July, 2014

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Good News / Bad News

Mark K. Neville, Jr.

There are generally two schools of thought when it comes to learning about the customs and trade laws.

The first is “what you don’t know can’t hurt you.” These are the people who tend to shy away from the effort involved in becoming more aware of how and why the laws impact them.

The second approach starts with the notion that such an attitude certainly doesn’t help the ostrich nor does it help importers and exporters. In fact, the scholars from that second group go further and pronounce that it is imperative to know as much as possible about the customs and trade laws, even if it will take some effort. While that knowledge is being attained, the importer will be learning both good news and bad news. It pays to know both.

First, some of the good news about the customs and international trade laws.

Good news

If you are an importer or exporter, goods news can lie in learning that there are benefits and preferences that may make commercial life easier. Not all importers or exporters will be treated the same, because some will have seized the initiative and taken advantage of these beneficial programs and others, i.e., those who are passive and reactive, will be playing the hand dealt them by the administrative agencies. There are wonderful planning opportunities, only a few of which are noted here. Companies should consider making use of some of the following:
  1. Free Trade Agreements (NAFTA, US/Colombia, etc.)
    The US is a party to almost 20 FTAs—if the goods meet each FTA’s specified origin rules, they enter duty-free into the US and into the FTA partner country. This bilateral elimination of duty should be factored into strategic planning. As an example, sourcing the identical product from, say plywood flooring strips, France and from Colombia could lead to a duty imposed under heading 4412, HTSUS, on the French product of 8% but the Colombian product would be duty-free. The FTAs are a wonderful duty-elimination program.

  2. Outward Processing Relief (US Goods Returned)
    Among other chapter 98, HTSUS, allows a company to send US components to a foreign country and assemble them there.
    • Duty is not paid on value of the US components
    • Example: Windshields, etc. in foreign-built cars
    • Issues arise over extent of “assembly” and “incidental ops”
    • Separate provisions for foreign repairs and goods exported for temporary lease
    • You should recognize this as the “assembly abroad” program that was at the heart of the maquiladora industry in Mexico pre-NAFTA.

  3. Generalized System of Preferences
    • The GSP and its regional variants allow eligible goods from eligible “beneficiary developing countries” duty- free access to US.
    • They must meet a 35% local content test
    • Think of the GSP as a poor man’s FTA, in the sense that qualifying US goods are not entitled to duty-free entry in the foreign market
    • GSP is now in lapse. It dates back to 1975 and has lapsed previously. As before, it is expected that the program will be retroactively reinstated.

  4. Foreign Trade Zones and Customs Bonded Warehouses
    These are legal fictions—discrete areas deemed outside the customs territory of US
    • For goods stored in them and re-exported directly from them, no US duty is ever paid
    • Duty payment is deferred while the goods remain in the bonded facility until the goods are entered into the US customs territory (cash flow savings)
    • Manufacturing in the FTZ may allow the use of an “inverted tariff” principle which will step down the duty rate on the imported components

  5. Duty drawback Refunds
    Duty Drawback is allowed on re-exported goods or exported goods made with imported parts. This can be very complicated, however, and there are limits under NAFTA rules.

  6. “Tariff engineering” and Valuation Planning
    • Designing the product with HTS and duty rate in mind (Example: athletic footwear where the duty rate is a function of the composition of the outer surface of the show—fabric, leather, plastic)
    • Importing in “retail sets”: Duty rate of the article that gives the essential character will be assigned to all articles
    • “Unbundling” of nondutiable charges (NDCs) such as installation costs “Middleman” sourcing strategy (with the foreign middleman playing either a buy/resell entity leading to the First Sale for Export valuation principle or a Buying Agency role)
    • Interest on trade payables can be nondutiable

  7. Inward Processing (aka TIB)
    This is the mirror image of outward processing, note 2 above. Just as US articles can be shipped abroad for assembly, repairs and other functions (point two, above), and pay no duty on the underlying US elements, an importer can bring articles into the US without paying duty of they will be “round tripped.” For those goods that will be altered—read so expansively as to include manufacture into another article—or repaired and then re-exported from the US within a timely fashion, no duty is paid. Instead, a Temporary Import Bond (TIB) obligating the re-export is posted. In essence, the importer is telling Customs and Border Protection, “Don’t collect duty; these goods are not staying here.” But be careful—100% of the goods must be re-exported, and satisfactory proof of that shipment provided. Any breach of the bond will lead to a liquidated damage claim in the amount of twice the duty that would have been paid.
    And now for some of the bad news.

Bad News—Compliance and Enforcement

  1. Unfair Subsidies.
    “Incentives” is usually a good word, and whenever we see the term we are pleased at the possibility of getting something nice. But in international trade, an incentive is a loaded word. If a company were to locate operations in a foreign country in response to incentives being granted by the host country, there is a possibility that any subsequent exports of goods produced there might be the subject of a countervailing duty action brought by the country to which the goods were exported. This is because many incentives, especially those which are not generally available and have been extended to a specific company or industry, or which are tied to export levels, might qualify as unfair subsidies. Be careful of the incentive regime if there is a plan to produce for export.

  2. Dutiable Assists.
    A very common profile for foreign production is a US company hiring a contract manufacturer in a foreign country to produce the goods to its design or making use of the parts and materials supplied by the customer (the latter is a “toll” arrangement). But this arrangement is filled with compliance hazards if the goods produced are intended to be imported into the US. Supplying tooling or molds, or other materials used in the manufacturing process, free or at a reduced cost, is a “dutiable assist.” This is because the value of the imported goods would have to be increased to capture the additional cost that would result from the foreign producer having to purchase or self-produce these elements. This failure to declare dutiable assist results in an under-valued import. It is an entirely innocent matter, and is so often overlooked that CBP automatically looks for it in any offshore contract manufacturing scenario.
    Note: if engineering work or designs are undertaken in the US, then they are exempted.

  3. Transfer Pricing.
    Whenever related party entities cross borders when they buy or sell goods or provide or receive services, such as buying agency services, there is a transfer pricing issue. The Internal Revenue Service is sure spot the Section 482 implications. There is a parallel world, however, insofar as these same transaction raise customs duty issues whenever we are looking at a sale of tangible goods. But there is at least one service transaction between related parties that raises customs concerns. If there is a related party buying agency in place, then there is also a customs issue to keep the Section 482 inquiry company. The customs authorities will insist that the arm’s length standard is honored, although they will be applying the customs valuation law standard, ensuring that the price for the imported goods has not been influenced by the relationship. The interface between the income tax and customs disciplines on transfer pricing is fascinating.

  4. IP Migration Headaches
    One of the biggest headaches in customs valuation concerns the treatment of royalties or license fees. If there is a separate royalty stream in play, the issue may be whether that separate payment will attract customs duty. This is an issue that is in constant debate over the twin issues—(i) is the payment related to the imported goods and (ii) is the payment a condition of the sale of the goods.

  5. Compliance Burden: Imports
    Take everything you know about dealing with the IRS and now apply it to Customs and Border Protection. Think of customs duties as an indirect tax and you will be half-way home. The US stands head and shoulders above any other jurisdiction on the planet in terms of compliance activity levels, twenty plus years and counting. The good news is that the transparency of the system makes it a bit easier to muddle through, but there is no escaping the burden of the importer having to show that he meets the “reasonable care” standard. A failure to meet that standard could lead to a civil penalty under Section 1592 of the Tariff Act of 1930, with penalty levels tied to culpability levels (negligence, gross negligence or fraud). The statute of limitations is five years, so CBP can—and almost always does—look to assess a penalty across the entire open period. The importer who learns of an error has an opportunity to manage this risk, however. In one of the best examples of a benefit accruing to him who takes the initiative, the importer who files and perfects a valid prior disclosure will drastically lower his penalty exposure. So an importer who sits back and waits “until the wolf is at the door” may be hit with a non-tax deductible penalty with “telephone book” numbers while the person who has filed a prior disclosure will escape with either no penalty or a penalty of simple interest in the context of a negligence case. Apart from the customs laws, importers must also comply with the dizzying array of Other Government Agency (OGA) regulations. These can run from issues arising from the Fish and Wildlife program that licenses the import of articles made from exotic animal skins, for example, to the Food and Drug Administration of the laws it administers, and over forty other federal agencies.

  6. Compliance Burden: Exports
    First off, there are no taxes allowed on exports, there being a constitutional ban. Thus, to be sure, while there are savings opportunities when the importation into the foreign market is to be considered, we are generally not speaking of savings on exports qua exports. But there is a compliance universe that is parallel to point 5 at work here. For any person subject to US jurisdiction—and that covers a wide swath indeed--there is a requirement to ensure that there is no license required or that a license exception is available. While there are special licensing regimes for specific product sectors, the laboring oars are wielded by bureaus within the Commerce Department for “dual [i.e., civilian and military] use” goods and the State Department for weapons and arms. For all exported goods, even those without any license issues, there is a general advance notification requirement if the value exceeds $2500 in a given tariff classification provision on a given day. The latter is an electronic filing requirement under the Automated Export System (AES) under a program administered by the Census Bureau and enforced by CBP. A failure to file is subject to a penalty assessment of $10,000, although mitigation is available.

Conclusion

Many of the discussions in this space go in depth along a narrow front, but others go into the shallows of a broad miscellany of issues. Faithful readers of this column will recognize that the topics I have pulled from the grab bag for this discussion have all been the subject of separate treatments in this column.

The overarching theme, of course, is that events may come to serve up good news to those companies who have faithfully studied how the laws might apply to them. The good news can be measured as either savings won or on compliance hassles avoided. Of course, the reverse is also true. There is bad news that will befall the companies who have disregarded these laws. That may come in learning after the fact that savings opportunities were lost or that they are in trouble for having unwittingly violated the customs laws. In short, “what you don’t know can hurt—or perhaps cost-- you.”


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