1. If we lower transfer prices to reduce the customs base will this in turn increase our tax risk?
Yes — unless the change in pricing is carefully considered and supported by the multinational’s transfer pricing model. A reduced intercompany price may trim the ad-valorem duty that the U.S. importer of record must pay, but that same reduction may shift taxable profit from the Danish / non-U.S. affiliate to the U.S. Non-U.S. tax authorities may challenge the reduction of a local margin, while the U.S tax authorities (IRS) is likely to ask why the pricing logic changed overnight. Hence, companies should evaluate transfer pricing policies and transactional characterizations while considering the overall income tax impacts and opportunities of supply chain decisions.
2. Who should bear the economic burden of the new tariff - our U.S. distributor or the affiliated manufacturer/principal outside of the U.S.?
Whether multinationals behavior is in accordance with the arm’s length principle depends on each entity’s realistic alternatives after the introduction of tariffs as well as the functional and risk profiles of the entities and requires a thorough analysis. The starting point is to examine what is stated in the intra-group contracts. However, it is often not specified in the contract who within the group bears the risk of such customs increases. Therefore, one must resort to considering how external parties would allocate this burden. Generally, the economic theory indicates that a rational supplier will seek to pass at least part of the cost increase to its customer when demand is not perfectly elastic, but the allocation within a group of the part that cannot be passed on to the external customer is, however, not always easy to carry out. Typically, the starting point will be that a limited risk distributor (LRD) is held harmless, and therefore the principal implicitly bears the additional customs cost.
3. Does the tariff environment change which transfer pricing method we should apply?
While the methods outlined in the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, remain the same, selection and / or application of some of the transfer pricing methods might require adequate adjustments. For example, the current tariff environment may require electing for another transfer pricing method as one historically applied, or the margins of routine distributors can be pushed outside of benchmarked arm’s length ranges, and updated benchmarked analyses or adjustment to the existing ones can be required.
4. How should we plan across different time horizons?
Companies are looking for a roadmap that distinguishes urgent actions from structural redesign. Some of the actions companies can consider across different time horizons are:
Short term: Quantify exposure product-by-product and entity-by-entity, review customs and transfer pricing values and analyse the options that could mitigate the impact of tariffs without requiring a redesign of the value chain, e.g. the first sale rule. Under this rule, a Danish principal that has contract manufacturing carried out in e.g. China for products sold in the US can, under certain conditions, use the lower factory price for customs valuation in the US, while at the same time the transfer pricing from the principal in Denmark to the US LRD is set higher and still only leaves a limited profit in the US.
Medium term: Analyse the transactional and functional characterization of the relevant entities within the group and consider bilateral advance pricing agreements (“BAPAs”) where exposure is material.
Long term: Reassess the global value chain footprint: near-shoring, on-shoring, or relocation of intellectual property may ultimately provide a sustainable solution and potentially redesign the value chain within the group.
5. What documentation and dispute management steps are critical in this environment?
Regulators will be dealing with the implications of the new tariffs for a long period and taxpayers need audit-ready files. Key actions that companies should consider include:
Preparing contemporaneous memos that describe each pricing change, the external data consulted, and the options realistically available to the parties.
Aligning customs filings, corporate-income-tax returns, and management reports to avoid mismatches.
Monitoring financial results throughout the year and booking true ups before the fiscal year-end.
In a current fast changing customs environment, it is important that companies continuously monitor developments, focusing on optimizing customs payments and looking at customs values, HS codes, countries of origin, supply chain, transfer pricing documentation, etc. The optimization options, and what is specifically relevant to your company, depend on exactly which goods the company sells to the U.S. or imports from the U.S., and we suggest that you take a closer look at the options.
Do you need help with your company's transfer pricing policies and documentation, optimizing customs payments, customs values, HS codes, mapping countries of origin, supply chain or other things that may be of concern in these changing times? Then PwC is ready to help.
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