Failure To Properly Report Product Origin Can Result In Substantial Penalties

Monday, May 1, 2006 - 01:00

You would think that as globalization continues to expand, the identity of the source and origin of the product would be of diminishing interest. Putting consumer preferences or lack of them aside, the U.S. government wants to know where imported goods are made, and what processes are performed in the country of origin. Failure to properly report "origin" can result in substantial liability. Likewise, a U.S. exporter or seller can also run afoul of these origin requirements.

Multiple And Overlapping Origin Requirements

As recent press articles reveal, the United States is party to and is negotiating a number of free trade agreements ("FTA"). These FTA's can offer substantial import duty benefits provided you can properly claim your imported products "originate" in that country. Likewise, U.S. exporters can claim benefits exporting to these countries provided origin can be proven. The programs involve not only lesser developed countries (under the Generalized System of Preferences (GSP)), but major trading partners (Canada and Mexico under the NAFTA) and a host of other countries (Caribbean countries, Singapore, Israel, Jordan, Australia, etc.).

It is interesting to see that even as duty rates continue to decline, competition is so fierce that elimination or reduction of even a small duty rate of 6.5% or less can make the difference between being able to compete in a market. Accordingly, the worst thing that can happen is that the company priced its products planning to enter duty free, only to find out later that they guessed wrong, or they did not maintain the correct records to sustain their duty free claims. The duty or penalty bill from the Government may not only wipe out the expected profit, it may result in a substantial additional liability.

Companies selling to customers in the U.S. and Canada or Mexico can also run afoul of country of origin marking rules. Let us assume that the product made in your U.S. facility qualifies for NAFTA duty free treatment when it is sold into Mexico and Canada, and that you want to mark your product "Made in USA" because that helps to boost sales. While that marking is likely acceptable in Canada and Mexico, the U.S. has a very high standard to be met before a product can qualify for "Made in USA" marking in sales in the U.S. Accordingly, it will be important to know the origin of the U.S. components and the nature of the U.S. processing to make sure you qualify for this marking standard.

Rules of origin are complex and often misunderstood. These rules differ under each program and are not logical, so they cannot be resolved by intuitive reasoning. Many companies operate under a mistaken belief that adding 50% of the value to the product in a country makes that country the origin of the goods, but it's not so easy. Under some FTA rules, origin is determined without regard to the value added. For example, under the NAFTA program, tariff shift rules determine origin. If this test is not met, goods may not qualify for NAFTA treatment even though many of the components were made in the U.S. or Mexico and the goods were assembled in Mexico or even New Mexico. Other programs rely on a more subjective rule called "substantial transformation" which is met when processing in a country creates a new product, with a new name, character, use, or identity. In order to qualify for benefits under programs, like GSP, the goods must be a "product of" a beneficiary developing country (BDC) under the substantial transformation test, and 35% of the dutiable value must be added in the BDC. Most newer programs have very product-specific rules of origin which require detailed knowledge of the components and processes performed in the beneficiary country. Because there are so many specific rules and exceptions to the general rule, it means that a study should be undertaken to confirm your initial opinion in each instance.

In some areas, the origin of the product will determine if it can be imported at all, or if it is subject to punitive duties. Some imported products like textiles from China, and milk and sugar products from most countries are subject to import restrictions such as absolute or tariff rate quotas. It is important to note that Customs frequently questions the country of origin of the products. In these cases it is perfectly legitimate to "design" products ( i.e., structure the transaction and processing) to take advantage of the rules of origin and tariff classification. Products are often redesigned ( i.e., textiles or food preparations) so they can be classified under a provision with lower duty rates and/or no quotas. The elimination of restrictions can also often be accomplished by shifting all or some strategic manufacturing operations to non-quota countries.

Dumping Duties

Antidumping duties - from 2% to 200% - are assessed based on specified products, producers, and countries of origin. The failure to plan for or take part in dumping proceedings often proves to be disastrous, well after the goods have been imported and sold. Suppose the company imported canned mushrooms from Canada, and long after the goods have been sold, Customs issues a duty bill for 148.1% (antidumping duties). Unfortunately, Customs determined these goods were made in China because the processing in Canada was insufficient to render them products of Canada. Now the company is liable for millions of dollars in antidumping duties on sales that at most made a few thousand dollars of profit.

In May 2003, the DOC announced a new reseller policy, effective for goods subject to antidumping duty ("ADD") annual reviews ("AR"). In the past, when an importer purchased goods from a reseller and the actual manufacturer was subject to an ADD, the Department of Commerce ("DOC") normally applied the manufacturer's ADD rate in liquidating the importer's entries, or in certain instances the cash deposit rate ( i.e., no change). As a practical matter, this policy worked to the importer's advantage, since experienced manufacturers normally obtain favorable rates during an AR. As a result of this new policy, however, when an AR is requested for a specific manufacturer, the DOC will only apply the manufacturer's rate to the reseller's shipments in those instances in which the DOC determines that the subject merchandise was destined for the United States on the manufacturer's initial sale. In contrast, if the DOC decides that the manufacturer did not know the destination of the goods on its initial sale, the DOC will apply the normally adverse "all other" rate from the initial ADD investigation to the importer's sales. Importers can avoid these disasters by (1) participating in "AR" to obtain their own ADD rates; (2) restructuring products, or (3) shifting manufacturing operations, to place the products outside the harmful ADD determination.

Buy America

Finally, if the company is selling products to the Government, there is another set of origin rules to consider. Under the Buy America Act (41 U.S.C. 10a -10d) and Trade Agreements Act, ("TAA"19 U.S.C. §2501, et seq .) a supplier under GSA contract must certify that the goods supplied are either U.S.-origin or originate in a Trade Agreement country. While goods from many developing countries qualify for this program, products from countries like China and Taiwan, do not. The restrictions are even more stringent when the sale is under a Defense Department contract. Generally, GSA and DOD contracts are subject to periodic audit, including validation of origin certifications. However, if the company does not know (or cannot document) the origin of the goods, then they have no basis to make a certification.

Penalties

If declarations or conclusions as to origin are wrong, or simply cannot be proven or documented, imported goods can be excluded, seized, recalled by Customs (in some cases up to 210 days after arrival), and subjected to liquidated damages or penalties. Mismarked merchandise is also subject to a 10% marking duty. Improper or false origin can also subject a company to damages under the False Claims Act.

Likewise, False Claims liability arises under Buy America/TAA certifications. In late 2005, three major suppliers of office products agreed to settlements totaling nearly $22 million under the False Claims Act and TAA. The important thing to note, however, is that the allegations that started the investigations were the result of a whistle-blowing competitor. The General Services Administration Office of Inspector General is now actively probing for violations of the Buy America rules in a number of industries.

A false designation of origin or a False Claim Act claim can result in a criminal investigation and penalties. Likewise, false origin may also result in claims under other statutes. Companies can face up to $500,000 in fines per violation or "double" the loss or gain from the violation related to these violations.

Solution

The only solution is to take responsibility for your origin information. A proactive approach of systematically managing the origin of components and products can assure that the company does not create the problems discussed above. On the bright side, the effort invested in this analysis may allow the company to seek out and utilize the benefits available under numerous and growing FTA's and other reduced duty programs.

Robert B. Silverman and David M. Murphy are Partners of Grunfeld, Desiderio, Lebowitz, Silverman & Klestadt LLP. Mr. Silverman practices in the area of customs law and litigation, valuation, classification and international trade regulation. David M. Murphy's practice includes customs law, international business transactions, foreign trade zones, export regulation and international sanctions programs (OFAC).

Please email the authors at rsilverman@gdlsk.com or dmurphy@gdlsk.com with questions about this article.