In determining “which tail, which dog” controls the intersection of the customs and tax disciplines, we must first define what we mean by “tax.” If we refer to tax in the broadest sense, to include all forms of tax levies, both direct and indirect, then there is no intersection at all, because customs duties, an indirect tax, are already subsumed within the general heading “tax.” If that is your perspective, then my task is half completed before I start, because you already perceive customs duties as a tax and implicitly recognize that there are compliance obligations to shoulder and planning opportunities to consider.
But I have spent much of my career in a dialogue with tax professionals who do not share that view. Instead, these tax professionals have defined tax much more narrowly. For them, international tax means an income tax.
While we are on the subject, we might define “customs” as the process by which duties are assessed on imports, primarily based upon their tariff classification, valuation, and origin. We might define “trade” for these purposes generally as the system that sets forth the internationally accepted rules for those three criteria.
Importance of Customs and Trade
This discussion is meant to establish that customs duties may be important, even if many of the duties are set at free rates, due to free trade agreements and other substantive international trade agreements, or are low—averaging something like three percent ad valorem. First, duties can spike upward of thirty percent in certain product sectors. Then, too, even a three-percent duty imposed “above the line” can be a significant number. Finally, an astute advisor can assist a client who is intent on sourcing goods from outside the United States to eliminate or reduce duties. From a compliance perspective, we should know there is an emphasis on proving at post-entry audits that a claimed free rate is justified.
In much the same way that state and local taxes assumed great importance over the past twenty-five years, and sales and use tax planning even more recently, I am hoping that tax professionals will come to embrace customs and trade under this wider view. There are compelling reasons.
As these lines are being written, both presidential candidates have staked out anti–free trade positions, and rollbacks/reforms of NAFTA and other free trade agreements are openly discussed as policy options.
A return to the levy of duty on imports previously free, or the raising of duty levels, can only increase the importance of customs duties for our clients, which means that we will likely be called upon to help our clients cope with them.
Naturally, if the United States ever joins the rest of the world and adopts a value-added tax (VAT) to be imposed at the border, you should know that the tax basis for applying VAT is normally set at the price of the goods plus the applicable duty. Tax professionals will need to offer a joined-at-the-hip practice that deals with both duties and VAT. That should be perfectly obvious to all.
And there are points of intersection between customs and income tax, especially transfer pricing.
Related Parties/Transfer Pricing
In one of the best examples of a shared focus, to the same extent that the IRS is focused upon transfer pricing (TP) on related-party transactions on imported goods, U.S. Customs and Border Protection (CBP) has been attentive to transfer pricing since 1956. The current CBP administrative practice is that advance pricing agreements (APAs) and TP studies may be helpful, but it would be a grave error for taxpayers or their advisors to think that the agreements with or submissions to the IRS will be dispositive with CBP. One very good development in CBP practice is to give effect to downward compensating adjustments and to refund duties, at least where CBP’s criteria have been met.
From the income tax side of the aisle you must recognize the impact of Section 1059A, which has been with us since the Tax Reform Act of 1986. This imposes the customs value at liquidation as a ceiling on the value for inventory purposes of a related-party import, at least where the goods were dutiable.
Quite apart from a need to satisfy both CBP and the IRS that the parties’ relationship did not influence the price, i.e., that the relationship meets the arm’s-length standard, on imported goods there is a lesser-known interface between the two disciplines when it comes to certain services being provided to importers.
In certain jurisdictions, such as Canada and Norway, there is a growing tendency to focus on post-importation payments from the importer to the related-party seller or other controlled party. Unless the importer can justify payments for such services as marketing and management fees, i.e., show that the payments tally with the level of services provided, the customs authority will impose duty on such payments.
Another example concerns monies paid by an importer to a middleman for buying agent services, which can be nondutiable. If the tax advisors are sensitive to this point, they may take greater care in characterizing the services offered by the putative agent and avoid creating the appearance that the middleman is acting on its own account. While that would justify a higher commission rate, it would surely lead CBP to impose duty on that commission, as buying agent status will have been undermined.
A staple of tax/TP planning, the use of a limited risk distributor, provides a final illustration. Here, too, if the tax advisor engages in planning “with a blunt instrument” and is unmindful of the customs consequences of paring back the functions and risks of the distributor, the result will be that CBP and other customs authorities will see the importer/distributor as a sales agent for the related-party seller. Surprise: a sales agent’s commissions are dutiable.
The $40 billion in duties collected by CBP is a small percentage of the $1.5 trillion in income tax collected. I get that. But duties are an above-the-line expense. Another point: clients expect advisory services that bridge any divide between tax disciplines. Finally, to be more colloquial, the tax dog already has a customs duty tail, and if we ever adopt a VAT, that tail will be a more substantial appendage.
Mark Neville Jr. is principal of International Trade Counsellors and a member of the board of advisors for the Thomson Reuters Journal of International Taxation, for which he writes a monthly column on trade and customs issues. He is also the editor of International Trade Laws of the United States: Statutes and Strategies for Thomson Reuters.