CBP’s Section 301 Enforcement Push

Dear Friends,

As companies consider mitigation strategies to offset the impact of the Section 301 duties, we wanted to share an important update regarding enforcement priorities at the border.  Further to recent reports, CBP’s Office of Regulatory Audit has confirmed that it will be ramping up enforcement of “various types” of imported electronics (i.e., products classified in chapters 84 and 85 of the Harmonized Tariff Schedule of the United States).  In connection with these efforts, Regulatory Audit is adding staff, including managers and auditors.  For instance, CBP is adding 60 new auditors across Regulatory Audit’s 10 field offices.  Our contacts in Regulatory Audit have informed us that, as part of this effort, a first “wave” of CF-28s (Requests for Information) since the imposition of the Section 301 duties will be issued in 2-4 weeks.  

There are several reasons for CBP to focus its enforcement on imported electronics.  Most importantly, billions of dollars in revenue are at stake for the U.S. government, and CBP is intent on collecting that revenue (the Trump administration expects CBP to collect “record-setting revenues”).  Also, given that electronics have generally been entitled to be entered duty free (or subject to very low duty rates), CBP recognizes that importers are under pressure to reduce the Section 301 impact and, therefore, may (intentionally or unintentionally) act in a manner contrary to U.S. customs laws and regulations.  Last, targeting electronics is justifiable given the conclusions of the Section 301 investigation, namely that the Government of China engages in intellectual property theft and forced technology transfers to support its industrial advancement goals.  Stated differently, targeting electronics aligns with the legal basis for the Section 301 duties and the administration’s messaging around China’s unfair policies. 

While CBP has confirmed that an enforcement push will be made with respect to electronics, we understand that CBP is increasing enforcement activities on all fronts.  As such, companies pursuing Section 301 mitigation strategies should tread cautiously.  Re-classifying products, changing the country of origin, and/or decreasing the customs valuation (for example, by declaring the “first sale” price in a multi-tiered transaction, rather than the price the U.S. importer pays), is likely to draw scrutiny from CBP.  As such, it is important that companies be able to demonstrate that they exercised reasonable care in carrying out these activities (not exercising reasonable care can lead to steep penalties, in addition to owing unpaid duties).  To demonstrate that a company is exercising reasonable care, we recommend having on file contemporaneously drafted documentation that substantiates the legal basis for any changes (e.g., documentation explaining that, based on changes to the supply chain, the product is no longer Chinese origin, since it is now last substantially transformed origin somewhere else).  Further, any company that receives a CF-28 or CF-29 (Notice of Action) should escalate the matter to the company’s legal department before responding and/or engage outside trade counsel, if appropriate. 

We hope this is helpful.  If you have any questions regarding the above, 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

Potential Changes to the “First Sale” Principle of Customs Valuation: What You Need to Know

Dear Friends:

U.S. Customs and Border Protection (CBP) is in the process of revising one of its Informed Compliance Publications (ICP) and this should be of interest to every company that utilizes the “first sale” valuation principle for customs purposes.  CBP is revising its ICP on “Bona Fide Sales & Sales for Export to the United States” to clarify what documentation CBP expects to be available in order to validate the use of the first sale value.  The draft revised ICP (in track changes) is attached for your reference.

The requirements to use the first sale value were established by judicial precedent and are relatively straightforward.  While CBP has never been a fan of first sale (and unsuccessfully tried to eliminate the principle entirely back in 2008), its use has not historically gotten a great deal of attention by the field.  CBP often simply accepted what was put in a company’s “first sale notification letter”.  In many cases, however, those letters were not entirely accurate, overreached, or became out of date over time (i.e., a program that was in compliance originally, drifted out of compliance over time).  In recent years, CBP has started taking a closer look at these programs.  We have seen CBP recently issue rulings denying first sale treatment, as well as an increase in enforcement/scrutiny by CBP Regulatory Audit and import specialists.  Two of the most common problems we have seen with first sale programs are:  (1) the terms of sale used in the transactions do not establish that there is a bona fide sale to the middlemen (e.g., the terms either indicate that a “flash transfer” of title occurs, or the parties are not actually abiding in practice by the terms set forth in the documents); and (2) whether first sale transactions between related factories and middlemen can be supported by financial documentation evidencing that those sales are arm’s length.  See attached for details.  These are the two issues the revised ICP attempts to address.

According to CBP, the impetus behind revising the ICP is concern from industry that CBP auditors are requiring unnecessary documentation to establish first sale eligibility.  CBP Headquarters is attempting to address that concern by explaining the requirements in detail and identifying the documentation that needs to be available to substantiate a first sale claim.  The draft ICP summarizes recent CBP first sale rulings and includes an extensive Appendix that provides examples of the types of documentation CBP believes an importer should be able to provide.  We recommend reviewing the revised ICP, and the Appendix, in particular.

Clients familiar with our first sale audits and first sale set-ups will not be too surprised by the draft ICP, as it emphasizes a “totality of the circumstances” approach that is consistent with recent administrative precedent.  That being said, we believe that the list of documentation included in the draft Appendix should be refined and qualified, in some instances.  History has shown that the lists like the one included in the Appendix, without further qualification, could be misconstrued by the field as a mandate to demand all of the identified records (regardless of whether they are applicable or necessary in every instance).  We understand that CBP Headquarters recognizes this concern and will be reaching out to industry and interested stakeholders over the coming weeks for comments on the draft ICP.

Regardless of what you think of CBP’s efforts, the bottom line is that companies that utilize first sale should expect CBP to be taking a closer look at their programs.  The first sale principle is here to stay, but the bar is going to be raised.  Companies should be reviewing their first sale programs and making any necessary changes now.  Companies who have robust first sale programs, and use it where appropriate (which, unfortunately, is likely not with every vendor), should be ok.  Companies who overreach, will likely have issues.

We have devised first sale programs for a number of companies and leveraged our global footprint to offer in-country vendor/factory set-up and initial transactional testing to clients.  We have also audited existing first sale programs for compliance and advised clients on how to improve their programs.  If the list included at the Appendix looks unfamiliar to you, there are proactive strategies that you can adopt to protect yourself from increased duties and penalties in the event first sale claims are denied.

If you have questions concerning the draft ICP, questions concerning the establishment/audit of first sale programs more generally, or if you are interested in submitting comments on the draft ICP, please let us know.

Best regards,

Ted