China Trade Sanctions: What to Do?

Mark K. Neville, Jr.

As of July 6, imported goods from China that fall with an array of 818 tariff classifications and which, in the aggregate, account for $34 billion in annual imports, are subject to the levy of additional duties of 25%.ⁱ Note that “additional” duties is just that—this 25% is in addition to the duties otherwise due. This is the US response to China’s unfair trade practices related to the forced transfer of US technology and intellectual property.ⁱⁱ Many would say that these are long-overdue but even they will admit that their levy has been disruptive. Of course the program was clearly intended to be just that, a “game changer.”

Unlike the duties assessed against basic steel and aluminum articles, which program was not limited to China, many of the Chinese products on this “List 1” are value added and advanced machinery. In fact, one reason for the selection of the specific products was that they were presumed to have benefited from the “Made in China 2025” program.

One result of the July 6 effective date for the program has been a scramble among importers and others with an interest in sourcing goods from China. Because US companies are not alone in having shifted production to contract manufacturers in China, customs lawyers and other advisors in the US have been fielding calls from many European clients concerned about the program and its effects on their business.

So, what to do? Here are some possible answers but we emphasize that there could be other solutions, such as a shift to third countries. In that case, the rules of origin and its necessary application of the “substantial transformation” rule will be confronted.

Exclusions

First off, the US has announced a program that allows for the filing of applications for exclusions. These would be “carve outs” on a product-specific basis, with the remaining tariff items within the target list still subject to the 25% duty. Applications must be submitted to the US Trade representative before October 9, 2018.

But don’t get your hopes up. A separate Federal Register noticeⁱⁱⁱ outlines the various requirements and processes for product exclusion requests, which diverge from those that apply to requests for exclusion from the additional Section 232 duties^iv.

Factors that will be considered include:

whether a product is available from a source outside of China;
whether the additional duties would cause severe economic harm to the requestor or other U.S. interests; and,
whether the particular product is strategically important or related to Chinese industrial programs including “Made in China 2025”.

In the absence of a successful exclusion, what are the other “work around” options available?

Let’s assume we are dealing with a clutch. Imported clutches and universal joints are classified in item no. 8483.60.40, Harmonized Tariff Schedule of the United States (HTSUS). Those products are on the China List 1. That means that fully complete, fully assembled clutches should be classified in heading 8483.60.4040, HTSUS, and would attract a normal duty of 2.8% and an additional duty of 25%.

So after we set that up with the “fully complete, fully assembled” phrases, you’re thinking, but what if the imported clutches are not fully complete nor fully assembled at the time of their importation?Is there some planning opportunity that would follow? To find out, we must press further, and go beyond an analysis under General Rule of Interpretation (GRI) 1, HTSUS, which holds that an imported article must be classified according to the appropriate tariff heading, plus any relative section or chapter notes and, unless otherwise required, according to the remaining GRI’s taken in order. This may offer some relief.

Separately Imported Parts
The Legal Principles of Section XVI Note 2 and Additional US Note 1 (c)

In the event that the goods cannot be classified solely on the basis of GRI 1, and if the headings and legal notes do not otherwise require, the remaining GRIs may then be applied. Goods that are (i) identifiable as parts of clutches should be classified in Chapter 84 according to Section XVI Note 2, HTSUS and (ii) if such singular use is not so identifiable, then classified in accordance with Additional US Note 1 (c).

Under Section XVI Note 2(a), parts which are goods included in any heading of Chapters 84 or 85 are classifiable in their respective headings. Under Note 2(b), other parts are classifiable with the machines or apparatus with which they are solely or principally used.

Additional U.S. Rule of Interpretation 1 (c), states that a provision for parts of an article covers products solely or principally used as a part of such articles but a provision for "parts" or "parts and accessories" (in tacit deference to Section XVI Note 2 (b)) shall not prevail over a specific provision for such part or accessory. In short, this Additional US Rule will trump Note (2 (b).

Taken altogether, a part for a clutch that is specifically classified in chapter 84 should be classified in that tariff provision (e.g., a clutch bearing is classified in subheading 8482.10, L87167, 8/30/05).A part that is used solely or principally on a clutch will be classified in the parts provision in subheading 8483.90 (see, e.g., plastic ball race so classified in ruling no. H024411 (7/22/90).A part whose use on a clutch is not so specifically delimited will be classified in its “home” tariff provision and not as a “part” (e.g., a plastic article in subheading 3926.90, see analogous discussion in ruling no. 954366, 9/7/93).

The lesson: any plan to separately import parts will need to be carefully scrutinized and these rules followed in order to ascertain the tariff status of the parts.

Effects of Unassembled Goods: GRI 2 (a)

GRI 2(a) provides that goods imported in an unassembled condition are to be classified as the assembled article. GRI 2(a) states that:

Any reference in a heading to an article shall be taken to include a reference to that article incomplete or unfinished, provided that, as entered, the incomplete or unfinished article has the essential character of the complete or finished article. It shall also include a reference to that article complete or finished (or falling to be classified as complete or finished by virtue of this rule), entered unassembled or disassembled.

This closes the door on simply importing an unassembled kit and then assembling after importation. The full 2.8% plus 25% duties will be assessed.

Incomplete Goods: The “Essential Character” Standard

That leads to the notion of importing a less-than-complete clutch. By its terms, GRI 2(a), HTSUS, extends the scope of a 4-digit heading to include an article, whether assembled or unassembled, that is imported incomplete or unfinished. The first part of Rule 2(a) extends the scope of any heading which refers to a particular article to cover not only the complete article but also that article incomplete or unfinished, provided that, as presented, it has the essential character of the complete finished article.

In interpreting the HTSUS, CBP has construed the term "essential character" to mean the attribute which strongly marks or serves to distinguish what an article is; that which is indispensable to the structure, core or condition of the article. See ruling no. 956538 (11/29/94). Factors found to be relevant in other contexts are the significance of the imported components or their role in relation to the use or overall functioning of the completed article and, to the extent that it validates that comparison, the cost or value of the completed article versus the cost or value of the imported merchandise. See ruling no. 956410 (10/14/94).

We would also point to ruling no. N231738 (9/19/12), which concerned the sub-assembly of an industrial robot. CBP observed

Under GRI 2(a), the factor or factors which determine essential character will vary with the goods. It may, for example, be determined by the nature of a component or components, their bulk, quantity, weight or value, or the role of a component or components in relation to the use of the good. In your letter, you indicate that Part Number 0190-32011 represents approximately 75 percent of the cost of the complete robot. It is this office’s opinion that Part Number 0190-32011 imported without arm and end effect assemblies has the essential character of an industrial robot.

While it was in the context of an examination under GRI 3 (b), another instance in which essential character plays a role, CBP has addressed the significance of relative values. In ruling no. 962090 (6/11/99) CBP essentially disregarded relative values, noting that

Of the criteria listed in EN GRI 3(b)(VIII) other than the roles of the constituent materials, bulk, quantity, and weight also support the conclusion that the glass component of the [imported glass and metal photo] cube imparts its essential character. In regard to the remaining criterion (value), although the cost breakdown you provide indicates a greater cost for the metal component than the glass component, we note that in [the CIT decision in] Better Home Plastics, supra, even though the relative value of the textile curtain was greater than that of the plastic liner, the plastic liner was held to impart the essential character (see also Headquarters Ruling Letters (HQs) 086166, dated April 9, 1990, and 952676 dated December 29, 1992, each of which held that the glass component of glass and metal boxes imparted the essential character, notwithstanding that the relative value of the metal component was greater than that of the glass component).

EN (V) to GRI 2(a) states that:

The second part of Rule 2(a) provides that complete or finished articles presented unassembled or disassembled are to be classified in the same heading as the assembled article. When goods are so presented, it is usually for reasons such as requirements or convenience of packing, handling or transport.

EN (VII) to GRI 2(a) states that:

For the purposes of this Rule, "articles presented unassembled or disassembled" means articles the components of which are to be assembled either by means of fixing devices (screws, nuts, bolts, etc.) or by riveting or welding, for example, provided only simple assembly operations are involved…. Unassembled components of an article which are in excess of the number required for that article when complete are to be classified separately.

CBP has been asked to classify unassembled articles and one ruling that is helpful is ruling no. 966610 (1/10/04). There, rotating elements for a pump assembly for a nuclear reactor were imported and Headquarters concluded that

the articles that are being imported are unassembled parts for a rotating element pump assembly, which is, in turn, a component of pumps used to circulate water in a nuclear reactor. Heading 8413, HTSUS, provides for pumps for liquids whether or not fitted with a measuring device; liquid elevators; parts thereof. Since heading 8413, HTSUS, includes parts, if the rotating element pump assemblies were imported fully assembled, they would be classified in heading

8413, HTSUS, as parts of a pump for liquids. We note that after importation, the pump assembly components are assembled together using bolts, nuts and other mechanical fastening devices. However, the pump assemblies are not subject to any further operations other than simple assembly, fixing or welding. Accordingly, we conclude that under GRI 2(a), the rotating element assemblies, imported unassembled, should be regarded for tariff purposes as if imported fully assembled.

Importantly, the ruling noted that there was not enough information to determine if the essential character test for tariff status as a pump was met.^v Thus, the next step must be to determine whether the imported clutch will meet this “essential character” criterion at the time of its importation.

Essential Character Analysis Met/Not Met

The analysis will be conducted on the basis of percentage of BOM costs represented by the imported parts, their relative weights and bulk and the extent of post-import processing required to produce the finished good.

If the “essential character” test has been met, then GRI 2 (a) demands that the imported article, even though it is an unfinished clutch, will be treated as a clutch for customs purposes under item no. 8483.60.4040 and it will be subject to the full 2.8% plus 25% duty.In short, this will not be a work around solution. –

In contrast, if the essential character test has not been met, then the imported articles, the various parts, will fall to be classified in their individual capacities.And that will lead to an application of the “parts” classification rules that we noted above.

In short, for parts that are specifically named in either Chapter 84 or 85 they will be classified under those more specific provisions (per Section XVI Note 2(a)) and otherwise, for those parts that are principally or solely used on the clutches as parts of clutches, under subheading 8483.90 (per Section XVI Note 2 (b).If the parts are not so dedicated to use on the clutches then they will be classified in their respective tariff provisions.

An example of Note 2 (a) at work would be clutch release bearings, classified in item no. 8482.10.50^vi and dutiable at 9% and, because that tariff provision is also on List 1, an additional 25%.An example of Note 2 (b) might be a housing for the clutch, classified at 8483.90.8080^vii and dutiable at 2.8% plus an additional 25% because parts are also on List 1.

The other parts may or not be on USTR’s List 1 and the BOM must be reviewed to ascertain whether they would fall out of the scope of List 1.

A review shows that a number of the tariff items shown at the 8-digit level on List 1 are accompanied by their parts, e.g., 8483.60.40 and 8483.90.80, as the US government can only have anticipated some of these creative solutions, as in, “we’ll import the modules and subgroups of parts and assemble them after import.”^viii

Unbundled software

Still another view has been to preload software but to not activate it until after importation when a special unlocking fee might be paid. The idea would be to lower the dutiable value of a “smart” machine by isolating the value of the software and thus lowering the exposure to the 25% additional duty. But that gambit may be of little value since the applicable US ruling specifically limits the application of this nondutiable status to preloaded software that is optional only and not needed for the intended functioning of the machine.^ix

Summary

Any attempt to get out from under the load of these additional duties must be made only after a searching and thorough examination, one that is clear-eyed and applies all of the various rules which we have set forth above for your consideration. There may be a solution, one with a happy ending to the exercise, but the happiness may be fleeting if the review has not pursued all of these rules.

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i. 83 Fed. Register 28710 (June 20, 2018).

ii. To be sure, as of this writing, there are two other lists of Chinese products that may also be hit with additional duties. The proposed List 2 (which would also be subject to an additional 25% tariff) includes products with an annual trade value of $16 billion including certain chemicals, plastics, metal articles, as well as additional articles of machinery and transportation (and other miscellaneous products). The USTR has also compiled a List 3 for products with an aggregate trade value of $200 billion annually which, if implemented, would be subject to a 10% duty.

iii. 83 Fed. Reg. 32181 (7/11/18).

iv. These procedures are set forth at 83 Fed. Reg. 12106 (3/19/18). Parenthetically, the USTR had earlier set forth exclusion rules for the Safeguards action on solar panels, 83 Fed. Reg. 6670, 2/14/18.

v. In reaching this decision, we note that in addition to the rotating element assemblies at issue here, a seal housing, thrust bearing assembly, motor support stand and assorted piping, together with a pump casing, are necessary to comprise a complete pump for liquids. The record is therefore inconclusive as to whether the unassembled components constitute an incomplete or unfinished pump of heading 8413.”

vi. Ruling no. N022417 (2/21/08).

vii. Ruling no. L89955 (2/8/06).

viii. This appears to be a bit counter-intuitive, as one might expect that the US would encourage such post-import processing.

ix. Ruling no. H239671 (6/7/13).

Mark K. Neville, Jr., LL.M. (International Legal Studies), NYU, is a long-time member of the Board of Advisors. He is Principal of International Trade Counsellors and may be reached at mkneville@itctradelaw.com. He has served as an adjunct professor at The University of California, Berkeley’s Haas School of Business and NYU’s Stern School. He is The Journal’s Customs & Trade correspondent.

September, 2018