In our blog post “The Hamamatsu TP/customs valuation case comes to a surprising conclusion” we summarized the final judgment of the German Federal Fiscal Court (Bundesfinanzhof; “BFH”) in the “Hamamatsu” case. The BFH had ruled that taxpayers cannot claim refund of import duties in case of lump-sum TP adjustments applied at the end of the fiscal year that result in a subsequent lump-sum decrease in resale prices and thus in an intercompany credit note for the German distributor. Examined more closely, the BFH judgment issued at the time could already only be interpreted in the way that year-end lump sum TP adjustments – whether upwards or downwards – may not have a retroactive impact on the customs value of transactions that were carried out during the fiscal year.
The recently published ruling 14 K 588/20 of the Local tax Court of Munich (the “Munich Tax Court”) dated October 27, 2022, addresses the opposite case of a lump-sum TP adjustment at the end of the fiscal year that resulted in a lump sum increase in resale prices and thus in an additional intercompany charge to the German distributor. In line with the BFH ruling, the Munich Tax Court held that lump-sum TP adjustments performed at the end of a fiscal year to obtain an arm’s length margin within the interquartile range must not affect the customs value if it is not yet certain at the time when the customs declaration is lodged whether or not any adjustment to the intercompany resale prices will be required at the end of the accounting period and, if so, whether it will be an upward or downward price adjustment. The customs value of the goods at the time of importation must not be determined on the basis of arbitrary or fictitious values.
In more detail
In the case ruled upon, the transfer prices of the goods imported into Germany were determined during the fiscal year using the resale price method. The plaintiff (importer) purchased the goods at their list price minus a discount that the plaintiff was to earn as its “Agreed Margin” for serving as a distributor. As per the end of the fiscal year, however, the preliminary EBIT margin (defined as the ratio of operating profit to net sales) of the German distributor was far above the arm’s length interquartile range of comparable companies. The plaintiff’s EBIT margin of approx. 23.24%, approx. 26.24% and approx. 28.49% (three-year period between 2014 and 2017) was therefore adjusted by means of a year-end lump sum TP adjustment to an “Agreed Margin” of 1.93% per annum. The TP adjustment, which involved a TP-induced lump sum increase of the resale prices, prompted the Main Customs Office (Hauptzollamt; “HZA”) to accordingly increase the declared customs values pursuant to the so-called fall-back method (Art. 31 CC / Art. 74 UCC) by means of an adjustment factor. The transaction value method (Art. 29 CC / Art. 70 UCC) was found not to be applicable because in the view of the HZA the transfer prices paid during the year were “obviously too low”, suggesting that the intra-group prices are influenced by the parties’ affiliation.
In its judgement, the Munich Tax Court explains the general principles of customs valuation taking the European Court of Justice’s (CJEU) judgment and BFH case law in the “Hamamatsu” case into account. The court points out that customs valuation must always reflect the value of specific goods at a specific point in time, namely the lodging of the customs declaration or the time of importation, respectively. The court argues that, for reasons of being inconsistent with the valuation date principle, it is generally impossible to use an agreed transaction value that is derived from an amount preliminarily invoiced and declared on the one hand and from a TP-induced lump-sum adjustment made after the end of the accounting period on the other hand as customs value, if it is unclear at the relevant point in time (here: the lodging of the customs declaration) whether or not any adjustment to the resale prices will be required at the end of the accounting period and, if so, whether it has to be an upward or downward price adjustment. According to the Court, this applies even if the fall-back method (Art. 31 CC) is applied instead of the primarily applicable transaction value method (Art. 29(1) CC / Art. 70 UCC).
Based on these legal principles, the Munich Tax Court concludes that the lump-sum TP adjustment at the end of the year did not lead to an increase in the customs value and that the subsequent imposition of additional import duties by the HZA was therefore unlawful. The Court argues that the plaintiff correctly determined the customs value according to the transaction value method (Art. 29(1) UC / Art. 70 UCC) based on the resale prices invoiced during the year. Despite the relatively high margin adjustment of approx. 21% – 26%, the Court does not see any indication suggesting that the invoiced resale prices did not reflect the actual economic value of the imported goods, that not all economically valuable elements of these goods were considered, or that the parties’ affiliation had impacted the price. Moreover, the plaintiff’s arrangement did not justify a retroactive adjustment of the customs value by means of the fall-back method (Art. 31 CC / Art. 74 UCC), because, at the time of the relevant customs declaration, it was not certain whether the declared prices of the goods would be adjusted at all after the end of the accounting period and, if so, whether an adjustment would be made in the form of upward additions or downward deductions.
The Munich Tax Court granted leave for an appeal on questions of law (Revision) to be lodged with the BFH. The proceedings are currently pending before the BFH under file number VII R 36/22.
Observations on the case
- For years, the German customs administration has applied different standards in treating retroactive year-end TP adjustments: If the year-end TP adjustments resulted in a lump-sum increase of the intercompany resale prices and thus in a subsequent intercompany charge to the German distributor, it assumed that the parties’ relationship had an impact on the prices of the goods invoiced during the year. The customs administration thus allocated the subsequent intercompany charges resulting from the year-end TP adjustments at a flat rate within the so-called fall-back method and, hence, levied and collected the import duties retroactively. If, however, the year-end TP adjustments resulted in a lump-sum decrease of the intercompany resale prices and thus in a subsequent intercompany credit note, the German customs administration assumed that the parties’ relationship had no impact on the prices of the goods invoiced during the year. As a result, the transaction value method remained applicable and the companies concerned could only obtain a refund of import duties paid during the year if they were able accurately allocate the credit notes to the specific imported goods a requirement many companies failed to meet in practice.
- This unequal assessment of potential price implications in case of year-end TP adjustments resulting in a lump-sum increase of intercompany resale prices versus year-end TP adjustments resulting in a lump sum decrease of intercompany resale prices resulted in the German customs administration’s levying additional customs duties in the first case but generally refusing refunds in the second case. The aim of the “Hamamatsu” jurisprudence, which was initiated by the Munich Tax Court, was, hence, to align the customs treatment of both situations. Ultimately, the courts have taken the view that, in accordance with the valuation date principle applicable in customs valuation, it is not admissible to consider lump-sum TP adjustments, whether upwards or downwards, if neither the specific reason for nor the specific amount of the adjustment could be determined at the time when the customs declaration was lodged. At present, the German customs administration is still refusing to apply the jurisprudence in practice and is unlikely to reconsider its current practice until the BFH has passed its judgment in the appeal proceedings. However, it is not to be expected that the BFH will divert from its course. Moreover, it is equally unlikely that the BFH will refer the issue to the CJEU once more. Therefore, importing companies should consider filing appeals against corresponding subsequent assessment notices.
- As much as it might be appealing for importing companies to set the resale prices at the time of import as low as possible, the transfer prices among affiliated enterprises may not be determined arbitrarily during the year.
The customs value of the goods must (at least) reflect the actual economic value of the imported goods at the time of importation and must take into account all elements of these goods that have an economic value (cf. reasoning of the Munich Tax Court’s judgment, margin no. 63). However, it remains to be seen which standards and methods the customs administration will develop for examining the economic value. It already transpires from CJEU case law, judgment of June 9, 2022, C-187/21 – FAWKES Kft., that the CJEU has allowed the use of internal databases of the customs administration that contain import values of similar goods for customs valuation purposes. Special caution is to be applied where internal CUPs for specific goods of the taxpayer are available.
- In addition, the agreed transfer prices must be economically justified even if the prices should be adjusted to a value within an arm’s length range at the end of the year. Usually, taxpayers can document the arm’s length nature of ex ante determined prices by means of a transfer price calculation that is based on contemporaneously prepared benchmark studies and budgeted figures (revenue, costs, etc.). Even if, due to lack of jurisdiction, the Munich Tax Court did not comment on the margin adjustment of in between 21 and 26 percentage points which is pretty high from a practical perspective taxpayers should always keep in mind and, if possible, avoid the potential income tax implications of a retroactive TP adjustment. Major downward adjustments of the German distributor’s margin might prompt a tax auditor to address this matter within the scope of an income tax audit.
- It is still unclear in how far the judgment will impact the customs value treatment of retroactive TP adjustments in other EU member states. From our experience, they currently remain unperturbed by the Hamamatsu judgment, despite the fact that the CJEU has laid the foundation for a “change of course”. We hope that the EU Commission will now develop uniform guidelines on the treatment of TP adjustments.
Please do get in touch with us if you would like to discuss the judgment in further detail and assess how it may impact your organization.