China to Impose Trade Measures on USA as a Result of Section 301 Investigation

Dear Friends,

As expected, China has announced that it intends to impose 25% additional duties on $50 billion worth of U.S. imports in response to the threat of the U.S. imposing 25% duties on Chinese imports as a result of the section 301 investigation. 

The list includes 106 categories of U.S. products, from agricultural products (e.g., soybeans, wheat, corn, beef, etc.) to chemicals to aircraft and autos.  These duties are in addition to the additional duties China threatened to impose on U.S. products last week in response to the additional duties the U.S. has imposed on steel and aluminum under section 232.

While the trade war is escalating (and all companies should be planning accordingly), the ‘goods news’ is that this latest of round of duties do not go into effect immediately.  Instead, there will be a process in the United States that will take time, and it appears that China may not impose its duties until after the U.S. duties go into effect.  This gives the two governments a chance to reach a negotiated settlement of the underlying concerns.  That said, until such a settlement is reached (which is not likely in the short term), companies should be taking appropriate action to prepare.

We hope this is helpful.  If you have any questions about how these developments impact your business (here or in China), please let us know.

Best regards,

Ted

 

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Interesting First Sale Ruling

Dear Friends,

We wanted to make sure you saw a U.S. Customs and Border Protection (“CBP”) Headquarters Ruling involving first sale that was just recently published.  Since many companies rely on first sale for meaningful duty savings, this ruling should be of interest to you.

First Sale Recap

As you know, in certain multi-tiered transactions (for example, involving a factory, a middleman and a U.S. purchaser/importer), the “first sale” principle of customs valuation allows the importer to declare as the customs value the price the middleman pays to the factory, rather than the price the importer pays to the middleman.  A first sale is viable for customs purposes three conditions are satisfied:  (1) it is a bona fide sale; (2) the merchandise is clearly destined to the United States at the time of the sale; and (3) it is an arm’s length price.  It is this third requirement that can the most difficult to satisfy, particularly where the factory and the middleman are related parties.  

The Ruling (HQ H272520)

This ruling focused on the arm’s length requirement for the first sale.  If an importer wants to use a related party price as the customs value, the importer must be able to establish that the parties’ relationship did not influence the price.  There are a few established ways for an importer to accomplish this, but the most common way is using what CBP refers to as the “all costs plus a profit” test, which is derived from an interpretive note in the CBP regulations.

Succinctly, the “all costs plus a profit” test involves comparing the profitability of a factory (usually a subsidiary of the middleman) with that of middleman (usually the parent of the factory).  In such a case, CBP would take the view that the factory’s profit margin must be equal to, or greater than, the profit margin earned by the middleman in order to be considered to be arm’s length.

In this ruling, the outcome of the “all costs plus a profit” test was different in different years.  In some years, the test was satisfied (so first sale was deemed viable for entries from those years).  In another year, the factory did not have a profit equal to, or greater than its parent company, so first sale was not allowed.

Key Takeaways

There are two key takeaways from this ruling:

First, this ruling was issued in response to a request for internal advice from the Port of Los Angeles after the port issued a CBP Form 28 Request for Information to an importer.  This is significant because it shows that CBP at the port/CEE level is questioning first sale.  All importers who utilize first sale should be thinking of these issues and be ready to respond.

Second, companies that are relying on first sale as a duty savings strategy need to be focused on whether they have objective evidence that related-party first sales qualify as arm’s length sales.  If a factory covers its costs and earns a profit, that is some indication that the factory’s sales are at arm’s length, but it may not be sufficient to satisfy the “all costs plus a profit” test, as this ruling demonstrates.  Companies should ensure that they have performed adequate diligence of this issue before claiming first sale.

To that end, just because a factory’s profit isn’t high enough to satisfy the “all costs plus a profit” test doesn’t mean that first sale is categorically unavailable.  Under the statute, a related party first sale can be a valid customs value if the circumstances of sale indicate that the relationship did not influence the price.  As this ruling indicates, this is a question to be proved, not assumed.  Working in conjunction with our in-house team of economists, we have developed secondary economic analyses that are useful in precisely these circumstances—establishing economically sound, empirical data which support the conclusion that the sale between a related factory and middleman is arm’s length. 

We have produced these economic analyses for various clients, and would be happy to discuss these, or any other first sale issues with you further.  If such a discussion would be helpful, just let us know.

Best regards,

Ted

Interesting Design Services/Assist Ruling

Dear Friends,

U.S. Customs and Border Protection (“CBP”) recently issued a ruling on a common customs valuation issue for the consumer goods/retail industry that we wanted to make sure you saw.  The ruling, Headquarters Ruling H287490, involved foreign product design services and whether such costs are to be included in the dutiable value of the goods those design services were indirectly used to produce.

In the ruling, the prospective importer, a U.S. apparel company, entered into agreements with unrelated designers in the Netherlands for services related to the creation of a new line of sleepwear.  Pursuant to these agreements, the designers would create an initial design package (concepts, patterns, color palettes, sketches, trims) and provide input on concept and marketing samples.  The importer will use the initial design package to create a technical package (“tech pack”) of garment patterns, bills of materials, size specifications and concept samples that it will then provide free of charge to an unrelated manufacturer in China for use in the production of market samples.  Using input from the designers, the importer will modify the market samples and send the modifications to the Chinese manufacturer for final production of the sleepwear garments.

In analyzing whether the foreign design fees are assists that should be added to the price actually paid or payable , CBP examined whether the design work is “necessary for production of the imported merchandise.”  CBP explained that design work necessary to production “does not merely convey a general concept as to what [ ] should be created, but instead imparts detailed instructions as to how [it] is to be created ….”  Citing its own precedent, CBP contrasted design work lacking in detail necessary for production (e.g., preliminary sketches) with more detailed plans, such as bills of materials and samples that a producer relies on for guidance when manufacturing.

Since the tech packs provided by the importer to the Chinese manufacturer include detailed plans, CBP concluded it is an assist within the meaning of 19 U.S.C. § 1401a(1)(A).  CBP then examined whether the foreign design work is a “dutiable step” in the production of that assist.  In its analysis, CBP focused on two factors: (1) whether the design activity was undertaken with the knowledge or intent that it would be used to produce the assist, and (2) whether the design activity plays a significant or crucial role in the production of the assist.  Applying these factors, CBP noted that the design activities performed in the Netherlands contribute significantly to the creation of the tech pack provided to Chinese manufacturer by the importer.  The designers generate the overall garment design and specify details such as their color, shape, pattern and material—features that are directly incorporated into the detailed production instructions provided to the manufacturer in the tech pack.  Moreover, CBP concluded that the designers are fully aware of the fact that their contributions will influence the instructions provided to the manufacturers since they will expect to review, and provide input on, both the concept samples and market samples.  For these reasons, CBP ruled that the designers’ fees must be included in the value of the assist.

This is an important reminder for all companies that provide U.S.-developed tech packs to foreign manufacturers for use in the production of articles imported into the United States.  If you do so, you should be asking whether the tech packs are based (in whole or in part) on design services provided by anyone outside of the United States – whether a design services company or a buying agent (since it Is common for buying agents to provide some level of design input/services).  If so, the extent of those services should be reviewed in light of the guidance provided in Headquarters Ruling H287490.

We hope this is helpful.  If you have any questions about this ruling, or its impact on your business, please let us know.

Best regards,
Ted

Interesting Customs Article

Dear Friends,

We wanted to draw your attention to an interesting piece in Saturday’s New York Times describing a customs compliance issue which blossomed into a worst case scenario.  To be sure, there were plenty of compounding factors in this case which led to such a highly visible outcome, but the underlying customs compliance issues are common.

The core issue here involved inaccurate recordkeeping of articles entered into, and removed from, a customs bonded area in mainland China.  This discrepancy was taken by China Customs as an indication that the company was removing merchandise from the bonded area for sale directly into China without the payment of customs duty, rather than for export.  The company’s position was that the import/export discrepancy was so large (larger than the company’s entire annual global sales) that the only plausible explanation was user error by its personnel operating the recordkeeping software.  China Customs did not agree, and threatened to levy $9.2 million in fines and unpaid customs duties.

This is where the story shifts from merely consequential to newsworthy—with the appearance of a shadowy shell company with government connections, promising to help make the customs liability disappear, for a fee.  The article spins quite a tale from there and is worth a read.

While this is an extreme case, the result could have been avoided (or at least minimized) with robust internal customs compliance controls (i.e., if there was no major recordkeeping discrepancy there would be no major potential liability and, therefore, no need for a shadowy “fixer”).  One of the key takeaways is that all companies engaged in meaningful import/export activity need to have documented internal controls over the activity and need to periodically test those controls to make sure they are working effectively.

If you have any questions about your import/export controls in any jurisdiction, please let us know.

Best regards,

Ted

Customs Valuation Implications of Year End Transfer Price Adjustments

Dear Friends:

Just a quick reminder for those of you working at multinational companies which operate on a calendar year basis – do not forget to ask your tax colleagues whether any retroactive transfer pricing adjustments were made at, or before, year end.

If such adjustments were made (whether upward or downward), please be sure to consider the customs valuation implications here in the United States and elsewhere.  The failure to declare upward transfer pricing adjustments is becoming an increasingly common enforcement issue in many jurisdictions (largely because the issue is so easy to identify and often involves significant amounts/penalties); whereas downward adjustments could lead to a refund of customs duties, taxes and fees in some jurisdictions (including the US, the EU and, based on some recent developments, now Canada).  A quick note to your tax colleagues now could save a potential headache down the line.

As part of our customs compliance assessment process, we have developed a questionnaire tailored to these issues for sending to your in-house tax colleagues.  If you think the questionnaire would be helpful to you, just let me know.

Best regards,

Ted