DUTY REDUCTION STRATEGIES
With duty rates on most commodities well below ten percent for years the costs of many duty reduction plans were not cost effective. Times have changed. With the US embracing sudden and substantial duty increases as a trade strategy the value of duty reduction planning has increased.
Duty applicability is tied, with a few exceptions, to three elements; (1) the classification of the item under the Harmonized Tariff System of the United States (HTSUS), which categorizes items under specific classification code numbers, (2) the Country of Origin, and (3) exceptions or exemptions provided by law. If you make a change in one or more of the elements you may substantially impact your duty costs.
Duty is nearly always a percent of the dutiable value of the goods. If the dutiable value is lower, the net duty paid is lower. For example, if something is valued at $100 with 25% duty the net duty is $25 but if the value of that item can be legally set at $80 then the net duty would be $20, a savings of $5 of duty per item. There are legally accepted methods of reducing the dutiable value.
The stated goal of the additional tariffs is to encourage companies to purchase products produced in the United States which are not subject to duty. For many products that is simply not practical or even possible. Our team has been assisting importers with finding ways to reduce cost and risk since our founding in 1965. Here are some of the duty reduction strategies we found helped our clients.
The HTSUS provides a numerical code (a classification) for items. Some items are directly and specifically described but that is not as common as items that are loosely described. There are historical interpretations of which classification applies in certain cases that have developed from tariff rules, notations, binding rulings, and court decisions.
Duty rates are established by the classification code and the Country of Origin. Sometimes, very minor changes in an item can bring about major changes in the applicable duty. This is referred to as tariff engineering. There is no simple guidebook to tariff engineering as it depends on understanding both the product and the applicable rules/interpretations of the HTSUS. Our team has provided clients with thousands of hours of consultation on tariff engineering. We recommend you consult your customs broker or call our team for assistance with a tariff review.
COUNTRY OF ORIGIN
When a product is wholly made within a single country then determining the Country of Origin is relatively simple. However, when a product is composed of parts and processes in more than one country then it becomes a matter of understanding the rules that define Country of Origin for the product in question. Many successful strategies are built on retaining the lower costs associated with producing a large portion of the product in a country subject to higher duty and transforming that product in a country with a lower duty rate to confer a new Country of Origin legitimately.
For example, take apparel, one of the newest group of items to be added to the additional duty of 25% from China. There are three basic rules conferring Country of Origin on apparel. (1) If the article is completely assembled from two or more components in a single country then it is considered a product of that country. [Beware—partial assembly in China can be a problem.] (2) For garments that are knit to shape then the Country of Origin is where the major parts are knitted or crocheted directly into the shape of the finished product. (3) For some articles the Country of Origin is where the fabric is produced [examples: pillows, cushions, comforters, drapes, curtains, bedspreads, shawls, handkerchiefs, various linens, and scarves to name some]. Utilizing these principles, a change in sourcing materials or some of the process may continue to realize some production savings and reduce duty.
Some forms of assembling can change the Country of Origin. For example, we successfully assisted a company in Asia in reducing duty on televisions sold in the US by shifting assembly of the components to Mexico and utilizing the provisions of NAFTA to bring the finished articles into the US duty-free. The primary cost of producing the televisions was comprised of the production cost of the flat panel and the electronics. These higher value components were produced in Asia and shipped separately to Mexico. We assisted our client in setting up the processes with a Maquiladora. We provided the guidance and services to move the goods from Asia, deliver it to the Maquiladora, ship the product to the US, clear it through customs duty-free, and deliver to the distributors. The product qualified for duty-free treatment despite the fact that the majority of the value of the product was from Asia simply by making a shift of Country of Origin.
The Country of Origin is typically where the product is produced. When an article covered by a specific HTSUS code is produced in one country and then something is done to the product in a second country which changes the HTSUS code applicable to the product then, in most cases, it is considered Substantially transformed in the second country. The principle of Substantial Transformation has been applied many times to retain the low cost of production in one country and then to take advantage of the low duty rate applicable to products from the country of substantial transformation.
The classic example is when a wafer (a flat surface containing several sets of printed circuits) classified as one HTSUS code is manufactured in Country A and is then shipped to Country B where it is cut and mounted onto connectors thus becoming an integrated circuit which is classified as another HTSUS code. The product is then, by substantial transformation, a product of Country B even if most of the value is in the wafer manufactured in Country A.
Here is an example of how this might work. Let us say you have a product that is made up of two major components. Component 1 costs $100, component 2 costs $2, and the production of the finished product costs $10. Currently this production is being done in China for a total cost of $112 and now subject to a 25% duty ($28). If you can ship the components to, let us say, Vietnam for $2 each and the cost of producing the finished product in Vietnam is $13 versus the $10 cost in China, the total cost of producing the item would be $117. In short this is a 4% increase in the cost of the merchandise. However, it is no longer subject to 25% duty on Chinese goods, a savings of $23 per item.
EXEMPTIONS & EXCLUSIONS
The most obvious is to apply under Section 301 for an exemption. Most past applications were rejected. It appears that the rejection rate has increased. Application for an exemption to the tariff is unlikely to be successful.
If you have traveled and purchased items abroad, you may already be familiar with the concept. Customs & Border Protection (CBP) regulations permit a person (company) to enter a limited value of goods each day without payment of duty. In 2016 this was changed from $200 to $800. https://www.cbp.gov/newsroom/national-media-release/de-minimis-value-increases-800
This has benefitted many importers. Let us talk about two strategies that have seen increasing interest.
Third Country Distribution
Some importers who regularly fulfill orders to individual customers of less than $800 per day have shifted distribution from the US to, for example, Canada. They ship product from China to Canada and perform the distribution work in Canada, sending the completed orders directly to customers via courier (common examples are UPS and FedEx) utilizing the de minimis exemption eliminating all duty.
Remember that the place of distribution does not confer Country of Origin. Use of the de minimis rule, however, eliminates all duty on qualifying shipments. The importers simply shifted distribution to Canada in order to connect with speedy delivery via courier services at more competitive prices than shipping directly from China to US customers. Having the inventory closer to the customer can be an advantage in many cases.
Other companies are electing to do the final distribution to end customers directly from the origin. Let us say you currently import containers of product in Los Angeles, hold them at your distribution center (CD) in the US, fulfill orders at the DC, and then ship directly to the customer. An alternative is to hold the goods at a DC in China and ship directly to the customer if the value of each shipment is less than $800. Such shipments are, presently, duty free under De Minimis.
In most cases shipping is more expensive as small consignments for long distances but when a 25% premium is placed on the value of the goods this may make such schema workable.
Duty is paid as a percentage of entered value in most cases. By legally reducing the entered value you reduce the actual net duty paid. Two strategies have received the most attention.
Shipments purchased under the internationally recognized terms of sale (INCOTERM) CFR (what Americans typically refer to as FOB) are subject to duty based on the CFR (say FOB) invoice value.
Let us use an example shipment. For our example goods are produced by an inland factory in Nanjing, China for a cost of $18,000 and shipped to the port of Shanghai for export at a cost of $2,000. The importer then takes possession in Shanghai and pays $2,500 to move the cargo from Shanghai to Los Angeles.
The most common term of sale for US importers is to purchase “FOB Shanghai” in this case. The internationally recognized terms of sale (INCOTERM) refer to this as FCA Shanghai. With FCA (or FOB) Shanghai the seller will charge $20,000 for the shipment which represents their $18,000 price plus the $2,000 to get it to the port of export. When the shipment arrives in the US the duty, for example of 25%, is assessed on the FCA Shanghai price of $20,000. In this case the duty would be $5,000. By changing the INCOTERM, you may be able save duty. How?
If, instead of purchasing FCA Shanghai, you purchased the goods FCA Nanjing, or EXW Nanjing (Ex Works). The seller should invoice you for the goods at $18,000 because they no longer must pay the costs of moving the goods to the port. You will be responsible for the inland cost from Nanjing to Shanghai of roughly $2,000 instead of the factory. Under this term of sale, the freight from Nanjing to Shanghai is not subject to duty. Therefore, you pay duty on $18,000 or $4,500. You would save $500 in duty (because you are not paying $500 duty on $2,000 of inland freight). Your terms of sale and the seller’s commercial invoice would need to be proper to enjoy this savings.
You may be entitled to other legal deductions from the commercial invoice price. Remember that your entered value has a similar relationship to your final duty as adjusted gross income is to total income tax on your federal tax return. Finding legal deductions that lower your entered value will likewise reduce your total duty obligation.
Customs & Border Protection rules permit, under applicable conditions, the valuation of the goods may be based on the price of the first sale, not the sale concluded and invoiced at the time of importation. The concept is simple, but it does rest on a set of complex conditions and limitations. Please speak with your representative for more information.
Ensuring that duty reduction strategies result in success requires careful planning. The devil is in the details. We can help.
Our team has years of experience helping importers reduce risk and cost by assisting them in engineering logistics solutions—including duty saving strategies. If you are studying alternatives it is vital that each detail, from transportation time and cost to the actual process of duty savings, be reviewed. Our team of professionals is anxious to help.