Ukraine
Oleh Marchenko and Anton Moyseyenko
Ulysses
Ukraine
The importance of transfer pricing methodologies is increasing in Ukraine. Oleh Marchenko and Anton Moyseyenko of Ulysses discuss transfer pricing and customs value controversies in the country.
Changing global background
In recent decades the importance of correct application of transfer pricing methodologies has been rising steadily. As rapid development of communication technologies facilitated cross-border transactions and multinational enterprises (MNE) obtained increased opportunities for optimising taxation, the determination of arm's-length prices for transactions became of paramount importance.
The issue is particularly sensitive in the context of customs valuation. Establishing artificially low transaction prices between related party may be tempting to MNEs to minimise customs duties and VAT. The WTO legislation, therefore, provides a framework of basic rules on acceptability of the prices in related-party transactions for the purposes of determination of customs value in the Agreement on Implementation of Article VII of GATT (Customs valuation agreement).
The dispute between the Philippines and Thailand on customs and fiscal measures on cigarettes from the Philippines, with the Appellate body report and the amended Panel report adopted on July 15 2011 is a landmark in modern trends of customs evaluation.
Though the panel and appellate body merely reaffirmed basic principles of customs evaluation laid down in the customs valuation agreement, the declaration of Thailand's non-compliance with Article III (national treatment in tax matters) of the GATT clearly indicates that an ill-founded refusal to accept the value of a related-party transaction for customs purposes may have far-reaching consequences and amount to a manifest breach of international obligations of a state. Remarkably, non-compliance with Article III was the main subject of the appeal proceedings, whereas Thailand accepted the Panel's interpretation on the customs valuation agreement.
The question of lawfulness of customs administrations' actions arises acutely for a number of newly-emerged market economies, where the customs authorities increasingly and more systematically challenge prices of (especially, but not exclusively) related-party transactions (import) to fill in local budgets.
Ukrainian developments
Though the US and national European authorities began to put related-party transactions under increased scrutiny as early as the 1970s, controversies related to transfer pricing had been isolated, if at all existent, in Ukraine. Even so, disputes regarding non-acceptance of declared customs values had occurred, though Ukrainian jurisprudence lacks clarity and consistency about this.
The major changes are all recent. Between the end of 2010 and September 2011, the State Customs Service of Ukraine (SCSU) carried out a resolute policy for revision of the customs values of various goods, including food products, furniture, and pharmacy. The pharmaceutical industry is under increased surveillance, as the products are largely imported by affiliated distributors of foreign manufacturers.
The statements by SCSU's high officials confirm that these actions form a part of a pre-meditated and consistent campaign aimed at elimination of evasion from customs duties. In 2010 and 2011, a number of well-known MNEs, especially in the pharmaceutical industry, encountered serious problems related to customs valuation in Ukraine. On certain occasions, the redetermination of customs value by the Ukrainian customs authorities in related-party imports even poses a threat to business.
Problems are especially common if the price database of the SCSU contains higher prices for transactions with identical goods. For example, if a foreign producer sells goods to an exclusive related distributor in Ukraine, but for commercial reasons makes episodic shipments directly to Ukrainian wholesale or retail buyers charging respective prices, the customs authorities may start using higher retail and wholesale prices of direct shipments for purposes of redetermination of the declared customs value in transactions between the foreign producer and the related distributor, often without making proper adjustments for differences in volumes and commercial terms.
Value justification
Though the section of the Customs Code of Ukraine (Customs Code) dealing with customs value is a slightly re-structured compilation of relevant provisions of the Customs valuation agreement, the Customs Code lacks clarity in the fundamental issue of justifying the transaction value in a related-party transaction.
Article 267 (paragraph 4) of the Code states that the customs value of the imported good shall be the transaction value provided that "the buyer and seller are not related, or where the buyer and seller are related, that this relationship did not influence the price of the goods being valued." In related-party customs value controversies, it is essential to demonstrate to the customs authorities or the court that the relationship has not influenced the transaction value of the goods being valued.
Article 267 (paragraph 4) of the Customs Code obliges the customs authorities to communicate the grounds for any doubts to the importer in writing and give the latter reasonable opportunity to respond and prove that the relationship did not influence the price. Essentially, this should be a transfer pricing exercise for the importer.
Next, Article 267 (paragraph 7) provides that an importer may justify the transaction price through demonstration of its "maximal proximity" to the customs value as calculated pursuant to one of the following methods for determination of customs value: 1) transaction values of identical or similar goods; 2) deductive value; or 3) computed value.
Article 267 (paragraph 4) and 267 (paragraph 7) are identical in wording to paragraphs (a) and (b) of Article 1(2) of the Customs valuation agreement. The Interpretative Notes thereto, which form an integral part of the Agreement, clarify that these are two separate ways to prove the acceptability of the transaction value.
However, while challenging related-party import transactions, the customs officials in Ukraine often lack sufficient knowledge in the area of transfer pricing (the same could be said about the courts). As a result, they tend to be reluctant to investigate or consider the circumstances surrounding the sale and the ways in which the buyer and the seller organise their commercial relations, including their transfer pricing policies.
One should note that this practice of the Ukrainian customs authorities is in deep contravention to the principles of the GATT. The WTO panel conducted a thorough analysis of Thai customs' non-compliance with the obligation to examine the circumstances of the sale in paragraphs 7.181-7.195 of its report of November 15 2010.
Paragraph 7.189 of the WTO Panel Report reads: "Turning back to the question before us, we recognise that it may well be that Thai Customs critically considered the information and data submitted based on the reasons it has provided to the Panel in this proceeding. However, we would not be in the position to find that Thai Customs did in fact examine such information unless such reasoning is provided in its communication of grounds and its explanations to the importer in accordance with the obligations under the Customs valuation agreement. In its explanation given in the April 12 2007 letter, Thai Customs does not elucidate the reason why it reached the conclusion that the relationship influenced the price for the entries at issue. We therefore do not have the evidence confirming that Thai Customs did in fact examine the circumstances of the sale by critically considering all information and data before it at the time of determination, as it claims in this proceeding. We do not find any other explanation in the subject letter than that the importer and the exporter are related and that the importer failed to meet the burden of proof. As explicitly stipulated in Article 1.2(a), however, the mere fact that an importer is related to an exporter is not sufficient in itself for a customs administration to reject the transaction value. Article 1.2(a) requires the customs administration to examine the circumstances of the sale in a related-party transaction. Consequently, it follows that Thai Customs was under an obligation to explain why it decided to reject the transaction value, including the basis for considering that the relationship influenced the price, after it had examined the circumstances of the sale."
Deductive value
The affiliated distributors of MNEs that operate under the resale price method could employ the maximal proximity rule to show that their transaction value totally corresponds to the customs value as calculated under the deductive value method.
Paragraph 1 of the Interpretative Notes to paragraph (a) of Article 1(2) of the Customs valuation agreement explicitly states that the related-party importer may "demonstrate that the transaction value closely approximates to [one of] the "test" value[s] previously accepted by the customs administration". Reasonable application of the maximal proximity rule should, in our view, allow reference to the transaction values previously accepted by the customs authorities, if these transaction values were calculated on the principles identical to those of the deductive value method.
Otherwise, the Ukrainian importers of unique products would mostly be deprived of the opportunity to substantiate the transaction values. Because of deficiencies of the Customs Code's wording and problems of its practical implementation by customs authorities, the explanations of the ways in which the seller and the buyer organise their relations might not be accepted. Granting all documents demanded by the customs authorities to dispel any doubts as to the acceptability of the transaction value could also be an issue.
Litigation practice
There are very few judicial cases in Ukraine concerning customs valuation in related-party transactions. Moreover, the prevailing customs valuation jurisprudence generally shows an extremely formalistic and often inconsistent approach of the courts.
The courts employ the vague concept of "reasonable doubt" when assessing the lawfulness of the decisions on customs value made by the customs authorities. It is often regarded that if an importer failed to provide all the documents requested by the customs authorities, the "reasonable doubt" that the customs authority may have enables it to determine the customs value of the goods being imported on its own.
Moreover, the courts often request evidence from the importer that the customs authorities manifestly violated applicable rules of procedure. Proving the correctness of the importer's determination of customs value is often not sufficient. This means that if the customs authorities obviously overstated the customs value, but generally acted in the way prescribed by law (had reasons for doubt as to the declared customs value and observed all procedural formalities), the claims will likely be dismissed by the court.
Advance pricing agreements
We consider that the practice of conclusion of Memorandums on Cooperation with the SCSU, which provide for advance pricing agreements (APA), may be important in the prevention of potential customs value disputes in related-party transactions. This practice is being developed in Ukraine. The process poses certain difficulties, as the SCSU often requests provision of a substantial volume of documentation, including costs of production information, which might be very sensitive. The importer would have to demonstrate increased transparency and carefully consider whether conclusion of an APA would outweigh possible risks from the disclosure of such data.
We expect that the issues related to transfer pricing in the context of customs valuation will gain increased importance in Ukraine in the coming years. The SCSU will probably continue its policy of questioning large related-party transactions. Customs value disputes are likely to become increasingly complex. The practice of entering into APAs can become common to prevent customs value controversies.
Oleh Marchenko (omarchenko@ulyssesco.com), Managing Partner, Ulysses
Anton Moyseyenko (amoyseyenko@ulyssesco.com) Associate, Ulysses