturer. — FP operates in the U.S. market via a licensed distributor

(“U.S. Co”)— U.S. Co purchases goods at cost plus 5% from a foreign

manufacturing affiliate (“China Co”).

FP(principal)

U.S. Customers

IP

Sales (resale minus)

China CoSuppliersU.S. Co

(limited risk distributor)Sales Sales

Sales


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Procurement structure: BEAT issues

ID of Potential BEAT Issues— USP’s procurement fee to Hong Kong Co could potentially be

considered a base erosion payment (assuming the procurement fee is treated as deduction and not a reduction in gross receipts for tax accounting purposes) and subject to BEAT.

— In many cases the procurement fee would be treated as allocable to inventory and hence would be treated as reduction in gross receipts. AMCS should be consulted.

Overview— U.S.-parented multinational corporation (“USP”) is a

multinational apparel company. — USP relies on third party manufacturers in China.— USP utilizes a foreign affiliated procurement company

(“Hong Kong Co”) to source goods from the third party manufacturers in China.

— USP pays Hong Kong Co a procurement fee / buying agency fee based upon the volume of goods Hong Kong Co procures.

USP U.S. Customers

Procurement fee / Buying agency fee

ChinaManufacture

Potential base-erosion tax on payment of procurement fee from USP to Hong Kong Co

Hong Kong Co(fee based)

SalesSales


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Procurement structure: Alternatives

Trade and Customs Considerations— Transfer pricing - Would the U.S. require compensation for giving up a contract?— Trade and customs – Will buying and importing goods from Hong Kong Co. (related party) results in more customs

costs than buying and importing directly from third party manufacturers in China? Was the sourcing commission included in dutiable value originally?

— Trade and customs - Can we mitigate the higher customs cost with “first sale” customs valuation? If not, does the new transfer price between FP and U.S. Co satisfy customs arm’s length?

— Impact of Sec. 232 or 301 tariffs?

ID of Potential BEAT Issues— Establish Hong Kong Co as a buy-sell procurement company

rather than a fee based procurement company. This would have the effect of transforming a BEAT payment (deduction) into a non-BEAT payment for inventory (reduction in gross receipts).

Overview— U.S.-parented multinational corporation (“USP”) is a multinational

apparel company. — USP relies on third party manufacturers in China.— USP utilizes a foreign affiliated procurement company

(“Hong Kong Co”) to source goods from the third party manufacturers in China.

— USP pays Hong Kong Co a procurement fee based upon the volume of goods Hong Kong Co procures.

USP U.S. Customers

Sales of inventory

Hong Kong Co(buy-sell)

Sales

Sales

ChinaManufacture

Looking Ahead


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Trade and customs professionals should be involved in strategic tax planning discussions.The trade point of view can be helpful to: — Assess feasibility and calculate customs duty and indirect tax costs;— Determine the potential net financial cost of any new arrangement is understood

before implementation; — Mitigate or reduce additional duty costs where possible (e.G., Through first sale, ftzs, etc.); — Address any import or export regulatory compliance risks (and exposures) that may arise; and — Recommend tailored trade compliance programs or global trade management systems

(automation) to facilitate trade operations.Companies should also continue to monitor United States trade policies and remedies that could potentially offer additional “carrots” or “sticks” concerning the supply chain (e.g., restructure or move existing operations) or could potentially necessitate a transfer pricing adjustment:— Section 201 safeguard tariffs— Section 232 national security tariffs— Section 301 unfair trade tariffs

ConclusionHave you thought of the customs costs to your tax reform planning?

Questions

Thank you

© 2019 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved. NDPPS 821761

The KPMG name and logo are registered trademarks or trademarks of KPMG International.

The information contained herein is of a general nature and based on authorities that are subject to change. Applicability of the information to specific situations should be determined through consultation with your tax adviser.

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Some or all of the services described herein may not be permissible for KPMG audit clients and their affiliates or related entities.

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