Risk of unspecific calculation of payment for administrative services

 

Pursuant to Article 25 (2) of the FOREIGN EXCHANGE TRANSACTIONS ACT (외국환거래법), the Minister of Economy and Finance is authorized to designate one or more legal entities or organizations that are related to or specialize in foreign exchange affairs as an institution to relay, concentrate, exchange, or analyze data on foreign exchange transactions, payments, or receipts. Such an institution is referred to as the Foreign Exchange Information Center (FEIC). Currently, the Bank of Korea (BOK) plays the role of FEIC to facilitate the efficient and transparent foreign exchange transactions.

Under the regulation of the BOK,  Foreign Exchange Information Center (FEIC) Operation Procedures (외환정보집중기관 운영절차), foreign exchange banks are required to report foreign exchange payments/receipts exceeding USD 1,000 to the BOK, and Customs may request the BOK for the reported data.

By comparing the reported data with the declared import data, Customs officials can detect numerous customs valuation violations.

 

Suppose there is an importer who is receiving apparel from a third-party manufacturer. This manufacturer produces clothes based on the instructions (such as design and job orders) provided by a supplier that shares a special relationship with the importer. Between the importer and the supplier, a Distribution Agreement has been established, encompassing additional agreements such as a Trademark License Agreement, Administrative Services Agreement, Purchasing Services Agreement, Standard Purchased Condition, and more.

The importer makes payments: the shipping invoice amount goes to the third-party manufacturer, and the planning marketing invoice (PMI) amount is paid to the supplier. Import declarations for the apparel are filed using details from the shipping invoice. In such a scenario, it is common for customs officials to in quire about the PMI amount during a customs audit.

As the supplier exercises control over the apparel production, Customs may assert that the supplier is, in fact, the genuine seller of the imported goods, and this stance can be difficult to challenge. Consequently, Customs may argue that the PMI amount shall be encompassed within the customs value of the imported goods. This assertion is based on the premise that the PMI payment is made in accordance with the Distribution Agreement, which outlines provisions such as design and trademark usage for the production of the imported goods.

Considering that the PMI is generated as part of the master Distribution Agreement, an objective and quantifiable allocation of the PMI amount, in alignment with the supplier’s services, can be pivotal. In such instances, the importer might reasonably contend that certain portions, akin to payments for the administrative services, should not be incorporated within the customs value of the imported goods. However, if substantiating data for this claim cannot be produced, Customs will likely include the entire PMI amount in the computation of the customs value.

 

The appeal case of 조심 2023관0010 exhibited similarities. The appellant argued that the PMI amount is independent of the price of the imported goods. According to their argument, this amount was paid for various business support services, such as the provision of marketing materials (catalogs, advertising materials, etc.), store operation support (store design, etc.), business development assistance, financial and general management, human resource management, global IT services, and provision of software and databases. These services were formally acknowledged by the tax authority through the Advance Pricing Agreement (APA).

The appellant contended that the PMI amount was intended to align the payment for these business support services with the arms’ length price, as recognized by the APA. Therefore, they argued that this amount should not be considered in the computation of the customs value for the imported goods.

To make the appellant’s argument persuasive, there should have been an explanation about how the value of design and trademark was paid. It appeared to be paid under the Trademark License Agreement and other related agreements, following calculations based on established formulas. Nevertheless, the appellant aimed to exclude the entire PMI amount from the customs value without presenting any objective and quantifiable data to differentiate the PMI amount for each provided service.

Finally, the tax judges ruled that it is justifiable to include the entire PMI amount in the customs value for the following reasons:

·      The related supplier is indeed the actual seller of the imported goods, and as such, the customs value must encompass the entire sum paid or to be paid by the buyer for the relevant imported goods. The PMI amount appears to constitute a portion of this total sum.

·      The mere existence of the APA does not impact the determination of the customs value.

·      Even if the amount paid for the business support services is embedded within the PMI amount, exclusion is unwarranted due to the appellant’s failure to provide objective data that distinguishes it from the PMI amount.

 

If the appellant could convince the tax judges of the possibility to differentiate the PMI amount per provided service, the judges would decide to re-evaluate the customs value, resulting in the exclusion of the amount unrelated to imported goods from the customs value.