Increased tariffs on imports into the United States introduce significant transfer pricing challenges for U.S. taxpayers that import goods from foreign affiliates. These challenges include adapting transfer pricing policies to account for increased costs associated with importing goods and implementing pricing changes in a manner that complies with customs and transfer pricing rules. Changes to supply chains or customs valuations to mitigate the effect of tariffs can also have significant transfer pricing and other tax implications that must be evaluated. While the underlying transactions giving rise to tariffs and transfer pricing issues are the same (e.g., the purchasing and importation of goods by a U.S. taxpayer from a foreign affiliate), the rules and procedures are quite different. U.S. taxpayers evaluating the impact of tariffs on their businesses should consider a coordinated approach to ensure compliance with both sets of rules and limit double taxation or other tax risk. 

Overview of Transfer Pricing Rules

U.S. transfer pricing rules require U.S. taxpayers to report arm's length results on their U.S. federal income tax returns. The reported results of transactions with related parties must be consistent with the results that would have been realized by uncontrolled taxpayers in similar circumstances. In practice, U.S. taxpayers commonly demonstrate compliance with this requirement by showing that their profitability on transactions with related parties is consistent with the profitability of comparable companies engaging in comparable transactions. For example, a U.S. distributor of imported goods might benchmark its operating margin for a tax year against the operating margins of independent distributors, with such information being obtained from public financial disclosures.

Transfer pricing analysis is often performed after the tax year has ended and before the tax return is filed. If a taxpayer's actual results from transactions during the tax year are not arm's length, the taxpayer is nevertheless required to report arm's length results on its return. When this occurs, a U.S. taxpayer can make a retroactive adjustment to the transfer prices paid during the year. U.S. taxpayers routinely seek to minimize such compensating adjustments by forecasting and monitoring actual results and making pricing adjustments as necessary, either prospectively adjusting prices later in the year or making an in-year adjustment to transfer prices already paid.

Possible Implications of Tariff Increases

The introduction of unanticipated costs into a supply chain can have significant implications for transfer pricing purposes. An immediate issue is determining which affiliate – the U.S. distributor, a foreign manufacturer, a foreign principal company, or some combination – should bear the cost to the extent it is not passed on to customers. Under the arm's length standard, that depends on, among other things, the allocation of risk among the parties, as evidenced from intercompany agreements and course of conduct, and relative bargaining position. Another issue is how to implement changes to transfer prices to ensure arm's length results. While it may be difficult to make adjustments in real time in light of policy fluidity, retroactive transfer pricing adjustments may increase tax risk and may put a U.S. distributor in the awkward position of subjecting itself to tariffs on a higher import price and a tax deduction on the lower adjusted transfer price. Finally, to the extent U.S. taxpayers are considering alternative customs valuation approaches to mitigate the impact of tariffs, for example by utilizing the "first sale" rule or otherwise excluding non-dutiable items from customs valuation, those changes may need to be reflected or properly accounted for in transfer pricing policies to ensure the availability of tax deductions for the full amounts paid by the U.S. importer. 

Our Approach

Miller & Chevalier's Customs & Import Trade and Transfer Pricing practices help U.S. importers evaluate and mitigate costs associated with increased tariffs and address conceptual and practical transfer pricing issues arising from tariff increases and mitigation measures. We work seamlessly to analyze the rapidly changing environment and develop bespoke solutions to complex issues.

For more information, please contact:

Rocco V. Femia, rfemia@milchev.com, 202-626-5823

Brian S. Gleicher, bgleicher@milchev.com, 202-626-1589

Richard A. Mojica, rmojica@milchev.com, 202-626-1571

The information contained in this communication is not intended as legal advice or as an opinion on specific facts. This information is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. For more information, please contact one of the senders or your existing Miller & Chevalier lawyer contact. The invitation to contact the firm and its lawyers is not to be construed as a solicitation for legal work. Any new lawyer-client relationship will be confirmed in writing.

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