|DOUGLAS P. ZUVICH, CPA, is a manager and director of customs compliance for KPMG Peat Marwick, New York City. He is a licensed broker and a former auditor with the U.S. Customs Service.|
Big companies used to be the only entities to conduct business internationally. No longer. Fierce competition at home, the prospects of new opportunities overseas and a surge of trade liberalization initiatives, such as the Customs Modernization and Informed Compliance Act, the North American Free Trade Agreement (NAFTA) and the General Agreement on Tariffs and Trade (GATT), are forcing small and midsize companies to look across borders to market and sell their products and services.
However, the increased import and export opportunities have exposed more companies to customs penalties. In fact, smarter companies already are considering customs duties "manageable taxes" that they must plan for. Consequently, CPAs who work with import or export companies must be better informed about customs and international trade practices. This article provides CPAs who manage, audit or review international companies with information on how customs procedures affect the bottom line, how to identify potentially costly customs problems and how to minimize and manage U.S. Customs Service intervention.
WHY NEW OPPORTUNITIES?
The modernization act is a wide-ranging U.S. law that dramatically changed the relationship between the U.S. Customs Service and international traders. It has streamlined and automated U.S. customs procedures for processing import transactions, shifting the focus of compliance efforts from prerelease merchandise and document examinations to postentry audits and reviews. For example, a typical shipment may not be highly scrutinized upon entry to the United States. However, after entry, customs could audit the importer's books and records to ensure the information provided to them was accurate and complete—an enforcement strategy similar to that of the IRS.
The act requires traders to exercise "reasonable care" in the entry, tariff classification, product valuation and marketing of imports. To satisfy this standard of care, the U.S. Customs Service expects all importers to adopt management systems that ensure import and export compliance is a priority. That includes strict recordkeeping procedures, internal reviews and consultations with outside experts to detect and remedy violations.
Along with drastically changing the importer's compliance obligations, the modernization act provides stiff penalties for companies failing to meet its new standards. For example, civil customs penalties may be as high as the domestic value of any imported merchandise. In addition, the modernization act provides for specific recordkeeping penalties of up to $10,000 per violation when an importer fails to exercise reasonable care in maintaining records such as purchase orders, invoices or receiving reports. These penalties may be assessed even if there are no errors on the underlying documents and may be doled out in addition to the general penalties.
Finally, to verify that importers are taking their new obligations seriously, U.S. customs auditors are scrutinizing more companies. In fact, customs has announced that it intends to audit over 1,000 companies by the year 2000. If an official customs audit discloses a lack of reasonable care, such as when the company's internal controls do not provide sufficient oversight, the company can be subject to the civil and criminal penalties. Just as significant, if not more so, the Customs Service will target that company for intense examination of future shipments, resulting in major monetary costs and delays in delivering imported goods to customers. If all that wasn't enough, Congress recently named Raymond Kelly, the former police commissioner of New York City, to be the Custom Service's new commissioner.
|Customs Warning Signs Checklist|
The following nine questions are customs red flags to note when working with or for international traders:
1. Are any additional payments made above the invoiced amount to an overseas supplier? Examples are
4. Are currency fluctuation payments made?
5. Are domestic or overseas royalties or license fee payments made?
6. Are there any yearend journal entries that affect purchase accounts?
7. Are there any overseas R&D costs?
8. Is there any defective merchandise?
9. Are there any shortages or overages?
WHO SHOULD BE IN THE KNOW?
Any CPA associated with a business that is involved in importing or exporting should be aware of all potential customs issues:
Controllers, tax directors and CFOs must plan and structure international transactions to avoid penalties and minimize customs duties just as they plan for income taxes. They also have to establish internal controls and recordkeeping procedures to comply with customs regulations.
For example, they should oversee the preparation of a customs compliance manual to lay the foundation for the company's compliance efforts. The manual should explicitly detail the proper controls, systems and procedures for the company's import operations. The compliance manual also should include information on employee responsibilities and the customs implications of their actions.
Internal auditors at least once a year, but preferably twice, must test the efficiency and the related recordkeeping and internal controls of company trade operations. They also have to ensure the company is taking advantage of the Customs Service's provisions for reducing tax exposure.
Independent auditors, during the annual audit or review, must identify possible customs issues and violations that result in material contingent liabilities.
Management and customs consultants who analyze company international operations must recommend increased efficiencies, ensure compliance and take advantage of tax-saving opportunities.
There is some good news, though: CPAs can help companies or clients reduce penalties significantly by ensuring they exercise reasonable care in their international operations. Specifically, CPAs can
- Help a company establish internal controls so the information given to customs is accurate and complete.
- Implement recordkeeping procedures to ensure the company maintains documents for the required amount of time (generally five years from the date of entry).
- Draft and implement a compliance manual detailing the company's relevant controls, systems and procedures. Such a manual also helps employees understand how their actions can affect the company's compliance with customs requirements.
- Review periodically whether the company's operating procedures, recordkeeping and internal controls are managed efficiently.
- Prepare a strong policy statement declaring the priority of customs compliance for management and all personnel.
MANAGING GOVERNMENT INTERVENTION
A customs audit can last anywhere from 6 to 18 months, requiring 1,200 to 2,000 person hours of work. In addition to being intrusive, such an audit can cost a company hundreds of thousands of dollars in time and professional fees. However, under the modernization act's spirit of shared responsibility, the Customs Service, working with the international trade community, has introduced two new compliance initiatives to help relieve the importer's audit burden. Self-Governance and Controlled Self-Assessment are two audit-based programs that allow CPAs to manage government intervention by limiting customs' intrusion into a company's operations.
The Self-Governance Program. Companies incorporate this program into their corporate structures. It was designed to encourage companies to develop and maintain efficient and effective internal controls over their import-related transactions. CPAs should use this program when implementing internal audit type mechanisms. These new procedures will allow the company to ensure it is compliant and customs to verify such compliance with minimal intrusion. In addition, participation in this program likely will deter a customs audit.
The Controlled Self-Assessment. This is available only to companies that are the targets of official customs' audits. Under this initiative, customs allows the company's internal audit department, or a third-party CPA, to conduct the fact-finding portion of its review. Because customs is not the fact-finder, any deficiencies can be disclosed, thereby limiting any penalty liability. In fact, customs' involvement in reviewing the importer's operations is significantly limited.
Both of the new audit initiatives allow CPAs to take a significant role in ensuring a company's compliance and managing the customs audit process. Participation in either of these programs brings the following benefits:
- The government does not pry into the company's operations. Customs cannot conduct wasteful "fishing expeditions," entrap unsuspecting employees or turn an ambiguous issue into a negative finding.
- The duration of the on-site review is cut to approximately four months from the usual 9 to 12 months. This not only allows the company to focus on its normal operations but it also limits the amount of time and resources spent on audit matters.
- The company can work proactively on a comfortable schedule rather than react to problems. Without an on-site government presence, companies need not worry about rushing to satisfy an information request or making the wrong impression.
- The whole tone of the audit is changed. Rather than being geared toward finding violations and assessing penalties, the goal becomes locating and resolving problems and establishing procedures to limit future problems.
- The company will undergo reduced cargo/transactional examinations. This is possible when acceptable compliance is determined.
MORE CPA SERVICES
The appraised value of merchandise imported into the United States is known as the transaction value of the goods; that is, the price actually paid or payable for the merchandise when sold for exportation to the United States (the invoice price). Certain costs must be added to this value for duty assessment, including
- The buyer's packing costs.
- The buyer's selling commissions.
- The value of any "assist"—almost anything the buyer of the imported merchandise provides, directly or indirectly, free or at a reduced cost for use in producing or selling the merchandise for export to the United States.
- Royalties or license fees the buyer has to pay, directly or indirectly, as a condition of the sale.
- Proceeds of the import's subsequent resale, disposal or use that accrue, directly or indirectly, to the seller.
| U.S. Customs Target Industries for 1998 |
Industries subject to heightened scrutiny
(including telecommunications and advanced displays)
(including bearings and fasteners)
Industries on Watch List
Source: U.S. Customs' 1998 Trade Enforcement Plan
Many companies have valuation difficulties because their employees don't know all the costs that customs considers taxable or don't realize that their daily activities have significant customs implications. Even if those implications are apparent, communication between corporate departments often is lacking.
For example, a purchasing manager for a U.S. apparel company purchases fabric from a factory in Italy and provides the fabric, free of charge, to a suit manufacturer in Hong Kong. Customs considers the Italian fabric and the related transportation costs to Hong Kong dutiable additions to the invoice price. If the purchasing manager doesn't notify the company's import department that the fabric was sent to the Hong Kong manufacturer, the cost information given to U.S. customs when the finished suit is imported will be undervalued and the duty underpaid.
This is a dangerous scenario for the company because customs scrutinizes assists carefully and undoubtedly will discover this material omission. The company then will be required to pay the loss of revenue to customs (assume, for this example, $100,000) plus penalties, which can be a maximum of eight times the revenue loss ($800,000) or the domestic resale value of the merchandise ($5 million). In addition to these monetary costs, the company's future shipments probably will be subject to extensive customs examinations at the port of entry, resulting in severe delays. Also, the negative publicity may damage the company's goodwill and brand name when the public learns of the penalty action.
A company's CPA could have prevented this situation by
- Detecting this violation through a review of the company's import operations. The CPA then could have helped the company prepare and submit a prior disclosure which would notify customs of the omission, thus eliminating the penalty liability.
- Establishing procedures and controls to notify appropriate parties when actions affected the taxable value of imported merchandise.
- Arranging an in-house customs training session for all employees with roles in the import process, including purchasing, research and development (R&D), transportation and traffic, legal, financial, tax, information management and manufacturing.
MORE TO BEAR
As with everything in life, bigger opportunities bring bigger risks. Although companies may realize significant benefits by expanding their cross-border operations, they must be aware of their complex responsibilities and obligations and the many possible penalties for customs violations. Because of this, tax directors, CFOs and other CPAs are being entrusted to make corporate decisions regarding customs and international trade matters. To effectively make the "right call," these professionals must understand the consequences of their decisions and be informed.
The regulatory environment has changed rapidly. Under the modernization act, the U.S. government has shifted the burden to the international trader to provide accurate tariff classification, merchandise valuation, country of origin and pricing and financial information to customs. Moreover, importers are now required to exercise reasonable care in their transactions.
Informed CPAs now are in a special position to assist their companies and clients to exercise the requisite care for customs purposes and maximize the benefits of going global. This is an opportunity that all CPAs must embrace.
Rulings & Regulations
International Trade Commission
|U.S. Customs Headquarters, Classification and
U.S. Customs Headquarters, Regulatory Audit Division
Department of Commerce, Export Administration
Harmonized Tariff Schedule of the United States ,
Department of Commerce, U.S. International Trade Commission,
Washington, D.C., January, 1994. To order an electronic copy
call the National Technical Information Service at 800-553-6847.
Order number: PB94-500980INC. Price: $31. |
Customs Regulations , Title 19, National Archives and Records Administration, Office of the Federal Register, Washington, D.C., April, 1997. To order a copy call the National Technical Information Service at 800-553-6847. Order number: PB97-179006INP. Price: $49.
Customs Valuation Encyclopedia , U.S. Customs Service, Office of Regulations and Rulings, Washington, D.C., 1995. To order a copy call the National Technical Information Service at 800-553-6847. Order number: PB97-150627INP. Price: $49.
Importer Audit Compliance Assessment Team (CAT Kit
Documents) , U.S. Customs Service, Office of
Strategic Trade Regulatory Audit Division, Washington, D.C.,
|American Association of Exporters and Importers
New York City
National Association of Foreign-Trade Zones