March, 2018

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European Court: Transfer Pricing Adjustments Derail Transaction Value

Mark K. Neville, Jr.

In a startling decision rendered just before this past Christmas, the European Court of Justice (ECJ), the EU’s top court, thrust an entirely new formulation into the long running debate about the intersection of processes for fixing income tax liability for transfer pricing (TP) purposes and the customs valuation of related party transactions.1 While they were at it, with the ECJ’s retrograde maneuver, the EU dropped out of the steady march of mature consideration that has led to a developing consensus at the World Customs Organization and at various national authorities.

To cut right to the chase, in Hamamatsu Photonics Deutschland GmbH v. Hauptzollamt Munchen (Case No. C-529/16) (December 20, 2017) the First Chamber of the ECJ held that, as a matter of law, for a price declared at importation that is subject to review and adjustment through application of an Advance Pricing Agreement (APA) (and, by extension, to any transfer pricing policy) a transaction value appraisement is not available.

This decision is an air bag crash test.

Transaction Value

By way of background, the Customs Valuation Agreement2 (Valuation Agreement) installs a hierarchy of methods for fixing the customs valuation of imported merchandise. The first method, used in the overwhelming majority of cases, is transaction value, which is defined in the Valuation Agreement as “the price actually paid or payable for the goods when sold for export to the country of importation…”3 (the PAPP).

The Valuation Agreement is applied by all but a very few trading countries, so the uniformity of approach to the process of ascertaining customs valuation is somewhat assured by that fact alone. Further, the Valuation Agreement itself carries an inbuilt premium on “…a fair, uniform and neutral system for the valuation of goods for customs purposes that precludes the use of arbitrary or fictitious values.”4 One of the measures that the WTO has taken to promote a shared approach to customs valuation—arguably, along with antidumping and countervailing duty law, one of the more abstruse topics encountered in international trade system norms—was to set up the Technical Committee on Customs Valuation (TCCV) at the WCO in order “…to ensur[e], at the technical level, uniformity in interpretation and application of this [Valuation] Agreement.”5

The TCCV is the WCO’s constituent body that is charged with primary responsibility over customs valuation matters. The TCCV meets in open session in Brussels at WCO Headquarters on a Spring and Fall basis, in large measure concerned with the promulgation of various “instruments” (advisory opinions, commentaries or explanatory notes)6 on technical questions of interest. It is safe to note that for a number of years the TCCV has been focused on royalty and on TP issues.

The primacy of a transaction value appraisement is so important that the Technical Committee on Customs Valuation of the World Customs Organization (TCCV) has observed in its earliest days

…in conformity with the basic intention of the Agreement that the transaction value of imported goods should be used to the greatest extent possible for Customs valuation purposes, uniformity of interpretation and application can be achieved by taking the term “sale” in the widest sense.7

Limits on Transaction Value Appraisements

To be sure, even in the presence of a bona fide sale, there may be still be complications. The Valuation Agreement8 will disallow an application of transaction value if there are restrictions on the disposition or use of the goods, conditions or a consideration for which a value cannot be determined or if there is a related party transaction and the importer cannot show that the relationship did not influence the price.9 In the latter respect, the importer can make the case that its invoice price is a valid basis for transaction value by either a “circumstances of sale” approach or through one of the test values.

Finally, there are certain methods that are strictly prohibited by the Valuation Agreement as sources of customs valuation. These are set forth in Art. 7.2, and include, inter alia, arbitrary or fictitious values. We will return to this last point presently.

As noted already, the TCCV has especially focused on problems posed by TP entries.

TP Challenges

There are some fundamental facts to grasp. First, there has been an exponential growth in transactions between related parties over the past decades. Some reliable estimates are that as many as 50-60% of all import transactions come under that heading.

Second, at least for trade in tangible goods, TP is not an income tax concern or a customs concern. By definition, it is concern in both tax disciplines, and it affects the tax authorities in both the exporting and importing jurisdictions as well as the taxpayers in each jurisdiction who are the exporter/seller and the importer/buyer, respectively. That common or shared interest notwithstanding, it is generally a concern for the customs authority in the country of import alone.

Third, driven by income tax legal requirements, many of the parties to TP transactions have taken various measures to ensure compliance with their legal obligations. These include contemporaneous documentation and record-keeping and such measures as Advance Pricing Agreements, which are taxpayer/tax authority undertakings, or transfer pricing studies so as to justify that their pricing has been set at arm’s length. Fourth, private sector traders and the TCCV alike have been focused on TP for over a decade, and that focus is especially concerned with the question of “convergence” or “intersection” of the two tax disciplines.10 The TCCV set up a Focus Group on the topic.11 For the past decade, the TCCV has had the full support of the OECD on this topic, with the OECD participating and often formally presenting at each TCCV Session.

As a participant at the TCCV sessions, through the ICC delegation, I can personally attest to the close attention of the TCCV and the OECD to this phenomenon. The key question is whether, and if so, how, an APA or a TP study may be relied upon by the importer and/or customs authority in reviewing a TP for customs valuation purposes? This leads us to the present TCCV position on this “convergence” point.

Convergence of TP

At the beginning of the wider dialogue on convergence, a bit more than a decade ago,12 there were some who argued that if an APA or a TP policy had been accepted by the tax authorities it should be accepted by the customs authorities as conclusive proof that the TP was acceptable, i.e., as showing that the relationship had not influenced the price. One reason advanced was that the TP methods were analogous to the Valuation Agreement valuation methods. There were others, many of whom were customs authorities, who argued the polar opposite--that the APA, TP policy or other work product undertaken for income tax purposes should be irrelevant for customs valuation. For them, the differences between the two disciplines, in methods and more generally, were profound.

At the TCCV, and in the US before that, a middle ground position was adopted--TP studies may be a possible source of information for examining the circumstances of sale and should be considered on a case by case basis.13 This general proposition was followed in 2016 by the TCCV’s Case Study 14.1, which functions as an affirmative example.

There the TCCV pronounced that customs authorities could make use of a TP study, in that instance based upon a Transactional Net Margin Method (TNNM) in assessing whether transaction value applied. No adjustments to the price were made, although the TP study provided that the prices would be reviewed and adjusted if that had proved necessary.

That TCCV instrument was followed by Case Study 14.2 in 2017, which set up an example where the TP study, based on the Resale Price Method, was not helpful for the importer. That was because the adjustments contemplated by the TP program had not been taken. As a result, the importer had not shown that its pricing was settled in a manner that was consistent with the normal pricing practices of the industry.

As an integral part of its Revenue Package, the WCO promulgated a comprehensive Guide to Customs Valuation and Transfer Pricing (WCO Guide) in 2015. The effort was a collaboration between the WCO Secretariat, the OECD and the private sector, represented by the ICC. It is both a full expression of the WCO position in the topic and, as its name implies, a useful guide for its Members’ customs authorities.14

One of the specific questions that were explored in the WCO Guide and, more widely, one of the most vexing underlying issues, was a price adjustment taken pursuant to a TP policy or APA.

Price Adjustments

As a parenthetical remark, the broader topic of a declared price that is subject to possible revision on a post-import basis had much earlier (March 1982) been the subject of another TCCV instrument. This was Commentary 4.1, dealing with Price Review Clauses. There the TCCV had commented (at para. 7) that “the Agreement recommends that, as far as possible, the transaction value of the goods being valued should serve as the basis for Customs valuation…the presence of such clauses should not, of themselves, preclude valuation under Article 1 of the Agreement [i.e., transaction value].” The TCCV had also observed there that Art. 13 of the Valuation Agreement allowed the delaying of the final determination of customs valuation.15

The effect of price adjustments—and more precisely retroactive price adjustments—on customs valuation has been a knotty problem. The WCO Guide does a creditable job (at 5.3.1) explaining that there is no generally accepted rule on how to deal with such price adjustments. Lines are drawn generally on two issues: whether the adjustments are increases or decreases and whether they are tax-only or actual price changes. In some countries, retroactive price increases must be reported to the customs authorities and additional duty paid but price decreases will be disregarded, in other words, ignored.16

There is a trending major exception to the rule as it pertains to retroactive price adjustments taken in the context of TP studies or APAs. In the US, the rule was changed in 2012 with a ruling that set forth the five-factor test that will govern whether a price decrease will be honored.17 Essentially, the US takes the view that such price changes may be dictated by the agreements over which the importer has no control. They are tantamount to price changes taken in a formula-based context.18 While not applying a formula-based pricing approach, the same result will obtain in Canada, the UK, Mexico and Australia. In each of these countries price changes will be acknowledged by the customs authorities.

What is striking about all of this—the decade plus-discussions, the TCCV instruments, the WCO Guide, the national customs authorities’ practices—is that in all of this there has not been any floating of the notion that an APA or TP study-inspired price change calls into question whether there should be a transaction value appraisement. All of these developments were taken squarely within a transaction value rubric.

A good expression of this fact is found in the ICC Policy Statement, which is Annex VI of the WCO Guide. There, Proposals 2, 3 and 4 concern TP adjustments, with the ICC urging, inter alia, that if the adjustments are made pursuant to accepted OECD TP methodology they should be recognized as part of the price actually paid or payable, that rules for allocation of the adjustments should be relaxed and that there should be no need to file amended documentation on an entry-specific basis. There was no discussion of the propriety of staying within transaction value because it was not necessary--there had never been any discussion which questioned the validity of a transaction value. Instead, the ICC simply noted (at Proposal 2) that, “Post-transactions adjustments that affect product price are permitted by both the OECD [G]uidelines and WTO customs valuation rules.”

To my knowledge the only time at which this notion of having to discard transaction value due to TP-driven price adjustments was raised was a short-lived US customs proposal to institute a reconciliation program in 1995. On that single occasion, Customs observed that the fact that there had been an upward price change suggested that transaction value was not appropriate because it appeared that the relationship had influenced the price.19 That proposal never came to fruition, however,20 and the idea that TP price adjustments precluded transaction value was dropped and never resurfaced when the discussions began in earnest. Until now.

The Hamamatsu decision just threw all of that out the window.

Hamamatsu decision

The ECJ was asked to consider the effect of the importer’s request for a refund of customs duties occasioned by a post-importation price refund which, in turn, resulted from an application of the APA. The operating margin of the importer was less than that called for in the APA, requiring a price reduction in order to comply with the targeted profit range using the Residual Profit Split Method. All of this was done in order to meet the arm’s length pricing test set forth in the OECD Guidelines. Once this was price change was done, and a credit issued to the importer, the importer sought a duty refund from the customs authorities. The opinion observed (at para. 18) that

the applicant in the main proceedings applied for the repayment [refund] of the customs duties for the imported goods of EUR 42, 942.24. There was no allocation of the adjustment to the individual imported goods.

That last point is important. The importer had imported a variety of goods, which carried duty rates that ranged between 1.4-6.7%. Despite the fact that a credit note was apparently issued to the importer, there was no allocation. Apparently, the refund sought was not allocated specifically to the imported goods—it was triggered by what was termed a “flat rate” adjustment and the refund sought works out to a duty rate of roughly 1.1%--below the range of duty rates in play. It appears that there may not have been any actual price adjustments at all. More details on this point would have been helpful. For example, the para. 22 (1) mention of an “allocation key” is intriguing. There is no further information about this point.21

The German court viewed the originally declared price as a “fictitious price” (para.21) but referred the legal question to the ECJ (paras. 22 (1 ) and 22 (2)), requesting a “preliminary judgment” in the nature of a legal interpretation.22 In turn, the ECJ, framed the salient question (at para. 23) thus

[Does the EU Code] 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 up or down.

In a quite perfunctory and somewhat disjointed fashion, the ECJ noted that allowances would be permitted for defective goods (paras. 30-32). But those allowances are narrowly permissible and impliedly did not extend to TP adjustments. The ECJ held (at para. 34) 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

For the ECJ, it followed (at para. 35) 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 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 up or down.

Thus, the ECJ’s stated logic is simple; it runs
  • No adjustment (upward or downward) to transaction value is permitted for TP-driven flat rate adjustments
  • Without the possibility of an adjustment the declared value will not reflect the “full economic value”
  • Transaction value is not permitted as the basis of appraisement
What follows is unsaid:
  • Valuation under an alternative method is required

Open Questions

The decision raises a number of questions that clamor, indeed demand, to be asked, including:

Can this decision be appealed? No, the ECJ is the highest court in the EU system and this legal interpretation of the Customs Code is final and binding.

Would the same result have obtained if there had been a fully allocated actual adjustment (e.g., a declared price of EUR 10.00 for a specific article that was later specifically changed to a price of EUR 9.00 for that same article) and not a “flat-rate” adjustment? The breadth of the opinion suggests this would not have made a difference.

Did the ECJ focus on the nature of the price adjustments, i.e., those that were actual price adjustments vs. those that are notional or taken only for tax purposes? No, the ECJ opinion did not draw any distinctions. Paras. 34, 35. It is notable that the referring court had asked for advice (para. 22 (1)) on the legal effect of adjustments regardless whether actual debit or credit notes were issued to the importer. The ECJ could have/should have parsed this issue.

While we are at it, it is worthy of note that (i) price adjustments are taken in order to bring the tested party’s profit margin into alignment with the range and (ii) if operating profit is the measure, as in those instances in which the TNNM is the TP method in play, the profit level necessitating adjustment may be a function of operating expenses and not of the Cost of Goods Sold (COGS). In plain English, not every TP adjustment is directly traceable to a need to adjust the PAPP, so tax-purpose-only adjustments might not have any customs implications whatever. Did the ECJ view the declared price as a fictitious price? Contrary to some reports, while the referring court mentioned an arbitrary or fictitious price, this point was not specifically addressed, let alone adopted, by the court. To be sure, the court did state that the transaction value should reflect the “real economic value of imported goods.” We note that what was also entirely ignored was any reference to Art. 1.1 (b), which would disallow a transaction value if there is a consideration for which a value cannot be determined. I believe that such an argument should not prevail, but it is at least closer to the issue raised here than a “fictitious” price argument and, at the very least, should have been discussed.

What is the effect of a TP-sponsored review of pricing that did not lead to a price change? A close study of the opinion leaves this an open question. The opinion dealt with a case where there had been a review and a consequent price change, albeit on a “flat- rate” basis. It would be untenable to have a system that (i) allows a transaction value appraisement where there had been an APA or TP study that called for a review and the possibility of a price adjustment and where no price change occurred but (ii) disallows a transaction value on the same facts but where a price adjustment, in fact, had been made.

How would the ECJ have dealt with a price review clause? Same result? Was this point briefed by the parties? Oh, for the transparency/accessibility of the U.S. system!

What arguments were presented to the ECJ by the importer? Discussion of these issues can be conducted on a rarified plane and it would be interesting to gauge the level of expertise of the advocates. For example, did the importer advance reasoning such as that present in the US treatment of TP adjustments, i.e., the APA is a binding contract with the German government and the price changes were required by that agreement? Again, we have no access and cannot even venture a guess.

What arguments did the EU Commission present? Was this result welcomed by/invited by the Commission? Did the Commission argue for a different result? Did the Commission anticipate the approach taken by the court? We have no clues.

How will the EU deal with customs valuation after this decision? Given the high percentage of related part transactions, are the EU and its Members prepared to deal with the monumental task confronting them with the mandated shift away from transaction value and an appraisement process based on alternative methods if this decision stands?

What was the motivation behind the decision? The opinion is so sparse that we cannot be more definitive than to speculate that the ECJ may have been motivated by a revenue protection mindset. At para. 33, the opinion recites that there is no obligation for an importer to report an upward price adjustment and that there is nothing to prevent an importer/taxpayer from claiming refunds for price decreases. Perhaps that informed the decision.

Will the decision prompt a change in the EU Customs Code and/or its administrative procedures, e.g., to allow for refunds in the face of price deceases as an opportunity cost for the mandating of reporting of upward adjustments? Coming so soon after the issuance of the UCC, quien sabe? Given the significance of TP generally, and TP price adjustments specifically, it is unfathomable that the current EU Customs Code and administrative procedures cannot accommodate these issues. The present iteration does not make for the Very Model of a Modern Major Trade Bloc.

Is the EU fully mindful of the broader implications? Specifically, are the EU and its Members au courant with and aware of the risks posed to their traders’ exports if other jurisdictions follow suit and disallow transaction value under similar circumstances? This may be a rhetorical question. If not, it would be interesting to see how the EU fashions a strategy to undo these effects. But, of course, that pre-supposes that there is an EU institution with an overarching view and a matching authority to implement such a strategy (to employ a U.S. analogue, as in a Dept. of Commerce/USTR qua U.S. Customs and Border Protection perspective).

How should traders plan to deal with this change? Perhaps the best approach is to avoid retroactive price adjustments entirely by insisting that prices are reviewed on a rolling, perhaps near-continuous or near-contemporaneous basis, basis throughout the year or other applicable accounting period. This could be followed by price adjustments, where necessary, that are prospective only. Even if price adjustments cannot be avoided altogether, at the least they will not be retroactive.

What will be the reaction of the EU’s trading partners? As noted earlier, the general trend at the WCO and in various national statutory and administrative regimes is in the polar opposite direction from this ECJ decision. It will be interesting in the coming months to follow developments arising from this disruption.


An air bag crash test.


1. For ease of reference, we do not here limit the term transfer pricing to direct tax matters but, instead, employ it in the customs valuation context as well.

2. Formally, the “Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.”

3. Valuation Agreement, Art. 1; in the US, this is at 19 USC § 1401a (b) (1).

4. Valuation Agreement, Preamble.

5. Valuation Agreement, Annex II, para. 1.

6. In fact, the TCCV also adopts Case Studies and Studies as other classes of instruments.

7. Advisory Opinion 1.1 at point (b).

8. Valuation Agreement, Art. 1.2 (a) and (b) and Notes to Art. 1.2, in US, 19 USC § 1401a (b) (2) (B) and 19 CFR §§152.103 (j) and (l).

9. Valuation Agreement, Art. 1.

10. The TCCV put on a theme meeting on this topic in its April, 2005 session (20th Session). I had the honor of presenting on that occasion. For more on this subject, an entire chapter (6) in my treatise, International Trade Laws of the United States: Statutes and Strategies, is devoted to this discussion. See also Neville, Chile and Other Stopping Points on the Customs and Tax Playing Field, 25 JOIT (Aug. 2014) at 19.

11. The Focus Group presented its findings and recommendations in October, 2007.

12. My first published discussion on the topic dates to 1993.

13. The TCCV position is set forth in Commentary 23.1 (2010); the US position is set forth in the Customs and Border Protection (CBP) Informed Compliance Publication, What Every Member of the Trade Community Should Know About: Determining the Acceptability of Transaction Value for Related Party Transactions (2007).

14. The Guide is in the early stages of an update at the time of this writing.

15. This delay factor is at the heart of the reconciliation program in the US, discussed in Neville, International Trade Laws of the United States: Statutes and Strategies, ¶6.05 [1] [g] [i].

16. In the US, this is set forth at 19 CFR § 152.103 (a) (4).

17. Ruling no. 548314 (5/16/12).

18. The US customs regulations provide for pricing based on a formula or external referent, such as the prices on the London Commodity Market, at 19 CFR § 152.103 (a) (1).

19. Notice, 60 Fed. Reg, 35,105, 35,106 (July 5, 1995). See Neville, International Trade Laws of the United States: Statutes and Strategies, ¶6.05 [1] [g] [i], text at n. 279.

20. To be clear, another version of reconciliation was in fact instituted in 1998 and is still in force.

21. This is entertaining, as in, “a good entertainer always leaves his audience wanting more.”

22. In fact, the German court asked whether transaction value could support retroactive price adjustments (para. 22 (1)) and, if so, whether it was possible to review or determine customs value using simplified procedures when there were upward or downward adjustments (para. 22 (2)) Because the first question was in the negative, the opinion did not address the second question. Para. 36.

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