Challenge to How the Substantial Test is Applied to Pharmaceutical Products

Dear Friends,

We wanted to bring to your attention a recent development regarding an issue that has been a thorn in the sides of pharmaceutical companies for many years.  The development involves how the substantial transformation test is applied to pharmaceuticals for purposes of determining country of origin.

As you know, will generally be found to have occurred if the manufacturing or processing operation results in a change in (1) commercial designation or identity, (2) fundamental character, or (3) commercial use.  In the pharmaceutical context, U.S. Customs and Border Protection’s (CBP) long-standing position has been that, for single API products, formulation (i.e., mixing a bulk active with excipients and putting it up in dosage form) is generally not enough to work a substantial transformation.  As a result, if an active is produced in one country and shipped to another country for formulation, the formulating operations performed in the second country will not be sufficient to change the origin of the active ingredient.  In short, the origin of the API controls (of course, CBP in its wisdom gets a different result under the NAFTA Marking Rules, which is maddening). 

A pharmaceutical company is now challenging CBP’s long-standing position at the Court of International Trade (CIT).  The case stems from an adverse final determination issued in the government procurement context.  CBP determined that the pharmaceutical at issue is not substantially transformed in the United States because the API, sourced from India, retains its chemical and physical properties upon processing in the United States.  The determination is adverse because, as a result of not being considered to be substantially transformed in the United States, the company’s product is not eligible for procurement by the U.S. government (India is not a TAA country).   In response to this determination, the company filed suit at the CIT.  The company argues that the API is substantially transformed into a new and different product with a different use as a result of the processes performed in the United States.  A copy of the compliant is attached for your reference. 

The case is significant because it means that CBP’s long-standing position of what constitutes a substantially transformation will be reviewed by an independent, third party — the CIT.  A positive outcome for the company could impact how country of origin is determined for pharmaceutical products across the board.

If this issue has caused you heartburn (or if your company sources API from non-TAA countries like India, China, etc. but formulates the finished products in TAA countries, like the U.S., Canada, Ireland, etc.), then you may want to consider weighing in at the CIT.  We would be happy to discuss how best to do that with you further.  If such a discussion would be helpful, just let us know. 

Best regards,



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,


Review of 2017 ITRAC/ACE Data

Dear Friends:

Just a quick note to remind you that one element of an effective internal customs compliance program involves a review of the company’s import data on (at least) an annual basis.  This is the time to review the 2017 data. 

The goal of internal controls is to effectively mitigate the risk associated with the company’s activities.  Thus, the starting point is understanding the company’s risk profile.  One way to do that from a customs perspective is to review the company’s import data (the same data that U.S. Customs and Border Protection looks at to select audit candidates).  The import data (whether ITRAC data obtained from CBP HQ, or ACE reports you are able to download).  This data includes general entry information, such as tariff classifications, values, preferential tariff programs used, etc.; as well as information regarding CBP’s review of a company’s import shipments (e.g., whether a CBPF-28 or CBPF-29 was issued).  It also identifies each of the links in the company’s international supply chain (i.e., foreign manufacturers, carriers, customs brokers and sureties).  In short, the import data is a useful tool for monitoring the effectiveness of your import compliance program, identifying areas of potential cost and duty savings, customs valuation reconciliation and identifying links in the international supply chain for security purposes (i.e., C-TPAT-related information). 

Given how useful this information is, we recommend that all companies obtain their import data and review it (at least) annually.  Due to the volume of data involved, and the way it is presented by CBP, we have developed simple macros that can extract the most relevant data and summarize it in a table format so that trends, issues and opportunities can be more easily identified.  If you would like to have us run your data through those macros and provide the summaries, please let us know.  If not, no problem, but please review it yourself and confirm that your controls are working effectively (e.g., your data does not know show the use of unapproved brokers, unauthorized preference claims, incorrect tariff classifications, etc.).  The business is always evolving.  You need to make sure your controls are keeping pace!

We hope this this helpful. 

Best regards,


More Private Party-Initiated Trade Enforcement Actions

Dear Friends,

We wanted to bring to your attention two recent qui tam case settlements involving the underpayment of customs duties.  They are as follows:

  • Further to our message below where Z Gallerie agreed to settle with the U.S. Department of Justice (“DOJ”) for $15 million, the DOJ recently announced that Bassett Mirror Co. (“Bassett”) agreed to pay $10.5 million to settle allegations that it violated the False Claims Act (“FCA”) by underpaying antidumping duties.  Total settlements in this case have now reached $25.5 million.  The underlying complaint, initiated by a competitor, alleged that between January 2009 and February 2014, several companies deliberately misclassified wooden bedroom furniture as non-bedroom furniture on its official import documents to avoid paying antidumping duties.  A copy of the most recent DOJ press release is available here.
  • DOJ announced that a textile importer, American Dawn, and three company executives, agreed to pay more than $2.3 million to settle allegations that they violated the FCA by intentionally misclassifying goods in order to pay lower duty rates.  The underlying complaint, initiated by a former employee, alleged that for more than a decade American Dawn intentionally misclassified certain textile articles, including bath towels and shop towels, as polishing cloths in order to pay a lower duty rate.  The press release is available here.

These cases and settlements are interesting for a few reasons.

First, both cases were initiated by whistleblowers under the FCA.  In Bassett/Z Gallerie, a competitor initiated the court action and, in American Dawn, it was a former employee.  The whistleblowers in these cases with receive a sizeable portion of the settlements.  This incentive will continue to feed the trend of there being an increasing number of private-party initiated trade enforcement actions.

Second, DOJ appears to be settling these cases for less than is available to it under applicable laws.  Under the FCA, maximum liability includes the unpaid duties, three times the unpaid duties, $11,000 for each false claim (i.e., each import entry), plus attorneys’ fees.  In addition, under the Tariff Act of 1930, maximum penalties include the full value of the imported merchandise (because the government alleged intentional evasion of duties, rather than negligence or gross negligence).  Considering that the PRC-wide rate for wooden bedroom furniture is ~216%, the importers could have been liable for many millions more than the government ultimately agreed to settle for.  It is unclear why the government would agree to what could be considered “generous” settlements , particularly since they appear to be “global” in nature (they resolve not just the FCA liability, but the liability imposed under the Tariff Act of 1930, as well), but it is unlikely that such generous terms would be afforded by CBP in an stand alone administrative proceeding.

Finally, in both press releases, government agencies restated their commitment to protecting the economy by investigating alleged evasions of customs duties.  For example, in the American Dawn settlement announcement, the director of the CBP field office in Atlanta stated, “[t]his settlement agreement is another example of CBP’s day to day collaborative efforts between U.S. Customs and Border Protection Officers at ports of entry, Import Specialists with the Centers of Excellence and Expertise, and Immigration & Customs Enforcement Homeland Security Investigations to protect the American public and the U.S. economy.”

In light of this, all importers should make sure that they effective internal controls in place over customs matters that include a mechanism for employees to raise legitimate compliance-related concerns.  In our experience, companies can generally protect themselves from enforcement actions (FCA or otherwise) by having reasonable internal controls.

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

Best regards,


Border Searches of Personal Electronic Devices

Dear Friends,

We wanted to highlight for you an interesting development regarding searches and seizures of personal electronic devices by U.S. Customs and Border Protection (CBP) at the border.   

CBP recently announced that, in fiscal year 2017 (which ended September 30, 2017), it searched the personal electronic devices of 30,200 travelers (inbound and outbound), which is up over 60% from the prior year.  Devices include any communication, electronic, and digital devices, including computers, tablets, removable media, disks, drives, tapes, mobile phones, cameras, music and other media players.  These searches and seizures are stated to be conducted to identify and respond to terrorism threats, smuggling attempts, illegal immigration, etc. and have been the subject of multiple lawsuits.  CBP also updated its directive “Border Search of Electronic Devices” (CBP Directive No. 3340-049A).   

What You Should Know

CBP has broad authority to search individuals, and their belongings, entering or exiting the country.  There is no reasonable suspicion, probable cause, or warrant requirement.  Encrypted and passcode protected content may also be searched.  Travelers that refuse to assist CBP in accessing protected content may have their devices detained. 

In addition to reviewing content stored on the device (a ‘basic search’), CBP may also conduct an ‘advanced search’ if there is reasonable suspicion of activity in violation of laws enforced or administered by CBP (e.g., customs, export control, immigration laws, etc.).  An advanced search is any search in which an Officer connects external equipment, through a wired or wireless connection, to an electronic device not merely to gain access to the device, but to review, copy, and/or analyze its contents.

Not all device content is treated equally.  For example, CBP treats content stored on the device differently than content stored remotely (CBP may only access content stored on the device).  In addition, CBP must initiate specific procedures when a traveler contends that certain content is privileged or sensitive. 

Considering the prominent role of electronic devices in today’s society, CBP’s updated Directive, and the Trump Administration’s focus on border security, device searches at the border will likely continue to increase.


If your company has executives or employees who travel frequently, we recommend preparing those individuals to respond appropriately if/when CBP Officers ask to search their devices (e.g., do employees have to provide their passcodes, if requested by CBP?).  For example, updating your company’s travel policies to address this issue and then publishing the updates internally could be a good start to preparing employees for this eventuality.  In addition, we recommend that all companies review their company’s data storage policies to ensure the company’s most sensitive data is stored remotely, rather than locally on devices (or that employees have only limited amounts of sensitive data stored locally).  While these are not traditional “customs compliance issues,” they are nevertheless important issues the in-house trade compliance team should be raising internally.

We are working with clients on these issues and would be happy to discuss how best to implement the recommendations discussed above with you further.  If you would like to do so, please let us know.

We hope this is helpful.

Best regards,


GSP Expiration Part II

Dear Friends,

Unfortunately, it appears increasingly likely that Congress will not renew the Generalized System of Preferences (“GSP”) program before it expires on December 31, 2017.  While the program may get renewed in 2018, and that renewal may be retroactive, there will be a period when GSP is not in effect.  U.S. Customs and Border Protection (“CBP”) has published a notice (copy available here) that advises importers of GSP-eligible merchandise to continue entering the merchandise using the “A” Special Program Indicator and to deposit the Normal Trade Relations duties (i.e., the regular, non-preferential duties) during any lapse in the program (e.g., as of January 1, 2018).  This will make it easier for CBP to process refunds IF Congress renews the GSP program retroactively. 

Any of you who regularly import using GSP should make sure that your brokers are familiar with CBP’s notice (in addition to making sure your finance colleagues are aware of the potential increase in costs).

If you have any questions about these issues, please let us know.

Best regards,


CBP Forced Labor Update & Recommendations

Dear Friends,

We are writing to provide you with an update on the developments with regard to U.S. Customs and Border Protection’s (CBP) enforcement of the U.S. import ban on goods made with forced labor (19 U.S.C. § 1307).  The last few months have seen both significant changes in the law and in CBP’s enforcement activity.  While the reputational risks of a forced labor entanglement remain as high as ever, these changes mean that (1) the likelihood of encountering enforcement activity has increased, and (2) the elements of a “compliant” forced labor program are evolving.  We have summarized the background, recent developments and our recommendations below.

Background – Import Ban & Loophole

As you may recall, in early 2016, Congress removed a loophole in the near-80 year old statute banning the importation of goods made with forced labor.  The effort to remove this loophole was led for many years by Senator Bernie Sanders, and was later championed by Senator Sherrod Brown.  The loophole had permitted goods made with forced labor to be imported whenever U.S. demand outstripped domestic supply (the “consumptive demand exception”).  The consumptive demand exception resulted in there being little application/enforcement of the import ban for most of its history.

CBP’s Old Enforcement Mechanism

Within weeks of the consumptive demand exception being removed, CBP initiated four new enforcement actions under a mechanism the agency adopted in the 1960’s.  This older enforcement mechanism allows CBP to issue “withhold release orders” (or WROs) for shipments of articles manufactured by a specific named foreign entity, which CBP has reason to believe may have been produced with forced labor.  An importer may challenge the imposition of a WRO, but only on a shipment-by-shipment basis.

The WRO mechanism has shown itself to be a blunt instrument.  Companies named in a WRO are likely to suffer significant economic harm, with little-to-no opportunity to review or respond to the allegations before the WRO is put in place.  The relative ease with which CBP can impose a WRO (upon information which “reasonably, but not conclusively” indicates the presence of forced labor) corresponds directly with the profound difficulty in having a WRO removed.  As we have explained previously, once a WRO is in place, it is difficult to have it removed (the standard for imposing a WRO is relatively low, but for removal is quite high).

CBP’s Emerging Approach to Enforcement

While the WRO mechanism remains a viable tool for CBP’s enforcement of the forced labor ban, CBP has also begun taking steps to hold U.S. importers more directly accountable for forced labor compliance.  Most notably, CBP recently updated its informed compliance publication governing “reasonable care” to specify that importers are expected to have documented controls in place to mitigate the risk of importing goods made with forced labor.  Specifically, CBP expects importers to be able to answer questions such as (but not limited to):

Have you taken reliable measures to ensure imported goods are not produced wholly or in part with convict labor, forced labor, and/or indentured labor (including forced or indentured child labor)?

Have you established reliable procedures to ensure you are not importing goods in violation of 19 U.S.C. § 1307 and 19 C.F.R. §§ 12.42-12.44?

Have you obtained a “ruling” from CBP regarding the admissibility of your goods under 19 U.S.C. § 1307 (see 19 C.F.R. Part 177), and if so, have you established reliable procedures to ensure that you followed the ruling and brought it to CBP’s attention?

CBP has broad authority to determine “admissibility” (whether an article presented for importation complies with “the requirements of the laws of the United States”) and to detain articles until compliance is confirmed.  As a result, importers who cannot answer these questions run the risk of having their goods detained or seized.  CBP is laying the groundwork for it to be able to (1) deny entry of merchandise that an importer cannot prove was not made with forced labor, and (2) assess penalties for forced labor violations against companies without adequate controls.

CBP has recently begun issuing requests for information (via CBP Form-28s, or informal requests from ISA account managers) asking importers to produce documentation regarding their forced labor policies and controls.

North Korea Forced Labor Presumption

In August 2017, as part of an wide-ranging sanctions bill, the forced labor ban was again modified.  The statute now specifies that merchandise made by North Korean laborers, regardless of location, is presumed to be made with forced labor, and, therefore, subject to the import ban.  No official guidance has been provided to use in determining whether North Korean laborers may be present in a given supply chain.  The risk of North Korean labor appears to be especially high in northeastern China, but North Korean laborers are known to be working in more than a dozen industries across more than 40 countries, according to the U.S. government.  Recent statements by U.S. government officials have made it clear that importers are expected to have updated their forced labor (and/or CSR) policies to take this change in the law into account.


In view of these developments, we have the following recommendations.

  1. Update your CSR/forced labor compliance program to reflect the recent changes in the law, including the presumption with respect to North Korean labor.  An effective forced labor compliance program will be tailored to a company’s forced labor risk profile (e.g., industry, area of the world, type of production, direct/indirect sourcing, etc.).  It will include updated policies around vendor/factory set-up and audit, and may include revisions to master sourcing agreements, POs and/or vendor contracts.  Depending on the risk profile, it may also include changes to sourcing activity.
  2. Prepare a memorandum explaining your forced labor compliance program to CBP.  All importers (and those in certain higher risk industries, such as apparel and footwear, in particular) should anticipate getting a question about their forced labor compliance program and prepare accordingly.  While many companies have robust CSR programs (that are hopefully now updated to account for the recent changes in the law – see #1 above), we believe it will be important to “translate” that program into “Customs speak”.  Stated differently, if CBP is going to ask about your forced labor controls (an area in which it has little expertise), it is in your interest to have an answer that addresses its concerns, in a language it understands.  Just like one should not provide CBP solely with transfer pricing documentation in response to an inquiry about the acceptability of intercompany customs values, one should not provide CBP solely with CSR documentation in response to an inquiry about the admissibility of goods due to forced labor concerns.  Producing documentation that recognizes CBP’s concern and summarizes your program from a customs perspective will go a long way to minimizing the interaction; whereas providing just the underlying CSR documentation and hoping CBP finds what it needs will likely prolong it.
  3. Ensure that any query you receive from CBP relating to forced labor (whether by CBP Form-28 or other means) is reviewed by counsel before it is responded to.  In our experience, companies can sometimes be eager to provide information to CBP which they believe it will cast them in a favorable light.  There will likely come a time and place for sharing such information with CBP, but doing so comes with risks, particularly if your forced labor/ CSR program has not yet been updated to reflect all relevant recent changes in the law.  If you receive any specific queries, please let us know.  We are advising several clients on these and related matters, and would be glad to assist.

We are working with several clients to implement these recommendations.  We have developed questionnaires to pull together the relevant aspects of a company’s existing CSR program, are updating those programs to account for the change in the law and are preparing reports summarizing the programs from a customs perspective (so the client’s have a response ready to provide CBP when needed).  We are also assisting several clients respond to general, as well as specific, inquiries from CBP in this area.

*     *     *

We hope this is helpful.  If you have any questions about this evolving area of customs law, or how best to respond, please let us know.

Best regards,