As of February 2020, we are going through a friendlier phase of the trade war between China and the US as things seem to be improving between both countries. These developments are almost always a talking point in every corporate meeting as many decisions concerning growth and financial projections of companies doing business in or with either of these countries is impacted by the trade war. While companies always try to mitigate any negative effects of the imposed tariffs, most hope that such tariffs will be eliminated altogether in a trade deal.
As it stands now, companies have to work with whatever cards they are dealt. That means molding their businesses and reshaping their supply chains to cater to the possibility of increasing tariffs. Many companies that enjoyed minimal tariffs or special tariffs are especially hard hit as they scramble to adjust to the higher tariffs. Dealing with the high level of uncertainty in itself presents a major challenge to businesses all over the world.
Tariff wars happen when one country starts charging higher taxes on imports from another country and the other country reciprocates with a similar retaliatory tariff hike. The purpose of such an exercise is to make exports more expensive for the importing country, in theory encouraging the buyers in these countries to look for alternative suppliers either locally or from other foreign countries not involved in the trade war.
What are Import Tariffs?
These are taxes or “duties” that are imposed on products imported from other countries. The importer has to pay these tariffs. In most cases, however, importers include the tariffs as part of the imported cost of goods and this increase in price is passed on to the consumer. Targeted increase in duties for specific products is achieved easily as most countries determine duty rates by referring to the HS code of a product.
Import tariffs can vary depending on the category or type of goods being imported. In some cases, the tariffs are calculated according to the number of units of a product imported. In other cases, they can be calculated as a percentage of the transaction value or the declared value. The size of the imposed tariff also depends on the country that exported the goods. Friendly countries will mostly have trade facilitation agreements in place that allow lower tariffs to encourage trade between the two countries.
The importer has to pay these tariffs. In most cases, however, importers include the tariffs as part of the imported cost of goods and this increase in price is passed on to the consumer.
Strategic Tariff Planning
When political issues get heated up between two countries, tariff wars can happen. Businesses need to assess the risks that such hostile situations bring and eventually mitigate those risks. Here are some ways companies in the US can mitigate the effect of trade wars.
Planning the Country of origin
As mentioned above, the size of the import tariffs also depends on the country the goods are being imported from. In the case of China, the US government recently increased tariffs on certain categories of goods. This increased the total cost of goods for these companies and in order to reduce this effect, some companies tried to alter their supply chain in a way that the finished product was made in a different country, resulting in the goods not being considered to have China origin.
It must be noted that the CBP (U.S. Customs and Border Protection) requires that if the country of origin is given as the country where the final product was created, then a “substantial transformation” needs to have taken place in that country. For instance, if some raw material was used to create intermediate components in country A, and those intermediate components were assembled to create the final product in country B, then a substantial transformation needs to have occurred before country B can be accepted as the country of origin. If, however, the final product is only painted in the final country, then that country cannot be considered as the country of origin. If it was, companies would conveniently move their product through a different country claiming a small change in the final product and hence bypass tariffs.
Assessing Tariff Classification
In order to find out what tariff rate applies to your goods, or what category they are classified in, you can refer to the HTSUS, which is the Harmonized Tariff Schedule of the United States. Importers need to carefully consider what category they classify their products in. As was the case above in determining the country of origin, a single component or function can alter the final category the product is classified in. Determining the correct HS code is a complex process and needs to be done carefully as false classifications can have serious implications for the importer.
Requesting an Exclusion from Tariffs
A company can always attempt to apply for exemption from tariffs imposed by the government. When Trump imposed sanctions on China during the trade war, affected companies were allowed to ask for exclusion from those tariffs. These requests are sent to the USTR (U.S. Trade Representative). The USTR receives hundreds of such requests, some of which are accepted and some are denied.
The USTR uses the following criteria in determining whether an application should be approved or rejected.
- Do the imposed tariffs threaten the economic health of the firm or the country?
- Is the item being imported obtainable in the US? Or available in any country other than China?
- Is the item being imported an important component of the ‘Made in China 2025’ campaign or any other similar Chinese policy?
Any exclusion gained in this way is valid for a year. Importers can also apply retroactively for a refund of the tariffs they paid on excluded goods.
Eliminating or Deferring Tariffs (Free Trade Zones and Bonded Warehouses)
Companies manufacturing or distributing goods inside the US can get some relief from tariffs with the help of Free Trade Zones (FTZs) or Bonded Warehouses. A bonded facility refers to a secured area where a product can be stored and used for different purposes, without the need for paying the import taxes on it for up to 5 years. FTZs provide similar protection and goods are often stored or assembled in Free Trade Zones to make use of this relief from tariffs. Companies that consume the product within these zones or areas or export them directly to other countries can save a lot of money that would otherwise have gone to import tariffs.
Recovering Tariffs in the Form of Duty Drawback
Companies can recover a large part of the tariffs using what is called a duty drawback. Here, companies can reclaim any fees paid in the form of import duties by destroying the imported product, exporting it to other countries, or using them in manufacturing processes that are used for manufacturing products for export.
The trade war between the US and China made duty drawbacks really attractive for companies. Changes made to the Trade Facilitation and Trade Enforcement Act recently have also made it easier for companies to reclaim these costs.
While it is true that duty drawbacks require a very complex and cumbersome process, the fact that they can help in recovering nearly all the tariffs paid on the goods makes it worth the time and effort.
Reducing Tariffs by Removing Non-dutiable Charges
The tariffs are usually calculated based on the transaction value of the goods. There are many methods that are used to obtain the transaction value and most involve the use of the invoice price. In most cases, however, the invoice price includes costs that are exempt from duty. If that is the case, such costs can be removed from the transaction value. This results in lower tariffs that need to be paid on the goods.
Here are some examples of costs that are non-dutiable and can, therefore, be removed from the transaction value:
- Interest payments
- Handling fees at the terminal
- Inspection fees at Customs
- Other taxes and prepaid duties
- Late fees
- Inspection fees, in case they were paid to a third party
- Shipping document fees
- International freight
- Costs incurred after importation(assembling, construction, etc.)
- Port fees
- Container fees
- Courier fees
- Fees for export declaration at customs
- Bank fees
Reducing Tariffs using the First Sale Principle
In order to bring down the transaction value of the imported goods, companies can also use the “First Sale for Export” principle. As the transaction value is reduced, the applicable duty on it also comes down, saving the company some money. This can be done in the following way – The company declares an earlier sale of the product, which happened between the producer and a middleman. This declared value removes the profit of the middleman as well as a few other costs like freight recovery costs. This leaves the company with a lower dutiable value for the goods, resulting in a lower duty payable.
Recovering Tariffs using Transfer Pricing
Income tax and tariffs are related to each other and one often has an impact on the other. Transfer prices that are agreed upon by two parties for the purpose of income tax are sometimes put forward as the Customs value of the goods as well. In this way, the transfer price forms the bases on the payable duties.
After the importation, the transfer price needs to be adjusted in most cases. This happens, for example, when the profitability doesn’t fall within the arm’s length range that was established for the purpose of income tax. Such changes or adjustments are usually needed when determining the customs value of the goods. In some cases, the adjustment reduces the transfer price making the importer eligible for refunds. Such refunds are judged against the 5-factor criteria for eligibility.
The 5-factor Criteria
Refunds on duty already paid are only approved if they fulfill the following criteria:
- A determination policy for transfer pricing between the two parties was already in existence and effective before the importation took place.
- A US taxpayer company that imports products into the US makes use of its transfer pricing policy when filing its income tax return. Moreover, adjustments made under this policy are then reflected in the income tax returns.
- The policy needs to state clearly how the adjustments and transfer price calculations are made.
- All the claimed adjustments in the US are recorded and maintained by the company in its accounting practices.
- There are no other circumstances that can have an impact on the CBP accepting the transfer price.
As long as these things are fulfilled and it can be proven that the association or relationship of the two companies was not a factor in the pricing, the CBP will possibly allow the companies to obtain refunds and recover a part of the money they paid in duties.