May, 2017
Small Companies’ Import Challenges
Mark K. Neville, Jr.
One feature of the importing experience in the United States is that legal compliance obligations are imposed on all importers, large and small alike.1 Likewise, planning strategies are available to one and all. But my years of experience have taught me that smaller companies may not be well-positioned to meet those obligations or to capture those savings opportunities.2
A recent project has reinforced this point for me.
A client had initially asked whether it would be possible to take advantage of “assembly abroad,”3 one of the US Goods Returned programs, for goods that were produced in a foreign country by a contract manufacturer. The company had been importing the goods for the past several years and had been paying duty on the goods.
In broad terms, the customs regulations4 specify that the goods must have been produced with US fabricated components which have been exported to the foreign location where they were then assembled into the finished product. The importer must prove that there has been an assembly and that the components have not been advanced in value except by operations that are incidental to assembly. There is a robust body of rulings and case law on status questions of operations as assembly or as incidental. If the products did qualify then we would be able to subtract the value of the US parts from the finished products’ customs value. This would confer a partial duty relief for the importer.
The GSP program is a unilateral program extended by the US toward BDCs. First made available in 1975, it is intended to foster development in the BDCs, the incentive lying in the fact that the qualifying goods imported directly from the BDC will be imported on a duty-free basis.6 Qualifying status is conferred if a minimum local content requirement test of 35% of the customs value is met. This 35% threshold may be met by the cost of materials and/or direct costs of processing in the BDC.7
Note: you will have grasped that assembly abroad encourages the use of US-origin parts, while the GSP will discourage their use unless the dual substantial test has been met.
As we studied the production processes in the BDC we found that the dual substantial test would not be a problem because the production process there was based upon the pulling of the components from inventory and the making of various subassemblies. These subassemblies had separate part number status and were in fact sold in some instances back to the US parent company. This proved that the individual components were substantially transformed into subassemblies which were intermediate articles with their own name, character and use. When the subassemblies were then assembled into the finished articles those intermediate articles underwent a second qualifying substantial transformation. That meant that the cost of the materials, both the BDC and non-BDC in origin, could be counted toward the 35% test. To the cost of the materials we could add the direct cost of production and thus meet the GSP threshold.
In many instances, the error was in the statistical level for the finished products, so there was no customs duty impact to the errors. But in all of the other instances we found that the errors had caused the importer to pay duty on articles—the subassemblies that had been purchased by the importer, whose importation should have been unconditionally duty-free. In fact, the same duty rate was collected on all of the imported articles. That allowed for an annotation to the commercial invoice which simply aggregated the cost of the materials and subassembly charges across all of the imported articles. All of this led to the creation of a tariff classification database for all SKUs, annotated to show the authority for the classifications assigned, and a protocol for the assigning of tariff classifications to new products.
Obviously we would need to assign actual costs on a product-specific basis so that we could implement our new approach. This necessitated the re-design of the vendor’s invoices on a prospective basis.
To be clear, we needed to file a prior disclosure with CBP—thankfully, all entries were made through a single port of entry. We needed to prepare a comprehensive submission to CBP that justified the claim of GSP for the imported finished products. For the intermediate subassemblies, there was only a single substantial transformation, so that eliminated a GSP opportunity. That would have been unnecessary in any event as these articles were classified in tariff numbers that were eligible for duty free entry unconditionally.
In terms of compliance, as noted, the importer needed to protect itself by filing a prior disclosure that extends back over the full five-year statute of limitations. Make no mistake--the importer was serious about its responsibilities. But it was a small company—less than $50 million in annual sales.11 The importer did not have a staff experienced in the intricacies of the customs laws and was heavily dependent upon its broker. The broker obviously earned an “unsat” fitness report.
One final note of risk for small companies must be sounded. Such companies are often dependent on moving product with express (or “integrated”) carriers. One selling point is that the carrier will shoulder most of the burden, including handling all transport of the goods, assigning duty rates and acting as importer of record.
That last point is often a big seller—companies think that if they are not the IOR then they will not be responsible for the customs compliance obligations that go with IOR status. Those companies are wrong. In the case of these express carrier entries, CBP feels that the consignee—our hypothetical small company—is in a position to know more about the shipment and is therefore more responsible for meeting the customs compliance obligations for the entry than the carrier. Beyond that, if the small company seeks to retrieve the entry documents in order to perfect a post-entry claim for a refund, the documents are typically not accessible. In my experience, this has been the case in some instances when they were only 3-6 months old.
Is there a solution? Perhaps the best—or indeed only--solution is that small companies should recognize that they cannot effectively, or at least easily, outsource this function. They will need to grasp the nettle by assigning some internal resources as well as carefully vetting the credentials and track record of brokers and other outside service providers. Once those outside resources are hired, the internal staffers will have to manage the relationship, i.e., will have to closely review the performance by the service providers. If not, surprises await.
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A recent project has reinforced this point for me.
A client had initially asked whether it would be possible to take advantage of “assembly abroad,”3 one of the US Goods Returned programs, for goods that were produced in a foreign country by a contract manufacturer. The company had been importing the goods for the past several years and had been paying duty on the goods.
Invoice Prices
Thankfully, the customs value was properly reported. This could have been a risky issue since the only invoice for the finished goods imported into the US was the invoice for the assembly/production service from the contract manufacturer. What was needed to be added to that amount was the value of all of the parts that were supplied by the importer, which if they had remained off the invoice would have been undeclared dutiable assists. The invoice was annotated to show the aggregated amount for the parts and this amount was then used to prepare the entry summary (the CF 7501). Typically the imported goods were entered under different tariff provisions, but the tariff items all carried the same duty rate. We did not review the tariff classifications at this initial stage, so we worked with the existing designations as placeholders.Assembly Abroad
So far, so good. The first thought was to review the foreign production processes under the “assembly abroad” regulations to ensure that the imported goods would have been eligible for this treatment.In broad terms, the customs regulations4 specify that the goods must have been produced with US fabricated components which have been exported to the foreign location where they were then assembled into the finished product. The importer must prove that there has been an assembly and that the components have not been advanced in value except by operations that are incidental to assembly. There is a robust body of rulings and case law on status questions of operations as assembly or as incidental. If the products did qualify then we would be able to subtract the value of the US parts from the finished products’ customs value. This would confer a partial duty relief for the importer.
GSP
We had only just started our inquiry when we realized that the client might be better off taking advantage of the Generalized System of Preferences (GSP), which would confer full duty relief if all of the statutory criteria were met.5 The country where the goods were being produced is a beneficiary developing country (BDC) and all of the imported products fell into tariff provisions that were eligible for GSP benefits.The GSP program is a unilateral program extended by the US toward BDCs. First made available in 1975, it is intended to foster development in the BDCs, the incentive lying in the fact that the qualifying goods imported directly from the BDC will be imported on a duty-free basis.6 Qualifying status is conferred if a minimum local content requirement test of 35% of the customs value is met. This 35% threshold may be met by the cost of materials and/or direct costs of processing in the BDC.7
Dual Substantial Transformation
One of the peculiarities of the GSP program is the “dual substantial transformation” test. If the product has been made with parts or materials that have been imported into the BDC, then their cost cannot easily be counted as local for purposes of meeting the 35% test. Those imported parts or materials must have been first used in making an intermediate product and that intermediate product must thereafter be transformed when it is used in making the finished product. In short, you must be able to point to a distinct two or more-step production process. A single, production run through might qualify as a substantial transformation but the product ensuing from that process would not qualify for GSP. If one reflects for a moment, one can recognize that in the case of a single, straight through production process, the materials that had been imported into the BDC will have retained their non-qualifying identity. By contrast, in a multi-stage production the foreign materials will have been transformed into local materials when the intermediate article is produced, such that the cost of the intermediate article can then be counted as “local” toward the 35% test when it is incorporated into the final product.8Note: you will have grasped that assembly abroad encourages the use of US-origin parts, while the GSP will discourage their use unless the dual substantial test has been met.
As we studied the production processes in the BDC we found that the dual substantial test would not be a problem because the production process there was based upon the pulling of the components from inventory and the making of various subassemblies. These subassemblies had separate part number status and were in fact sold in some instances back to the US parent company. This proved that the individual components were substantially transformed into subassemblies which were intermediate articles with their own name, character and use. When the subassemblies were then assembled into the finished articles those intermediate articles underwent a second qualifying substantial transformation. That meant that the cost of the materials, both the BDC and non-BDC in origin, could be counted toward the 35% test. To the cost of the materials we could add the direct cost of production and thus meet the GSP threshold.
Prior Disclosure: Classification Errors
It was at this very point that we discovered that we needed to make a prior disclosure before we did anything. That was because we began to review the entries for a two-fold task. We needed to ascertain how to make entry for future shipments wherein we claimed GSP on the finished products and we needed to prepare the submissions for refunds to Customs and Border Protection (CBP) by the broker for the unliquidated entries and by our firm for protests of liquidated entries.9 When we analyzed the prior entries we discovered that all of the tariff classifications that had been assigned by the previous broker were wrong. Let me be clear--every single tariff classification for all 500 SKUs was wrong. On every entry.In many instances, the error was in the statistical level for the finished products, so there was no customs duty impact to the errors. But in all of the other instances we found that the errors had caused the importer to pay duty on articles—the subassemblies that had been purchased by the importer, whose importation should have been unconditionally duty-free. In fact, the same duty rate was collected on all of the imported articles. That allowed for an annotation to the commercial invoice which simply aggregated the cost of the materials and subassembly charges across all of the imported articles. All of this led to the creation of a tariff classification database for all SKUs, annotated to show the authority for the classifications assigned, and a protocol for the assigning of tariff classifications to new products.
Obviously we would need to assign actual costs on a product-specific basis so that we could implement our new approach. This necessitated the re-design of the vendor’s invoices on a prospective basis.
To be clear, we needed to file a prior disclosure with CBP—thankfully, all entries were made through a single port of entry. We needed to prepare a comprehensive submission to CBP that justified the claim of GSP for the imported finished products. For the intermediate subassemblies, there was only a single substantial transformation, so that eliminated a GSP opportunity. That would have been unnecessary in any event as these articles were classified in tariff numbers that were eligible for duty free entry unconditionally.
Lessons
The first lesson here is that when we embark on one of these engagements we should be prepared to have to tack to a new course. What stated out as a simple assembly abroad review got us into GSP, tariff classification analysis, preparation of a tariff classification database, a re-design of the vendor invoice and ultimately a prior disclosure. Whew! As for the importer, it had missed out an opportunity to make some duty-free entries. On a practical level, protests can only reach back to cover entries made in the past 16 and ½ months. Absent a reconciliation entry,10 any older entries are off the table for the importer. For those entries that might be eligible for GSP claims, the claims must be pursued for each entry. Even acknowledging that protests might cover more than a single entry, that was a major project.In terms of compliance, as noted, the importer needed to protect itself by filing a prior disclosure that extends back over the full five-year statute of limitations. Make no mistake--the importer was serious about its responsibilities. But it was a small company—less than $50 million in annual sales.11 The importer did not have a staff experienced in the intricacies of the customs laws and was heavily dependent upon its broker. The broker obviously earned an “unsat” fitness report.
One final note of risk for small companies must be sounded. Such companies are often dependent on moving product with express (or “integrated”) carriers. One selling point is that the carrier will shoulder most of the burden, including handling all transport of the goods, assigning duty rates and acting as importer of record.
That last point is often a big seller—companies think that if they are not the IOR then they will not be responsible for the customs compliance obligations that go with IOR status. Those companies are wrong. In the case of these express carrier entries, CBP feels that the consignee—our hypothetical small company—is in a position to know more about the shipment and is therefore more responsible for meeting the customs compliance obligations for the entry than the carrier. Beyond that, if the small company seeks to retrieve the entry documents in order to perfect a post-entry claim for a refund, the documents are typically not accessible. In my experience, this has been the case in some instances when they were only 3-6 months old.
Is there a solution? Perhaps the best—or indeed only--solution is that small companies should recognize that they cannot effectively, or at least easily, outsource this function. They will need to grasp the nettle by assigning some internal resources as well as carefully vetting the credentials and track record of brokers and other outside service providers. Once those outside resources are hired, the internal staffers will have to manage the relationship, i.e., will have to closely review the performance by the service providers. If not, surprises await.
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1. 19 USC § 1484 (duty of reasonable care imposed on importers of record (IORs)).
2. For the twin challenges of savings/compliance on imports, see Neville, “Good news/bad news grab bag,” 25 JOIT 29 (July 2014).
3. Item no. 9802.0080, Harmonized Tariff Schedule of the United States (HTSUS). See, Neville, “Trade Court: Importers are free to hire latter-day Michelangelos,” 24 JOIT 25 (Aug. 2013). Our non-US friends will recognize this as an “outward processing relief” program.
4. 19 CFR §§ 10.11-26.
5. 19 USC §§ 2461-2467, 19 CFR §§ 10.171-178.
6. Many other developed countries extend their own GSP benefits to developing countries.
7. For more information on GSP, see Neville (ed.), International Trade Laws of the United States: Statutes and Strategies, chapter 7..
8. See ruling nos. 555881 (5/16/91) and 560747 (1/16/98).
9. CBP recently changed its practice which had not allowed the filing of protests for GSP and other benefits that had not been claimed at entry.
10. Reconciliation is a voluntary program by which the importer is able to keep the entry open and delay liquidation under certain circumstances. See Neville, “Customs Treatment of Price Reductions,” 22 JOIT 17 (Dec. 2011).
11. Perhaps its relatively low profile was the reason why it had not come to the attention of CBP.
2. For the twin challenges of savings/compliance on imports, see Neville, “Good news/bad news grab bag,” 25 JOIT 29 (July 2014).
3. Item no. 9802.0080, Harmonized Tariff Schedule of the United States (HTSUS). See, Neville, “Trade Court: Importers are free to hire latter-day Michelangelos,” 24 JOIT 25 (Aug. 2013). Our non-US friends will recognize this as an “outward processing relief” program.
4. 19 CFR §§ 10.11-26.
5. 19 USC §§ 2461-2467, 19 CFR §§ 10.171-178.
6. Many other developed countries extend their own GSP benefits to developing countries.
7. For more information on GSP, see Neville (ed.), International Trade Laws of the United States: Statutes and Strategies, chapter 7..
8. See ruling nos. 555881 (5/16/91) and 560747 (1/16/98).
9. CBP recently changed its practice which had not allowed the filing of protests for GSP and other benefits that had not been claimed at entry.
10. Reconciliation is a voluntary program by which the importer is able to keep the entry open and delay liquidation under certain circumstances. See Neville, “Customs Treatment of Price Reductions,” 22 JOIT 17 (Dec. 2011).
11. Perhaps its relatively low profile was the reason why it had not come to the attention of CBP.
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.