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

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An Interesting Customs-Related Whistleblower Case

Dear Friends,

We are writing to let you know about a recently unsealed customs-related False Claims Act (“FCA”) case involving low value e-commerce shipments imported under “Section 321” (so-called “de minimis” value shipments that are permitted to enter the United States without entry duty and tax free).  There are a number of details that make this case interesting.

Facts

The original whistleblower complaint was filed by an aggrieved former employee in May 2016.  As is customary, the case remained under seal until the United States decided to join the litigation.  Once the United States entered the case, the complaints were unsealed in July 2017.  While this is only the most recent in a series of False Claims Act (“FCA”) cases involving customs valuation, this is the first known False Claims Act case specifically involving Section 321.

The complaint asserts that the Defendant, a UK-based online retailer of women’s apparel, routinely split individual U.S.-bound orders into shipments that fell below the de minimis threshold for the explicit purpose of avoiding the payment of customs duties.  Under Section 321, shipments below the specified dollar threshold (historically $200, but recently increased to $800) to a single customer on a single day may be entered duty and tax free.  U.S. law expressly forbids the splitting of shipments to get under the dollar threshold.

The complaints include eyebrow-raising allegations— e.g., an excerpt from an employee handbook with detailed instructions on how and why orders were supposed to be split; an alleged conversation among supervisors “boasting” about duty evasion and acknowledging its illegality.  The government’s complaint is too large to attach here.  If you would like to see it, however, just reply to this message and we will send it to you.

Observations

While some of the facts alleged seem to suggest this is a more extreme case, it nevertheless holds important insight for all companies importing into—or even just selling into—the United States.  A few thoughts:

  • Extraterritorial reach of U.S. customs law. This is one of the few cases we are aware of where the government has pursued only a non-U.S. entity for violations of U.S. customs law.  The government’s complaint goes on at length to establish why it has jurisdiction over the Defendant (which counted the United States as its most important market).  This suggests a willingness on the part of the U.S. government to hold entities outside the United States liable for U.S. customs violations.  While the U.S. government has regularly exercised such jurisdiction in other trade contexts, this is rare in the customs context.  In addition, it appears that the U.S. government will have help in this context. The New York Times has an interesting article on this case that focuses on the U.S. law firms that are seeking potential UK and EU whistleblowers for future cases.
  • Risk of high volume, low value shipments.  The case challenges common assumptions about the customs risk associated with selling in the U.S. market.  One common assumption is that high volume, low value shipments present a lower customs risk than larger value commercial shipments, particularly when sent by express courier or U.S. mail, and especially when the seller is not the importer of record into the United States.  This case provides a powerful counterpoint to that line of thinking.  The FCA authorizes the government to collect “treble damages”—that is, three times whatever damages it actually suffered as a result of the false claims. In this case, the potential loss of revenue to the government might be in the single digit millions of dollars, so treble damages is a meaningful sum.  The False Claims Act, however, also authorizes a penalty on a per infraction basis (recently raised to $10,000 per infraction).  This apparently modest FCA penalty provision could prove to have enormous impact in the e-commerce space.  Just a few hundred offending monthly shipments across a 5 year window could easily yield a mandatory penalty in the range of hundreds of millions of dollars.

Recommendations

We have recommended in the past, and wish to reiterate again, the importance of having not only effective internal controls over customs matters, but also an effective avenue for employees to notify company leadership about potential compliance issues (to reduce the feeling that they need to go outside the company to effectuate change).  We have significant experience advising companies on how to test and improve trade-related internal controls in a cost-effective manner and would be happy to discuss that experience with you.

We hope this helpful.  If you have any questions, or would like to discuss these issues further, 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 (assuming they do not send this information to you on their own).  

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 a very 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 Canada).  A quick note to your tax colleagues now could save a potential headache down the line, or put some money back in the company’s pocket. 

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

 

Trump on Trade/NAFTA’s Future – Part II

Dear Friends,

It is being widely reported this afternoon that President Trump is considering imposing a 20% tax on imports from Mexico in order to pay for the border wall (which would mean that U.S. companies/consumers will be paying for the wall, not Mexico. . . ). 

While nothing is imminent, this is a further example of how the rhetoric on renegotiating/withdrawing from NAFTA is being ratcheted-up.  Any company with meaningful investments in Mexico, or that otherwise imports meaningful volumes from Mexico, should be modeling different scenarios and developing contingency plans.  We are assisting numerous clients with this and would be happy to discuss the issues with you further.  If you would like to do so, please let me know.

Best regards,
Ted

Trump on Trade/NAFTA’s Future

Dear Friends,

Earlier today, I had the privilege of speaking at a seminar hosted by my colleagues in Toronto entitled “Trade and Business Strategies for a Post-Globalization World – CETA, Brexit, NAFTA and Preserving Cross Border Data Flows.”  I spoke on a panel entitled “NAFTA’s Prospects and Preserving its Benefits” with colleagues from the US, Canada and Mexico.  I thought that you might find the slides from this panel to be of interest.

If you have any questions about the future of NAFTA, or trade in general, in these interesting times, please let me know.  Also, please check out our “Trump on Trade” webpage for further updates.

Best regards,
Ted

 

Dutiability of Royalties

Dear Friends,

U.S. Customs and Border Protection (CBP) recently published a customs valuation ruling that we thought you might find to be of interest.  The ruling, HQ H233376 (Sept. 19, 2016) involves the dutiability of royalties paid to a licensor unrelated to the importer or the manufacturer of the imported merchandise.  The issue in the ruling was whether the payment of royalties to a third party licensor unrelated to the manufacturer were considered to be a “condition of the sale” of the imported merchandise.

This ruling is worth a quick read, but we have summarized the key facts for your reference below.

The importer entered into an agreement with an unrelated U.S. patent holder to license certain utility patents.  The license covered, among other things, the right to “make, have made, use, sell, offer for sale and import” licensed devices.  The technology covered by the patents was developed in the United States.

The importer also entered into a manufacturing agreement with an unrelated Malaysian manufacturer to have the imported merchandise made.  The agreement authorizes the manufacturer to use the technology disclosed to it by the company to make the imported merchandise.  The importer declared upon importation the price it paid to the manufacturer for the goods.

The importer pays the U.S. patent holder a royalty based on the resale price of the imported merchandise in the United States.

Based on these facts, CBP concluded that (i) the royalty was related to the imported merchandise, and (ii) the importer was required to pay it directly to the licensor.  As a result, the only remaining issue was whether the royalty payments were a “condition of the sale” of the imported merchandise.  This is was particularly important here since the royalties were paid to a licensor who was unrelated to the manufacturer of the imported merchandise (i.e., is a royalty payment to an unrelated third party licensor a condition of the sale of merchandise between two other parties?). 

CBP ultimately adopted what it referred to as a “practical, common sense” approach to this issue and concluded that the royalties were part of the dutiable value of the imported merchandise.  CBP found it relevant that the royalties were for patents, as opposed to trademarks, and that the licensed technology was necessary to produce the imported merchandise. 

The ruling highlights several important points all importers should keep in mind, namely:

(1) royalties paid for patents are more likely to be dutiable under U.S. law than are royalties paid for trademarks, regardless of to whom they are paid (i.e., to the seller or even to a party unrelated to the seller);

(2) the request for internal advice grew out of a Focused Assessment – which demonstrates how closely Regulatory Audit looks at such issues; and

(3) the ruling was issued more than 4 years after the request for internal advice was originally submitted to CBP HQ — which demonstrates how long it takes CBP HQ to issue customs valuation rulings, in particular.

In light of the foregoing, all importers should confirm internally whether any royalties or licenses fees are paid in relation to any imported merchandise.  If so, then the agreements should be reviewed to determine whether the royalties or license fees are dutiable additions to value.  This is not particularly difficult to do.  We regularly help importers with this issue and would be happy to discuss with you how best to do so, if helpful.  If such a discussion would be helpful, just let us know.

We hope this is helpful.

Best regards,

Ted

Customs-Related Qui Tam Actions

Dear Friends,

We are writing to let you know about two recent developments that highlight the continued evolution of private party-initiated trade enforcement actions filed under the qui tam provisions of the False Claims Act (“FCA”).  The developments are as follows:

  • Earlier this month, federal prosecutors filed suit in the Southern District of New York (“SDNY”) alleging that a double invoicing scheme, involving a Chinese manufacturer (Wuxi Yifeng Garments), its U.S. subsidiary (Yingshun Garments), and a U.S. wholesale customer (Notations, Inc.), defrauded the United States of millions of dollars of customs duties on garments imported from China.  The complaint, filed following an investigation by U.S. Customs and Border Protection (“CBP”) and Immigration and Customs Enforcement’s (“ICE”) Homeland Security Investigations, alleged that between 2009 and 2014, Yingshun submitted fraudulent commercial invoices to CBP, purposefully undervaluing imported garments by 75% or more.  Additionally, the complaint alleged that Yingshun’s managing director oversaw much of the undervaluation scheme and Notations (who purchased imported garments from Yingshun) actively participated in the scheme by falsely representing to U.S. retail customers that documentation submitted to CBP by Yingshun was accurate.  A copy of the compliant is attached for your reference.
  • Last week, the U.S. Court of Appeals for the Third Circuit remanded a May 2013 suit against a U.S. pipe fittings manufacturer, Victaulic Co., back to the U.S. district judge (who had originally dismissed it).  The underlying complaint alleged that Victaulic (1) purposefully failed to mark its foreign-made pipe fittings to hide the country of origin, and (2) falsified entry documents to avoid having to pay marking duties.  In dismissing the suit, the U.S. district judge found that, while the alleged violations could rise to a claim under the FCA, the relator “provide[d] no basis for its wholly conclusory allegations that [the U.S. company] had falsified its customs entry documents or knowingly avoided paying any required marking duties.”  In remanding the case, however, Judge Jane Richards Roth emphasized that “the plain text of the FCA’s reverse claims provision is clear:  any individual who knowingly conceals or knowingly and improperly avoids or decreases an obligation to pay or transmit money or property to the government may be subject to liability”.  A copy of the Third Circuit’s opinion is attached.

These cases are significant for a few reasons. 

First, the targets being pursued for customs noncompliance under the FCA are expanding.  While private party-initiated trade enforcement actions are increasingly common, most qui tam FCA cases that we have seen focus enforcement efforts against parties that make direct representations to the government (e.g., importers that submit false invoices to CBP).  In the SDNY case, however, federal prosecutors included a U.S. downstream purchaser, that neither imported the subject garments nor made direct representations to the government, as a defendant in the complaint.

Second, the types of parties pursuing customs noncompliance under the FCA are expanding.  Both cases were initiated by relators that had little or no relationship to the target companies.  Specifically, the relator in the SDNY suit was the mother of an ex-employee of the target.  As we originally reported in 2014, the relator in the Third Circuit appeal was Customs Fraud Investigations, LLC (“CFI”), a company that was created for the specific purpose of analyzing potential customs fraud, filing FCA suits, and recovering financial incentives resulting from the settlements of those suits (i.e., the case was brought by an entity that did nothing more than scour the internet for possible violations).  While we have seen cases initiated by various categories of whistleblowers (e.g., competitors, disgruntled employees, trade associations, etc.)  these are the first instances we are aware of where the relators are this far removed from the targets.

Finally, the SDNY suit highlights the government’s willingness to prosecute not only companies for customs noncompliance, but the individual employees involved in the noncompliance, as well.  As discussed above, federal prosecutors named the target importer, as well as its managing director, as defendants in the complaint.

 *     *     *

Taken together, these cases underscore the continued trend (and evolution) of private parties initiating their own trade enforcement actions.  Given the increasing number (and type) of these cases, all companies should make sure they have effective internal controls in place that include processes for vetting suppliers and reporting issues of non-compliance.

We hope this is helpful.  If you have any questions, or would like to discuss these issues further, please let us know. 

Best regards,

Ted