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Slaying Customs Myths

Mark K. Neville, Jr.

As with most anything that has been around for some time, certain commonly held beliefs achieve such a wide following that they attain almost mythical status. What makes them myths is that they are statements that are held to be true but, in reality, are not. In some instances, they reflect what believers would like to be true. Arguably, the best way to deal with myths, whether creatures or statements, is to confront them. As Saint George prepared for his meeting with his mythical dragon, let us gird and arm ourselves and sally forth.

No Duties Means No Worries

This old myth arises from the misguided belief that customs officers are interested only in revenues, and if imported goods are duty free, they do not care, and if they do not care, neither should the importer. First, some goods are unconditionally duty free and others are only conditionally duty free. The first category covers such product sectors as toys, furniture, civil aircraft, and pharmaceuticals. The second covers goods the importation of which attracts no duty because of their origin or their qualifications for special tariff programs, such as free trade agreements (FTAs) or the Generalized System of Preferences (GSP), or because of the circumstances surrounding their importation, such as goods under bond in a free trade zone (FTZ) or a customs bonded warehouse, or under a temporary importation bond (TIB). In every one of these circumstances, the customs officers are intensely interested in the entry. For example, U.S. Customs and Border Protection (CBP) has long counted pharmaceuticals as one of its priority compliance initiatives, even though they are duty free.

One reason is that customs authorities always have an abiding interest in ensuring that they collect the appropriate trade statistical data, and false or missing data will put that effort at risk. Another motivation is that the customs authorities are not complacent about importers lying to them. Regardless of the motivation, the customs authorities want to make sure that the information they receive is correct.

A final point is that imported goods may or not be duty free, and their status must be determined and confirmed before the issue is settled. For example, how many rulings and court cases have involved whether an imported article is a duty-free toy or classifiable in another tariff provision that carries a duty? Given the practice of post-entry verification of duty-free status by customs officers through audit or a directed inquiry by means of a request for information, it is a mistake for importers to conclude that their entry of the goods will be the final word on the subject. Duty-free status cannot be presumed, and an unjustified claim for that status would lead to a gross error. In addition, the penalty levels for violations that do not cause revenue loss can actually be higher than those associated with a revenue loss, because in the former instance they are a function of the dutiable value rather than of the duties owed.¹

My Broker Does it All

The idea that a customs broker will "take care of everything" is another myth. First, Congress made it clear in the 1993 Customs Modernization Act ("Mod Act") that importers are responsible for exercising reasonable care in the import process. The declarations on tariff classification, valuation, and origin, for example, are made by the importer, and it is the importer who is held accountable.² It is not the broker's responsibility, and if there is a problem with the customs entry, that is the very first thing that the broker will say. One of the first red flags for CBP of an importer's faulty internal control program is when the importer says "My broker takes care of that" in response to a question on audit.

It makes sense to rely on the advice of professionals and other service providers only when they are fully qualified on that specific issue. Who is better suited to advise on a customs valuation issue, which is usually a matter of interpretation of the statute and is informed by a close study of the statute and case law, as well as experienced customs lawyer, who can provide legal guidance and practical advice, or a broker? What about a prior disclosure of a past violation and other endorsement activities-that same experienced lawyer or a customs broker? What about a customs entry issue, perhaps one that goes to the need to secure a bond? Here, brokers have the edge because they deal with surety companies all the time. If there were to be a question of a legal interpretation, a lawyer can assist on that question.

One key is for the importer to control the import process by providing the tariff classification database to the broker and insisting that the broker follow its lead. Only by actively driving the process, and including a broker management element that relies on timely access to the entry documents for post-entry review, can the importer really develop a best-in-class internal control over the import process. It is not possible for a customs broker to know more than (or even as much as) the importer about the importer's business.

Duties Are Not Important, It is All About Income Tax

This is a common misconception among tax professionals, and is like the worker whose only tool is a hammer—all his problems start to look like nails. Certainly a tax advisor for a company in product sectors with high duty rates, such as textiles and apparel, footwear, and luggage, would never make such a statement because some of those duty rates are as high as the effective tax rates. Those duty rates apply to an above-the-line tax—a 5% ad valorem duty on a purchased item cannot be dismissed out of hand because it is less than a 35% income tax. In the same way that many tax professionals came to acknowledge the importance of state and local taxes (SALT), including sales and use taxes, beginning in the mid-1990s, so too should tax professionals recognize that duties are another, and equally important, indirect tax.

Experienced tax advisors who are participating in an expansion of businesses into the BRICS (Brazil, Russia, India, China, South Africa) and other emerging markets also know that the real pinch is from the imposition of duties and a multilayered array of indirect taxes, not from income taxes. A total border tax impact of 60% or more, which is common in many of these new markets, will influence a business entity as quickly as any income tax.³

Managing Imports Is a Logistics or Transportation Function

One of the striking points about advising importers is the variety of ways that they manage the import process. Except for the high-tech sector, where this has traditionally been a tax function, many companies have placed the customs compliance function within transportation or logistics. There is a certain logic to this. If the goods are held up by Customs at the border, the transportation or logistics department is charged with the responsibility of getting their release. But the transportation department's goal is to move product from point A to point B, and speed and cost are the two principal meas ures used. Compliance, as in getting the move done "right," is not a typical measure. In fact, there is a certain tension between moving goods quickly and nailing the compliance tasks.

Many importers are starting to recognize that the process of importing cuts across several disciplines, and there are many instances in which the group responsible for imports reports up to the legal department, tax, or both. An argument for the former could be made because the process of importing requires compliance with many laws and regulations, and for the latter because duties are an indirect tax and an audit by CBP will look and sound very much like an IRS audit. So, while managing imports may be a logistics or transportation function, it is better to place primary responsibility with one of the other departments named.

Duties Are a Fixed Cost—the Only Issue Is How to Pass It Along to Customers

This myth gives rise to an utterly passive role by the importer, and that air of resignation will certainly make life easier, as there is nothing for the importer to do but write a check. But the reality is that, as an indirect tax, a point made earlier, a customs duty payment is often susceptible to strategic planning to generate savings. The question should always be asked, "Am I paying as much as I should?" In this Goldilocks circumstance, the "just right" answer is that the importer should be paying what is owed, and neither leaving money on the table nor unpaid.

There are a variety of planning opportunities that may be appropriate—from "tariff engineering" a product to ensure tariff classification under a provision with a more favorable duty rate, to customs valuation strategies, such as "unbundling" nondutiable charges, and such "middleman" strategies as a first sale for export ("First Sale" or FSFE) appraisal⁴ or use of a buying agent, to relying on an FTA or GSP, as noted above.

Consideration should also be given to the use of bonded facilities, such as FTZs or customs bonded warehouses. Refunds of duties are also available through duty drawback for imported goods that are later exported. These are but a few of the planning options that might provide a benefit to the importer.

The key is for the importer to seize and retain the initiative. Admittedly, that takes some work, but consider the competitive advantage gained by an importer who takes full advantage of its planning. opportunities. To be sure, it may be that there are few or no planning opportunities, but the question must always be asked and all of the options analyzed before reaching that conclusion.

First Sale Is a Snap" or "First Sale is a Waste of Time”

These polar opposite myths are both alive and well. For those who are "selling" First Sale, the program is a walk in the park for the importer with lots of "found money" to be had for the asking. The naysayers' perspective is that First Sale appraisement is never a worthwhile project, and is always a waste of time and energy.

Each of these positions reflects a mythical status and neither is true. The truth is in the middle. First Sale can provide a significant planning opportunity, but the importer must be prepared to show a complete audit trail and to answer all relevant questions by CBP along the way.

Compliance Can Be Put Off Until Tomorrow

Those who have provided professional advice to importers, exporters, and tax payers know well how difficult it is to "sell" compliance. It is seen as a true "cost," and many importers and taxpayers are willing to wait until the proverbial wolf is at the door—or actually chasing them down the hall—before they take it seriously. The basic error is the view that making sure compliance is in place is discretionary. But compliance with the import or export process is no more discretionary than dealing with the IRS. The error stems from a failure to see the parity between IRC Section 6662 (accuracy-related penalty on underpayments) and the similar federal law provisions governing import and export compliance.

In reality, a compliant company is actually a better-managed company, with better internal controls, visibility, and responsiveness, and a highly compliant company can run rings around a more lax competitor. For example, the lax importer with goods held at the border will often lose vital days due to this kink in the supply chain, while the compliant importer's goods sail through. With regard to compliance, the importer or exporter cannot control the outcome but at least it will have the benefit of having done all that it should. At a minimum, that effort will be tor if there has been a lapse.

All Advisors Are Created Equal

In this myth, obtaining advice from professional advisors is no different from buying floor wax. Indeed, in some companies the process is driven by Purchasing. People in that department cannot determine the credentials of prospective service providers on anything other than a straight cost basis, so the floor wax analogy is apt.

But the reality is that the Declaration of Independence does not apply. In fact, all customs lawyers, brokers, or international tax or transfer pricing professionals are not created equal. Some are better than others. It is less an issue in international tax, where many of those who have in-house responsibilities have professional backgrounds that are virtually identical with those of the outside advisors. The problem is much more acute in customs and trade, where the issues tend to be so narrow that many of those in house cannot gauge the credentials of the experts or even identify or fully recognize the narrowness of the issue in the first place. In this space of the importer or the exporter "not knowing what they don't know," the less qualified outside advisor may be selected. A customs broker may be engaged to file a prior disclosure, for instance.

I’ll Deal With Customs After I Finish With My Tax Issue

This myth also has an identical twin—I'll deal with tax after I finish with my customs issue." Both presume that it makes sense to deal with these issues in sequential fashion; they are implicitly founded on more of a hope than a firmly established fact, i.e., that no harm can be caused by this "first one, then the other" plan.

That is false. In a simple example, a common international tax strategy is to go to a limited-risk distributor to justify a low return for that entity. Some tax advisors might actually want to style the distributor an agent. Whether or not there is an affirmative designation as an agent, if CBP or another customs authority were to view the importer/distributor as an agent acting on behalf of a foreign seller, its compensation will become subject to duties. Therefore, setting up the distributor status based only on an income tax analysis will expose the structure to a disadvantageous customs treatment, and the extra customs duties will offset any tax savings.

As an example of the twin myth, establishing part of a purchase price for imported goods as interest may save some customs duties, as interest on a trade payable is nondutiable when established criteria are met, but it could expose the interest payment to withholding tax absent bilateral treaty protection.

Conclusion

All that it takes to dispel these myths is to hold them at a proper distance and look at them in a fresh light. Those actions may require a step outside one's comfort zone, but the exercise is worth the effort. No sword or buckler needed.

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