Customs valuation in times of crisis

This global financial crisis is also a crisis of “valuation.” The growing sophistication of transactions and intangibles has spurred debates on how values should be recognized and treated. Whether it be the value of an entity, a collateralized debt obligation, equipment or other assets, the latest financial crisis has brought the appreciation and scrutiny of these concepts under a new light. However, as the scales are recalibrated to appraise large, fixed and intangible assets for accounting and tax purposes, companies engaged in cross-border trade must not neglect another form of valuation — one that relates to their merchandise, the very bloodline that sustains them.

Amidst the flurry of companies reassessing their internal controls and their compliance with financial reporting standards, caution must be taken so as not to overlook the valuation of their imported merchandise for customs purposes. Few realize that this concept of “customs valuation,” is a significant cost factor that may spell a big difference in their bottom lines.

It is a common attitude for importers to treat customs duties as a mere expense, a nondescript item hidden among their costs of goods sold. However, taken together, these duties may oftentimes constitute a larger percentage of a company’s sales than any direct taxes it pays. This is because customs duties are assessed based on the cost of the imported products, unlike corporate taxes which are based on profit margins. In these times of crisis and shrinking margins, it would not come as a surprise if companies begin paying more customs duties than corporate taxes.

An incorrect valuation may cause importers to either overpay (if over valued) or underpay (if undervalued) customs duties. Overpayments are difficult to recover, and the costs of undergoing the process to claim tax and duty credits may invariably outweigh the tax benefit. On the other hand, underpayments may lead to substantial penalties if Bureau of Customs discovers this in the course of a post-entry audit. It is no longer uncommon to encounter companies being assessed penalties for underpaid duties in amounts exceeding the actual costs of the products involved, thereby further reducing profits. Cost reduction schemes being contemplated by companies to offset the ill effects of the global financial crisis therefore should not leave out customs valuation and planning as a cost saving/planning area.

How then should imported products be valued for customs purposes? We know now that the universally accepted means of appraising goods for customs purposes is the transaction value as provided in the World Trade Organization (WTO) Agreement on Customs Valuation. Defined as “the price actually paid or payable for the imported goods when sold for export to the Philippines”, the transaction value was envisioned as a system to simplify customs procedures and speed up the clearance of cargo. True enough, it abolished the notional and arbitrary valuation methods that preceded it (e.g., Brussels Definition of Value, Home Consumption Value) wherein Customs could assign values to imported goods based on criteria that favored higher bases for customs duties. The transaction value system allows importers to make self-declarations that Customs officers at the border may take at face value, with the important caveat, however, that Customs can, any time in the next three years, scrutinize importers’ records to check if such importation was properly valued. Findings of underdeclared values could result in penalties up to eight times that amount along with the filing of criminal charges. Similar penalties and charges would apply to companies who fail to keep records or refuse to give Customs auditors full access to their documents and premises. As profits fall, and revenues follow in the midst of the present crisis, Customs officers may be expected to be more aggressive in this aspect to meet their revenue collection targets.

One may ask then, how can a transaction value be underdeclared or overdeclared? Returning to the definition, an important phrase must be remembered: “paid or payable on the imported goods.” All too frequently, importers consider whatever is indicated in the seller’s invoice as the transaction value and hence, the basis for customs duties. However, it must be reiterated that the supplier’s invoice does not reflect any amounts payable after the importation of the goods (e.g., royalties, license fees, post importation price adjustments) – which should be added, and may include costs that are not at all related to the imported goods (e.g., installation costs) – which should be deducted. Thus, depending solely on the invoice price can lead to overpayments or underpayments of customs duties. Customs valuation planning requires companies to closely examine their supply chain, breakdown the invoice price and examine contracts to see if any post-importation adjustments to the price of the goods are effected.

Another important consideration is the reality that Customs officers may reject the invoice price in an import transaction, if the buyer and the seller are related. This could arise on suspicions that that the established transfer price may have been influenced by the relationship. In such an instance, the importer would have to prove before Customs that the price was set at arm’s length. One’s failure to convince Customs of this may compel the latter to construct values which, more often than not, would be much higher than what was originally declared - leading to higher duty costs. With more mergers and acquisitions taking place due to the financial meltdown, it is likely that more cross-border transactions in the future would be between related parties. 

There are other occasions in which the transaction value may be rejected by Customs, such as “no-sale” situations. Should this be the case, other valuation methods can be adopted, based on the WTO Agreement, to obtain the proper customs value. These methods are followed hierarchically as follows: the transaction value of identical goods, the transaction value of similar goods, the computed value method, the deductive value method, and the fall back value method. Even with the adoption of these alternative methods, companies should still be vigilant to ensure that the ultimate duty base was reasonably and fairly derived.

In fine, customs valuation should be looked at very carefully since this may actually hold the key to various savings and risk mitigating opportunities – which, especially in these times of crisis, companies will be in dire need of.

(Raphael B. Madarang is a Manager for Business and Financial Advisory 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 [email protected] or [email protected]).