Year-end adjustments on transfer pricing: ECJ denies use for custom purposes

On 20 December 2017, the Court of Justice of the European Union (ECJ) announced its decision (preliminary ruling) on the Hamamatsu case (C-529/16):

in short, the case under examination by the ECJ concerned the possibility of using for the purposes of restatement of the customs value (for the “Transaction Value” method) the year-end adjustments in relation to transfer pricing with retroactive effect on intra-group transactions carried out in the previous months.

In brief, ECJ had determined that the European Union provisions related custom matters do not allow, in order to correct the customs values previously declared at the time of imports, price adjustments (carried out after closing of the year) with retroactive value from the beginning of the same tax period (regardless of whether they are positive or
negative) in case these changes had not been quantified ex-ante or at the time of the original execution of the transactions.

The case

The present case starts with the request for reimbursement of custom duties presented to the competent German office by the company Hamamatsu Photonics Deutschland GmbH (“Hamamatsu Germany”), a local branch of the Japanese group Hamamatsu Photonics (“Hamamatsu Japan”). Hamamatsu signed a preliminary agreement (Advance Pricing Agreement – APA) on transfer prices with the German Tax Authority selecting the Residual Profit Split as a methodology for setting the prices within the group. In particular, the transfer pricing policy concerning the sale of finished products from the Japanese holding to the German subsidiary, provided a price adjustment mechanism (so called year-end adjustment) if at the end of the tax period the transfer prices applied had determined – for the European branch – a margin outside (lower or upper) a range of values resulting from a specific benchmarking analysis. Likewise, the same methods of “temporary” determination of transfer prices (during the year, before the calculation of the adjustment) were also used to identify the value of the goods sold at the time of importation. At the end of 2010, Hamamatsu group realized that the operating margin of the German branch was lower than the range agreed in the APA: it was therefore necessary to reduce the transfer prices adopted in the previous months in order to bring back the marginality of Hamamatsu Germany, for this tax period, within the range of market profitability identified through benchmark analysis.

Following the adjustment, during 2012 the German branch of the group decided to submit a specific request
for reimbursement of customs duties which – on the basis of the calculations made for income tax related to transfer pricing – resulted to have been paid in excess.

The German custom authorities rejected the request, arguing that the price adjustment was a total amount, without any specific allocation being made to the individual intra-group transactions that took place earlier in the year. Hamamatsu appealed against the decision of the custom authorities before the competent tax commission of Munich, which – given the complexity of the case and the absence of specific legal provisions – suspended the proceedings, submitting the controversy to the ECJ, asking for official interpretation regarding

(i) the possibility of using transfer pricing to determine the custom value of the goods if the prices are subject to any subsequent adjustment after the end of the tax period and (ii) if so, whether subsequent corrections (for carrying out of the operations) of price can be asserted also for the purpose of a redetermination of the custom value.

The ECJ – resuming the provisions of the Custom Code (see articles 29-33 and 78) takes the opportunity to underline that the Transaction Value method based on the value attributed to goods at the time of importation is not passable if the value of the same goods cannot be identified with certainty from the moment in which they are released for free movement. In such cases, alternative methods should be used.

Furthermore, ECJ states that the Transaction Value method should take into account all elements that characterize the goods and that are subject to economic valuation (for example, sales commissions, transport costs, royalties). Once the goods have been put into circulation, the valuations obtained with the application of the Transaction Value method can be corrected only under certain specific circumstances like – for example – an adjustment in relation to quality defects or faulty workmanship discovered after the marketing of these goods.

Therefore, the position taken from the ECJ is that, for the determination of the import value of goods for customs purposes, a method that involves the invoicing of an initial value subsequently modified due to a total adjustment(flat-rate) operated after the end of the financial year is not viable.

Preliminary considerations

The ECJ decision, which is an isolated case so far, is short and concise and does not provide any detailed analysis
as to a possible convergence of the methodologies applicable for the determination of transfer prices (for the purposes of direct taxation) and valuation for custom purposes.

However – at least in the present case – it seems to exclude (or not to contemplate) a connection between the assessments made for customs purposes and the methodologies applied for transfer pricing purposes to satisfy the arm’s length principle.

The decision of the ECJ on the Hamamatsu case certainly deserves further investigation both in terms of European customs legislation and in light of the intense work carried out in recent years by the World Customs Organization on the subject of a greater desirable convergence between transfer pricing guidelines and custom principles.

However, multinational groups that have significant flows of import-export operations between related entities will have to monitor the future developments that the decision above may have at the level of tax administrations to assess possible economic-financial impacts as well as the possibility of a structural revision of infra-group flows and related transfer pricing policies.

Gian Luca Nieddu, Hager & Partners, Italy.