The increasing globalization of company sourcing and production structures has created new challenges that corporate counsel must consider and address. Because these issues are esoteric and often unknown outside a company's logistics and sourcing departments where they first arise, many good corporate counsel have faced unpleasant surprises shortly after their companies expand abroad or acquire a company with transnational operations.
Fortunately, a corporate counsel who is poised to address the potential pitfalls can steer his or her company toward increased compliance and significant savings.
Below is a brief summary highlighting some of the most important customs and trade issues of which corporate counsel should be aware.
Tariff classification is the categorization of imported merchandise within the Harmonized Tariff Schedule (HTS), an internationally-agreed nomenclature, which contains over 5,000 article descriptions.The tariff classification of a product determines its duty rate when imported into countries around the world. It also determines the applicability of: special duty reduction or exemption programs, such as the Generalized System of Preferences and free trade agreements such as the NAFTA; certain punitive tariffs (e.g., punitive duties levied as a result of the U.S.-E.U. dispute over U.S. foreign sales corporations); special duties (such as antidumping or countervailing); and import restraints, that may limit the quantity of merchandise that can be imported, or foreclose such imports entirely.
Incorrect classifications may create hidden liabilities that can surface in an audit by customs authorities. Therefore, tariff classification review should be part of due diligence whenever a company contemplates the acquisition of an entity with foreign sourcing. It should also be incorporated into a company's regular internal compliance review and reporting processes.
Companies that begin sourcing or operating in multiple jurisdictions often find that inconsistent classifications by customs authorities can make planning difficult, decrease cost efficiency and increase potential liability for improper classification. However, a company can avoid these difficulties, and in fact minimize the cost of foreign sourcing, by proactively reviewing: a) the relative tariff levels for the company's products in countries where it sells; b) the relative tariff levels for component materials in countries where it produces; c) the countries into which it is likely to expand in terms of sales and production; and d) the production structures of its competitors, so that efforts to obtain favorable treatment for its products do not give a disproportionate advantage to the competition.
Most companies know that they must declare the value of merchandise at the time of importation, as duties and taxes are often assessed as a percentage of this value. However, some may be surprised by the costs that must be included in the calculation, which is relevant for VAT purposes as well.
Customs value is generally defined as the price paid or payable for the imported merchandise, excluding international freight. However, customs laws require certain additions to declared value, such as the cost of "assists," which are articles (e.g., materials, machinery or tools) that the importer provides to the manufacturer of the merchandise either free or at a reduced price. The rationale is that, had the assist not been provided, the manufacturer would have to obtain it elsewhere and the added cost would be reflected in the price.
In addition, any payments made to the seller, or a party related to the seller, are often assumed to be part of dutiable customs value unless a company's documents clearly show that the payments are not related to the production or the supply of the purchased goods or materials. Management fees paid to a parent company, and royalties can become hidden liabilities if not handled correctly, as can fees for shared research and development or design costs and commissions. Conversely, the high value of software can often be excluded from dutiable value by the savvy company.
Transaction structure planning can enable a company to exclude many large costs from value. For example, many jurisdictions, including the U.S., permit the use of a "middleman" sales structure, e.g., involving a manufacturer, middleman and importer, in which the declared value is based on the lower-priced sale from the manufacturer to the middleman, provided that certain conditions are met. Companies may also locate high costs such as royalty and warranty expenses in a related middleman to avoid duty.
Transfer pricing between related parties is viewed more closely by customs authorities than prices between unrelated parties. When properly presented, customs authorities will generally accept the amount paid for the merchandise as the dutiable value if the parties can demonstrate that their relationship did not influence the price of the merchandise. Otherwise, they will calculate dutiable value by more onerous methods, including constructing a value by deducting costs back from domestic sales in the U.S. or computing a value by adding all component and processing costs plus overhead and a "reasonable" amount for profit. Because few countries outside the U.S. publish decisions on these issues, U.S. precedent can often be persuasive when dealing with exports to other countries.
Corporate counsel should also be aware of the relationship between the value declared to U.S. Customs and Border Protection and the inventory cost or basis declared to the IRS for tax purposes. That basis cannot be greater that the value declared to Customs (taking into account certain permissible rebate adjustments as well as any amounts properly excluded from customs value such as international freight and insurance). The problem, of course, is that a tax-conscious importer will do everything it legally can to both: a) reduce customs value so as to reduce customs duty and overall cost and b) maximize inventory cost so as to reduce taxable income, without necessarily realizing the interrelationship between the laws. In one famous case, a company was audited by both the IRS and Customs and was not permitted to reach a settlement with the two agencies on a single value that would suffice for both dutiable value and inventory purposes, but rather was required to decrease its basis for tax purposes while increasing declared customs value on the same transaction. Fortunately, this problem can be avoided entirely when addressed proactively.
Preferential Duty Regimes
In the past few years, the United States has been actively increasing the number of countries with which it conducts trade based on free trade agreements or other preferential duty mechanisms. These countries include Canada, Mexico, Israel, Jordan, Singapore, Chile, Australia and countries of sub-Saharan Africa. Additional agreements with certain Middle-Eastern and Central and Latin American countries are being negotiated. Likewise, the E.U., Australia, the ASEAN nations also have preferential trading regimes with certain countries.
Careful review of these regimes can enable a company to optimize the benefits of global sourcing structures. U.S. companies may want to take advantage of these regimes by sourcing from or establishing manufacturing operations in the beneficiary countries.
These agreements are complex legal instruments and corporate counsel should be familiar with their basic structures to ensure that their company can reap maximum benefits, without incurring liability for improper claims. Among the most important aspects are the so-called rules of origin, which are product-specific, and can be quite intricate. These determine whether a good is originating from the territory of a party to an agreement and is thus eligible for preferential treatment. FTAs also require exporting companies to maintain detailed records to demonstrate that their products qualify for preferential treatment and for importing companies to conduct due diligence before relying on the claims of their suppliers.
An important preferential duty program is the U.S. Generalized System of Preferences (GSP), a program designed to promote economic growth in the developing world. The GSP program provides preferential duty-free entry for more than 4,000 products from over 100 designated beneficiary countries and territories. GSP eligibility is based primarily on per capita GDP and is designed for "developing countries." However, counsel should track current status of countries carefully. Notwithstanding its relatively low per capita GDP, imports from China are not eligible for GSP status, whereas countries and products may be added for certain reasons, such as tsunami relief. In addition to HTS classifications which are already eligible for GSP treatment, it may be possible for companies sourcing inputs from developing nations to persuade the U.S. Government to add their product to the list of items that can come into the United States duty free under the GSP program. However, some "import sensitive" products such as textiles, shoes and most steel products generally are not eligible for GSP treatment.
Corporate counsel should be aware of both the significant potential cost savings of sourcing in GSP-eligible countries and of the tracking and recordkeeping requirements to confirm that goods meet the percent local value content requirements for eligibility. Many companies get into trouble due to insufficiently detailed or supported local value content calculations, which are discovered only during a Customs audit of a shipment or of the company as a whole.
Country Of Origin
Most countries, including the U.S. and countries in the EU, require that certain imported goods must be marked with the country of origin. In the U.S., failure to label most imported goods properly with country of origin can result in significant liability, including marking penalties and "liquidated damages" equal to the value of the imported goods, if errors cannot be corrected within certain timeframes.
In addition, based on origin, goods from particular countries may be subject to either preferential treatment (such as GSP or FTA eligibility), disadvantageous treatment (such as antidumping or countervailing duties) or outright embargoes.
In the U.S., the rule for determining the country of origin of goods partially manufactured in more than one country is generally that the country of origin is the last country where the good was "substantially transformed" into a "new and different article of commerce." This rule is very subjective and the outcome varies based on the product at issue and the number and type of processes performed in each country.
However, the rules for determining origin are not yet internationally harmonized. For example, under U.S. law, companies that perform primary manufacturing in the U.S. often need not label imported components or finished goods with the country of origin at all. However, the U.S. will not allow goods that were primarily made in the U.S. to be affirmatively labeled "Made in the U.S.A." unless "all or virtually all" of the components are U.S.-origin and the processing was performed in the U.S. These very same goods, when exported to other countries often must be labeled as made in the U.S. in order to satisfy local labeling requirements. Due to the inconsistent rules for determining origin and for labelling, and the potential penalties involved, proactive planning is essential.
American Goods Sent Abroad And Returned
One way for companies to save on operating costs is to shift labor-intensive operations, such as assembly, abroad. A proactive company that exports U.S.-made components to be assembled often may deduct the value of the components from the value of the complete article, once it is imported into the United States, provided that certain records are generated and maintained as a part of the operation.
U.S. companies may also export articles to be repaired in foreign countries. Upon return, only the value of the repair may be dutiable if proper procedures are met.
Amy J. Johannesen is a Partner in the Global Customs and International Trade Practice of Coudert Brothers LLP in the firm's New York office. Predrag Rogic is an Associate in the New York office.