November, 2018

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International Accounting Standard on Distribution: Principal vs. Agent

Mark K. Neville, Jr.

Some readers of these articles will know by now that the hallmark of customs valuation laws is the notion of a bona fide sale for export. Of course that is because Transaction Value, which has pride of place in the hierarchy of valuation methods under the Customs Valuation Agreement1 and all implementing domestic statutes, depends on fixing the price actually paid or payable when the goods are sold for export to the country of importation.2 In the absence of a Transaction Value, meaning in the absence of an acceptable sale for export, then life becomes immediately more complicated for all concerned—the importer, the customs authority, the customhouse broker and other service providers. That is because the Customs Valuation Agreement dictates that, if Transaction Value cannot be applied, alternative appraisement methods must be applied, in their turn.3 And that is a far more involved practical exercise than simply looking to an underlying commercial invoice issued by a seller to a buyer and, where necessary, adjusting the price thereon, pursuant to the Art. 8 “statutory additions.”4

Other readers, and specifically those who ply their trade in international tax, will also know that it is important to ascertain whether a given transaction is a sale. One reason is because the revenue recognition rules under accounting standards will distinguish between revenue arising from a sale vs. revenue earned in compensation for a rendered service.

And to get straight to the point, both direct tax authorities and private sector professionals and their counterparts in the customs field need to discern whether there has been a sale for export or whether, instead, the putative buyer/importer is not a buyer at all but a selling agent, or to use the European term a “commissionaire,”5 representing the interests of a foreign principal.

Customs Law Impact

The customs law effect of the importer being an agent and not a buyer would expose the compensation of the importer/agent to customs duty, as selling agents’ commissions are dutiable.6

Income Tax Effects

The income tax effect would be to possibly expose the foreign principal to income tax liability in the country of importation because the foreign party would have a “Permanent Establishment” (PE) in the person of the agent that was entering into local contracts that bound the principal.

Actions taken in the Base Erosion and Profit Shifting (BEPS) project undertaken at the OECD spoke to this issue directly. Action 7 of the BEPS project was designed to forestall artificial avoidance of PE status through commissionaire strategies and similar arrangements. Action 7 explained this succinctly

A commissionaire arrangement may be loosely defined as an arrangement through which a person sells products in a State in its own name but on behalf of a foreign enterprise that is the owner of these products. Through such an arrangement, a foreign enterprise is able to sell its products in a State without technically having a permanent establishment to which such sales may be attributed for tax purposes and without, therefore, being taxable in that State on the profits derived from such sales. Since the person that concludes the sales does not own the products that it sells, that person cannot be taxed on the profits derived from such sales and may only be taxed on the remuneration that it receives for its services (usually a commission).7

The approach taken in Action 7 is to amend certain provisions of Art. 5 of the OECD Model Tax Convention. As a result of such changes, a foreign enterprise is deemed to have a PE in a country if it has a person acting there on behalf of the enterprise and, in doing so, that person habitually concludes contracts or habitually plays the principal role leading to the conclusion of relevant contracts that are routinely concluded without material modifications by the enterprise (par. 5) and drawing a sharp distinction between an “independent agent” and a “dependent agent,” i.e., a person that “acts exclusively or almost exclusively on behalf of one or more enterprises to which it is closely related.” (par. 6).

Moreover, the specific exemptions created by Art. 5 (4), such as the maintenance of inventory stocks, were limited to instances in which they are preparatory or auxiliary activities only.

Post-BEPS Experience

When faced with the possibility that a tax authority will find a PE for the foreign entity through application of Action 7 standards, one reaction to the BEPS has been the migration from the sales agent model to a buy/resell model for related party transactions. The binary choice—buyer/reseller vs. sales agent—is frequently isolated in the context of a distribution agreement. This is because a distributor can be set up so that the importer can act in either capacity.

If the issue of PE is skirted by moving to a buy/resell model, there is a further great and obvious international tax planning advantage to be gained if the related party distributor is a limited risk, buy/resell distributor (LRD). Consider if the country of importation is a “high tax” jurisdiction, and the country where the seller is located is a low tax jurisdiction. By assigning functions, assets and risks that are limited, the income tax liability of the LRD in the country of importation is managed, and it is at the same time appropriate to recognize a larger share of the revenue by the foreign seller in the low tax jurisdiction.

As an example, the LRD, like its full risk distributor brethren, will also take title, but its other risks are limited--another party (the exporter or another related party) may assume some responsibility for fulfilling such other aspects of the customer contract as after-sales service Inventory and credit risks may be limited, as well, and some brand building and advertising may be undertaken by the exporter or brand owner. We must note that the LRD strategy has been applied for many years, but that it has gained much greater momentum post-BEPS.

LRD as buyer vs. agent

The classic dilemma faced by an importer/taxpayer is how “limited” the LRD’s role should be. The risk is that if the importer’s role is “skinnied” down too far, meaning the attributes of ownership are discarded, then the underlying sale is denied8 and the importer’s status as a buyer/reseller is lost. This can be traced back in the US at least as far back to the CBP’s unsuccessful efforts in Orbisphere case.9 Following that loss, the predecessor of US Customs and Border Protection (CBP) nevertheless issued a “limiting Treasury Decision” and announced that it would continue to look to a transaction value based upon a presumed sale from the foreign seller to the US customer, with the importer cast into a sales agent role.10

With the post-BEPS migration to LRD structures, customs and income tax authorities are sure to confront many more instances in which the buyer/agent issue must be decided. Customs authorities can look to customs law jurisprudence in that effort. There is a body of case law in the US, for example, and many binding rulings issued by CBP as well.11 At the international level, the World Customs Organization’s Technical Committee on Customs Valuation (TCCV) Case Study 9.1 (dating from 1995) is also helpful, with the importer’s status as an independent legal entity, taking of title and assuming risk of loss and assuming financial risk of non-payment by the customer all supporting a finding of a sale for export.

Tax authorities may be guided by the principles set forth in the BEPS instruments and they may also turn to the International Accounting Standards Board (IASB) issuance of a new revenue standard: International Financial Reporting Standard (IFRS) 15, Revenue from Contracts with Customers and Accounting Standards Codification (ASC) 606. The effect of IFRS 15 is to differentiate between the two models:
  1. A buy-resell model requires recognition of gross revenue by the distributor with a deduction for cost of goods
  2. A sales agent model requires recognition only of the net revenue (the commission) earned by the sales agent.
The IFRS 15 Standard is entirely consistent with the principles underlying both income tax and customs law analysis, viz., it is the substance not the form which controls the analysis. Further, the Standard draws the same distinction between principal (in this case, meaning a buyer/reseller that is acting on its own behalf) and agent that any customs authority need to draw in analyzing an import transaction, on the basis of performance obligation (defined as a promise to transfer to the customer a good or service (or a bundle of goods or services) that is distinct”):
  • A “principal” has a performance obligation directly with a customer
  • An “agent” arranges for another party (the principal) to have the performance obligation.
You will recognize here the alignment with BEPS Action 7.
IFRS 15 paragraph B35 (Principal versus agent considerations) states: “An entity is not necessarily acting as a principal if the entity obtains legal title only momentarily before legal title is transferred to a customer.” This is a reference to “flash title,” a device disfavored and often disregarded in customs valuation law. 12 As for the standards to be applied to “agent” status IFRS 15 sets forth several indicators (at para. 37) of agent status, all of which I submit are entirely consistent with both BEPS Action 7 and customs valuation law principles
  • Another party is primarily responsible for fulfilling the contract
  • The entity does not have inventory risk before or after the goods have been ordered by a customer, during shipping, or on return
  • The entity does not have discretion in establishing prices
  • The entity’s consideration is in the form of a commission
  • The entity does not have a credit risk for the customer receivables
Can it be argued that this standard is not relevant to a customs valuation inquiry into a sale for export? No. It is beyond cavil that the standard is entirely consistent with the customs valuation law principles and the interpretations of those principles expressed in the extant customs law jurisprudence with which I am familiar.

The Examples 45 and 46 are quite relevant illustrations of this Principal/Agent dichotomy. To those customs practitioners in the private sector and to those responsible officials in customs authorities, be certain that I am not suggesting that the BEPS 15 and/or the IFRS 15 Standard take precedence over, or supersede, the pertinent customs valuation law statutes or the WCO and the country-by-country interpretations promulgated in administrative rulings. Likewise, I am not counseling that they should be ignored altogether. That would be a dreadful mistake, and one that flies in the face of these realities.

Instead, as with a general discussion of most transfer pricing analysis and documentation, the document or other external standard should be evaluated on a case-by-case basis and on its merits and dispassionately and, where, the external sources are found to be relevant and helpful they might be/should be consulted.13 In this connection, we have seen that the customs valuation authorities have wrestled with these issues for three decades. I submit that these tax and accounting standards are both relevant and helpful, especially so in the context of a “totality of facts and circumstances” standard of review that characterizes, or should characterize, most customs authority reviews.

As an illustration, I would submit that the BEPS distinction between “dependent” and “independent” agents, while helpful in eliminating harmful profit shifting for income tax purposes is also helpful for customs valuation purposes. A sole or exclusive agency, one that might be classed a “dependent agency,” is not regarded as a related party unless it is subject to management control.14 A review of the Action 7 discussion on this Art. 5(6) issue reveals a focus on what may be characterized as “dependent” status,” one that might be paraphrased “management control” and thus would be consistent with and relevant to a customs valuation law review under Customs Valuation Agreement, Arts. 15.4 and 15.5, albeit with a different end result in mind. See Art. 5 Commentary, par. 38.2.


1. Formally, the Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade 1994.

2. Art. 1, Customs Valuation Agreement; 19 USC §1401a (b) (1) in the Tarff Act of 1930.

3. This hierarchy is is similarly provided for in the Customs Valuation Agreement and is explicitly set forth in the US statute, 19 USC § 1401a (a).

4. Art. 8, Customs Valuation Agreement, 19 USC §§ 1401a (b) (1) (A)-(E).

5. Some have defined “sales agent” in the narrow sense to refer only to those persons who solicit orders on behalf of a principal and refer the sales prospects to that principal. When used in this discussion, however, the term sales agent refers broadly to those persons who not only fall under that narrow descriptor and also to those who actually sell products in their own name but on behalf of another, i.e., in the same sense as “commissionaire.” In the U.S. we use the single term “sales agent” or “selling agent” to refer to both of these connotations, the term “commissionaire” not being recognized.

6. Art. 8.1 (a) (i), Customs Valuation Agreement, 19 USC §§ 1401a (b) (1) (B). For a discussion of this issue, see Neville, International Trade Laws of the United States, ¶5.20 [1] (2012).

7. OECD, BEPS Project, Action 7, Preventing the Artificial Avoidance of Permanent Establishment Status, at 9 (2015).

8. The US continues to apply the definition of a sale, transfer of title and risk of loss for consideration, from J.L. Wood v. United States, 62 CCPA 26, 33, CAD 1139, 505 F.2d 25 (1974).

9. Orbisphere Corp. v. United States, 13 CIT 866, 726 F. Supp 1344 (1989).

10. 26 Cust. Bull. & Dec. No. 8, at 13 (Feb. 19, 1992). See also Neville, International Trade Laws of the United States, ¶5.10 (2012).

11. See, e.g., ruling nos. 548380 (10/23/03) and 546820 (9/28/02).

12. See, e.g., ruling nos. H266540 (9/8/16) and H281340 (12/12/17).

13. See, e.g., TCCV Commentary 23.1

14. Arts. 15.4 and 15.5, Customs Valuation Agreement. See TCCV Explanatory Note 4.1.

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