Failure To Substantiate Product Origin Can Result In Problems At The Border

Tuesday, May 1, 2007 - 01:00

All products imported into the United States are required by law to be permanently marked with their country of origin. Additionally, the origin of goods is often a determining factor as to whether they are subject to import restrictions; whether they are eligible for duty free trade programs; or whether they are subject to additional duties. Importers who do not plan to document the origin of their goods may be in for big surprises at the time of Customs clearance, or worse, after the goods are long gone into commerce.

Multiple And Overlapping Origin Requirements

As recent press articles reveal, the United States is party to and negotiating a number of free trade agreements ("FTA"). These FTAs can offer substantial import duty benefits provided importers can substantiate that their products "originate" in a participating country. U.S. exporters can similarly claim benefits exporting to these countries provided U.S. origin can be proven. These agreements 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.).

Interestingly, even as duty rates continue to decline, competition among companies is so fierce that elimination or reduction of even a small duty rate of (6.5% or less) can make the difference between a company being able to compete in or being excluded from a market. Accordingly, one of the worst things that can happen to a company importing goods is planning to enter them duty free, only to find out later that they guessed wrong as to origin, or that they did not maintain the correct records that substantiate their duty free claims. Moreover, the duty or penalty bill from the Government may not only wipe out the expected profit, it may result in a substantial additional liability.

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 just not that easy. Under some FTA rules, origin is determined without regard to the value added. Under other programs like NAFTA, tariff shift rules determine origin. 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 new 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.

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. Customs frequently questions the country of origin of these products. If importers fail to prove the origin of goods subject to quotas, the goods may be excluded, seized or recalled. Unfortunately, this often happens after a company has paid the manufacturers or exporters for the goods. In these cases, not only are customers disappointed and contracts potentially lost, but the importer may not be able to recoup the purchase price of its goods.

In cases where origin is a determining factor for duty free treatment under an FTA, and origin cannot be proven, duty free treatment will be denied. Even worse, Customs can collect back duties, and possibly assess massive civil penalties which will be a multiple of the duties (i.e., 400% in gross negligence cases) that have to be paid to the government.

Importers are legally responsible for the accuracy of the information included in their entries. Filing claims for duty free treatment without knowing that origin of those goods can be substantiated through documentary evidence is taking an unnecessary business risk. In 2007, Customs is intensively scrutinizing entries of goods claimed to be free under FTAs, and it is likely that inquiries will be raised with respect to FTA goods imported by many companies.

Even goods that are imported and then processed or repacked in the U. S. can be the subject of Customs scrutiny. Under the Customs laws unless foreign goods are subjected to substantial processing in the U. S., their origin does not change. Furthermore, importers are charged with making sure that goods are properly marked with foreign origin when they are resold in the U.S. Once again, the failure to properly mark the goods can result in product seizures, and the assessment of penalties, liquidated damages, and marking duties.

Dumping Duties

Antidumping duties - from 2% to 200% - are assessed based on specified products, producers, and countries of origin. The uninformed importer may not be aware that after entry Customs can determine that these goods are products of a dumping country because the processing in a third country did not change origin.

The DOC is enforcing a new reseller policy 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 result of this new policy, 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 AD investigation to the importer's sales. Importers can avoid these disasters by (1) participating in the "AR" to obtain their own rates; (2) restructuring products, or (3) shifting manufacturing operations, to place the products outside the harmful ADD determination.

Penalties

An importer's errors on entries can subject a company to millions of dollars in penalties. If declarations or conclusions as to origin are wrong, or simply can not 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. Mis-marked 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 continues to probe for violations of the Buy America rules.

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 to this problem is to take responsibility for your company's reporting of country of origin information. 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.

A proactive approach of systematically managing the origin of components and products and requiring document production by your manufacturers 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 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.