Originally published by the Journal of Commerce in April 2018

The brewing trade war between the U.S. and China serves as a reminder to international traders that knowing where your goods are made and being able to prove it are two very different issues.  At a time when it remains common place for U.S. Customs to deny duty deferral benefits to American importers over the lack of adequate paperwork, companies would do well to again examine what they are doing and how they are documenting it.

Customs auditors have been open for many years that duty deferral programs are “low hanging fruit.” What they mean is lots of companies make those claims, but few have the documentation to back them up. Given the current climate, let’s start with the obvious context – free trade agreements (“FTA”).  It has never been enough to just rely on a certificate of origin from your supplier.  It has always been necessary for the importer to conduct a proper written analysis and make sure his products qualify, or not make the claim.  It has always been necessary to make sure that you track any sourcing changes and timely analyze their impact on your FTA qualification. It has also always been necessary to keep those records for five (5) years. Do you?

GSP is another duty deferral program where the lack of documentation routinely ends up with claims being denied.  The requirement to qualify is that the product and country both be designated as GSP eligible.  Then, at least 35% of the materials and labor must originate in the GSP eligible country.  What frequently trips up successful claims is there is a foreign raw material or component and it represents a significant portion of the overall value. In other words, the remaining labor and materials cannot meet the 35% requirement.  Put another way, because the raw material is foreign, the resulting good does not qualify, unless that foreign item undergoes double substantial transformation, and the intermediate product is itself something that is a commercial product.   Substantial transformation is the concept of taking a raw material, further processing it and ending up with a new and different article of commerce.  In the simplest terms, you take wood from Country A and cut it to size and shape in Country B. Once it is cut in Country B, it is ready to be assembled into a bookcase. In so doing, you have substantially transformed the wood into a bookcase, even if you import it into the U.S. unassembled.  If bookcases and Country B are both GSP eligible, that is great, except the wood has to go through the substantial transformation twice to be GSP eligible, and, in this example, it did not.

A circumstance where double substantial transformation is more likely is with steel.  We will assume the steel is made in Country A.  It is then formed, shaped and finished it into a cylinder out of which a lunch pail is made.  We will also assume the lunch pail (the intended end product) and Country B are GSP eligible.  What the importer needs to have in his records when Customs asks for it is evidence of the origin of the steel, where it is formed, shaped and finished into the cylinder, and then how that cylinder is further manufactured into the resulting lunch pail, and how that change confers Country B origin and so GSP eligibility on the lunch pail which exported to the U.S.  The importer will succeed only if he can document the first change – from raw steel into the cylinder shape – is substantial transformation, and then the second change – from cylinder into lunch pail – is the second substantial transformation. Additionally, the importer also has to be able to prove the 35% local content requirement is met, and the closer you are to 35%, the more closely our claims will be examined (and likely rejected). The cylinder itself is a product of its own, one from which lunch pails are made, so the requirement of it being a commercial product  should be clear, but importers would be nonetheless wise to have evidence of that fact in their records.  It has been our experience that importers do not have those details in their files and, in fact, typically rely on the supplier to provide information if it is requested.  All too often we have seen the supplier go out of business or the parties no longer do business together (perhaps over a billing dispute), and so the importer cannot document his claims, they are denied and the importer ends up paying the duty plus interest.

With the recent 232 tariffs, a number of international traders have started looking more closely at how their goods are classified.  They want to see if they properly belong in one of the assessed classifications. The legal obligation on importers is to exercise reasonable care.  This has been interpreted by Customs to mean at time of entry, the declarations made about value, classification and other admissibility factors should be correct. If you are relying on your broker and do not check their work, that is not reasonable care.  It is not required that each entry be audited, but a spot check at least should take place.   We frequently hear about importers whose broker or forwarder says, we did you a favor and saved you some money – by using a different classification  – not a good position with Customs is demanding proof of eligibility!

We should also be clear, this is not just an importer issue.  If you are an exporter and supply product to buyers, every time you change sourcing, an analysis of on-going qualification for a given, for example, FTA claim should be conducted.  It is equally troubling how often we hear – well, the product was made in the U.S., but what they really mean is it was purchased in the U.S. Where it is purchased is generally not relevant to whether it qualifies under a given duty deferral program.

Exporters, of course, also have compliance concerns when it comes to export license and economic sanctions issues. And again in this context, what analysis did you perform and how have you documented it?

It is true that many companies do not have their own compliance departments. Nonetheless, someone on the staff should be the resident expert on what is required to keep your products compliant, and that those decisions are properly documented.  It is always a significant loss to a company when it has to pay additional duties, or loses a customer because somebody overlooked a sourcing change!  When asked how he was doing, a former boss used to say – “Putting out fires!” Right now, there seems to be a lot of that going on unnecessarily!

As a starting point, here is a list of basic questions:

1)         What is the correct classification for your products? Who makes the classification decision and how it is documented? If you are relying on your broker (for imports) or forwarder (for exports) does your contract with your broker or forwarder make clear they have agreed to assume that responsibility and are liable if it is wrong? How are you making sure any classification assigned to your products is correct? Your service provider classifying your goods does not get you off the hook for any mistakes made with the enforcing agency, even if the service provider agreed by contract to assume the responsibility.

2)         What is the correct value for your products? Have you considered the typical additions to value? Assists, royalties, commissions, packing and subsequent proceeds? What is the INCOterm of sale on which we are selling or buying the goods? If you are entering the goods into the U.S., what documentation do you have of the actual amounts paid or to be paid for any deductions if the term of sale is other than FOB?  Is duty paid in the importing country based on the FOB or CIF value of the imported goods? Are you related to the other party with whom you are doing business? If so, how are you documenting the arms-length nature of the pricing between you?

3)         What other requirements apply to your goods? Are they only for the export of the goods? What more do you or your buyer need to import the goods at destination?

All too often international traders wait until a problem arises to figure out the requirements, or they rely on a service provider and while some of them are very good, honestly, some simply are in over their heads. So, even if you think your broker or forwarder is really good, you have to take reasonable steps to make sure they are giving you sound advice. Otherwise, you are the one who will pay the price when something goes wrong! Are you ready for that?