The Risks of Being Global

How to manage overseas opportunities.
BY ANDREW L SICILANO AND DOUGLAS P. ZUVICH

EXECUTIVE SUMMARY
Increased international trade regulations have led to greater risks for companies that do business abroad. How CPAs help companies manage these risks will vary based on the countries and products involved, the size of the company, the potential penalties and the company’s import/export structure.

In going global, companies face a number of import/export risks including exporting without a license, attempting to re-export to bypass an embargo and improper tariff classification.

Companies face significant penalties if they do not comply with relevant import/export rules and regulations.

Some companies participate in voluntary self-governance programs offered by the U.S. government in exchange for not being audited.

CPAs can help companies identify the possible risks, test the adequacy of internal controls intended to spot those risks and consider any violations before they become costly in terms of penalties and damaged reputation.

CPAs can provide companies with information that will enable them to develop appropriate internal controls. Reviewing data from the Census Bureau about a company’s trade activities can give accountants the information they need to make these recommendations.

Andrew L. Siciliano, CPA, JD, is a senior manager in the trade & customs services practice of KPMG LLP based in the firm’s Melville, N.Y., office. Douglas P. Zuvich, CPA, is the national partner in charge of the trade & customs services practice of KPMG LLP based in the firm’s Chicago office. Both are licensed customs brokers. Their e-mail addresses are asiciliano@kpmg.com and dzuvich@kpmg.com , respectively.

The information contained in this article is general in nature and based on authorities that are subject to change. Applicability to specific situations is to be determined through consultations with your tax advisor. The views and opinions are those of the authors and do not necessarily represent the views and opinions of KPMG LLP.

s global competition expands, companies are exposed to myriad risks related to their international trade activities. It’s important for companies to manage these trade risks in the same way they manage other business risks. New opportunities overseas, increased government scrutiny of exports due to heightened security concerns, a surge in special trade programs and increasing trade activity make 2007 a year in which businesses will need to manage these trade risks more than ever before.

U.S. International Trade

In 2005 U.S. companies exported $1,275,245,000,000 in goods
and services to other countries. For
the same period U.S. imports
were $1,991,975,000,000.

Source: U.S. Census Bureau,
www.census.gov/foreign-trade .

The potential for severe noncompliance penalties has made monitoring import and export activities a key requirement for U.S. business, and CPAs who work for or advise companies that do business internationally need to be aware of trade-compliance risks. This article takes a closer look at the international trade regulations with which companies must comply and provides guidance to help CPAs advise them on how to minimize risk and remedy trade-compliance-related internal control deficiencies.

WHAT ARE THE RISKS?
Trade risk is not as simple to manage as other business risks, given the number of government agencies involved and the fact that every transaction may be subject to numerous regulations. Importers and exporters use a variety of risk-management approaches depending on the countries and products involved, the size of the company, the financial impact of noncompliance and the company’s overall import/export structure.

Some companies participate in voluntary self-governance programs offered by the U.S. government in exchange for not being audited. Others incorporate the import/export function into their Sarbanes-Oxley Act testing program. But perhaps the most common practice is to rely on customs brokers, the agents responsible for filing entry paperwork with U.S. Customs and Border Protection, to help manage trade risk.

In the United States, the importer of record must use “reasonable care” to enter, classify and determine the value of imported merchandise and provide any other necessary information Customs needs to properly assess duties, collect accurate statistics and determine whether the transaction meets all applicable legal requirements. Customs also is responsible for determining the final classification and value of the merchandise. An importer’s failure to exercise reasonable care could delay release of merchandise and, in some cases, result in the imposition of penalties.

A number of executive branch agencies have responsibilities for regulating exports from the United States, including

The Bureau of Industry and Security (BIS), which implements and enforces the Export Administration Regulations (EAR), which regulate the export and re-export of most commercial items.

The State Department, which controls arms exports.

The Census Bureau, which is responsible for trade statistics.

The Department of Energy, which controls exports and re-exports of technology related to the production of special nuclear materials.

The Department of Treasury, which administers certain embargoes.

Exhibit 1 lists contact information for agencies involved in international trade.

Export regulations generally impose legal responsibility on all persons who have information, authority or functions relevant to carrying out a transaction. This includes exporters, freight forwarders, carriers, consignees and overseas companies.

  Helpful International Links

CPAs can use the following links to obtain additional information about import and export compliance and planning.

American Association of Exporters and Importers
www.aaei.org

U.S. Census Bureau
www.census.gov

Bureau of Customs and Border Protection
www.cbp.gov

Bureau of Industry and Security
www.bis.doc.gov

Commerce Department
www.commerce.gov

State Department, Directorate of Defense
Trade Controls
www.pmddtc.state.gov

National Association of Foreign Trade Zones
www.naftz.org

Office of Foreign Assets Control
www.treas.gov/offices/enforcement/ofac

U.S. International Trade Commission
www.usitc.gov

U.S. Court of International Trade
www.cit.uscourts.gov

COMMON IMPORT/EXPORT ERRORS
Listed below are some common risk areas CPAs should be aware of when advising import or export companies on risk management issues.

Undeclared import values. A product’s import value is critical because, in most cases, it directly affects the duty owed—generally a percentage of the value assigned. This value should include the price of the imported merchandise, plus any additional costs of (re)manufacturing or other payments related to the product borne by the importer.

IRC section 1059(A). When a company imports dutiable goods from related parties, section 1059(A) limits the amount of deduction or cost of goods sold basis to the amount declared to and finalized by Customs. Section 1059(A) prevents an importer from simultaneously declaring a lower value to Customs in order to pay less duty and a higher value to the IRS in order to pay less income tax. If a taxpayer underreports a customs value due to an undeclared royalty, price change or the like, it can lose its tax deduction or basis for the entire amount not appropriately reported to Customs and also be liable for the unpaid duties, fees, interest and applicable penalties.

Exporting without a license. Many exports, including software and technology, require a license from the BIS or some other government agency. License requirements are based on a number of factors, including technical characteristics of the exported item, its destination, the end user and the end use. Exporters unaware of these obligations or with insufficient internal controls in place do not always get the licenses they are required to have to export legally.

Re-exports. Companies cannot bypass the export regulations by shipping items through a third country. The transshipment, re-export or diversion of goods and technologies in international commerce may violate U.S. law. For example, an exporter cannot bypass the U.S. embargo against Country A by shipping an item to a distributor in Country B and asking the distributor to transship the item to a customer in Country A. This would be considered an export to Country A, even though it does not go directly to that country, and both the U.S. exporter and Country B could face liability.

Tariff classification. Proper classification of tariffs determines the duty rate that applies to each imported good. Incorrectly classifying a product could result in a company’s paying duty at the wrong rate. Since duty typically is included in the cost of goods sold, an incorrect tariff could have a direct impact on the accuracy of a company’s cost of goods sold account.

TRANSACTIONS TO CONSIDER
CPAs should make companies aware that trade risks may arise even when there isn’t a purchase or sale transaction. For example, an item’s import value can be much higher than the actual purchase price. The law requires companies to take into consideration certain other costs and expenses—paid separate from the purchase or sale price—when determining a product’s dutiable value. These include royalties, commissions paid to the supplier’s agent and the cost of materials or other items provided to the supplier free of charge or at a reduced cost.

Here are some examples of trade-related activities that have the potential to trigger import/export risk:

Tax-transfer prices used for customs purposes. In related-party transactions, tax-transfer prices used for customs declaration need to satisfy customs-related party pricing rules. Customs wants to make sure related companies don’t set prices too low.

Transfers and payment for intellectual property rights. Payments for such rights may be dutiable if they correspond to an imported good. Companies should factor in the potential customs implications of any royalty or license payment an importer makes to a foreign seller.

Pricing adjustments, including transfer pricing adjustments. If post-import pricing adjustments are related to an import transaction, the company may need to declare such adjustments to Customs.

Other examples include the following:

Transactions involving multiple buyers and sellers.

Mergers and acquisitions of companies that trade internationally.

Sales of U.S. products to foreign subsidiaries not subject to U.S. sanctions.

Furnishing assistance to a foreign manufacturer when producing a good.

Sales of goods, shipments of samples, transfers or disclosures of technology and providing services to foreign customers.

Electronic transmissions of technical data via fax, the Internet or intranet.

International joint ventures and other cross-border arrangements with companies engaged in business with U.S. embargoed countries.

THE COST OF NONCOMPLIANCE
The penalties companies face for not playing by the rules include imprisonment, monetary fines and suspension or debarment from any further export activity. For import transactions, penalties range from two times the lost duties for mere negligence up to the domestic value of the merchandise in cases involving fraud. Even when there is no actual duty loss, Customs can impose penalties equal to a significant percentage of the dutiable value of the goods.

Although Customs has worked closely with the trade industry since the Customs Modernization Act of 1993, it still needs assurance that companies are following the rules. As a result audits and penalty assessments are becoming more common. For example, The Court of International Trade recently issued significant penalty decisions in undervaluation cases, further highlighting the importance of strong and effective internal controls related to the import and export function. Companies also need to be aware of the potential financial statement impact of noncompliance with trade regulations.

The export penalties a company faces can be very significant. Exhibit 2 summarizes export penalties under the Export Administration regulations and other practical risks. The chart does not include fines other government agencies such as the Bureau of Census and the State Department may impose, which also could be quite severe.

  The Potential Cost of Export Violations
US Government Agency Civil Penalties Criminal Penalties
Bureau of Industry and Security (Commerce Department) $50,000 per violation 20 years’ imprisonment and/or $50,000 per violation
Directorate of Defense Trade Controls (State Department) $500,000 per violation 10 years’ imprisonment and/or $1 million fine
Office of Foreign Assets Control (Treasury Department) North Korea/Cuba Sanctions: $65,000per violation North Korea/Cuba Sanctions: 10 years’ imprisonment and/or $1 million corporate fine/$100,000 individual fine
  Other: $50,000 per violation Other: 20 years’ imprisonment and/or $50,000 per violation
Census Bureau (Commerce Department) $1,000 to $10,000 per day $10,000 and/or 5 years’ imprisonment

TESTING AND DEALING WITH VIOLATIONS
To effectively manage trade risk, CPAs can help importers and exporters identify the risks, test internal controls and business processes and properly deal with violations.

Identifying risk. Developing an internal control framework around trade compliance begins with a systematic approach to identifying risks. Evaluate each risk area separately, as the types of trade risk are specific to a company and depend on the products, countries, trade programs and methods of valuing goods. One way of identifying risk is to analyze a company’s import and export trade data. The Customs Office of Strategic Trade and the Census Bureau provide raw import/export data for a nominal fee. CPAs should examine these data periodically to better understand a company’s import/export trade patterns and determine the highest risk areas.

Testing the adequacy of internal controls. Reasonable-care standards require companies to incorporate a risk-monitoring program into their internal control framework. It should include not only frequent post-entry reviews of trade documentation, but also a program designed to test high-risk transactions. When preparing to audit a company that trades goods internationally, CPAs should consider including a testing plan for assessing trade risks in the scope of the audit. Companies also should incorporate a periodic risk-monitoring program into their internal audits or conduct one with outside assistance.

Due diligence reviews. Many import and export risks are inherited through acquisitions and only arise years later. When a client or employer acquires a company, CPAs should consider testing for contingent liabilities associated with noncompliance with import and export regulations by conducting a review or audit.

Voluntary self-disclosures. Both Customs and the BIS accept voluntary prior disclosures of past problems. A CPA who discovers such an error should recommend a timely voluntary disclosure, which could reduce or eliminate penalty exposure or be a mitigating factor when negotiating settlements.

Importer self-assessment program. Importer self-assessment (ISA) is a partnership between Customs and the trade community that gives importers maximum control of their own import compliance. Customs expects companies that participate in the program to adopt internal control standards in line with the Committee of Sponsoring Organizations’ (COSO) internal control components as defined in SAS no. 78, Control Environment, Risk Assessment, Internal Control Activities, Information and Communication and Risk Monitoring. (For more details see “ Building a Compliance Infrastructure. ”)

EFFECTIVE INTERNAL CONTROL
The benefits of an effective internal control structure extend beyond trade compliance and may even be the foundation for achieving financial savings. Companies can improve their financial performance by pursuing these opportunities:

First-sale principle. To reduce duty liability in transactions involving multiple parties, companies can assess duty on the earlier price between the manufacturer and a middleman company, instead of the later price between the middleman and the importer.

Foreign trade zones (FTZs). Operating in an FTZ allows companies to realize cash benefits based on reduced customs entries and increased cash flow resulting from duty deferral. Though located in the United States, FTZs are not considered part of the U.S. customs territory.

Tariff reengineering. Under the Harmonized Tariff Code of the United States, a company can classify its own products and determine the proper duty rate. By carefully planning import transactions, a company may be able to obtain lower duty rates by classifying goods under more favorable provisions.

Duty drawback. Companies can obtain duty refunds on exported merchandise that was previously imported if they meet certain documentation requirements.

» Practical Tips
Evaluate each area of trade risk separately as the types of risk are specific to each company and depend on factors such as the products, countries, trade programs used and methods of valuing goods.

Periodically examine the company’s import/export data available from the Census Bureau to determine the relevant risk areas and to better understand the trade patterns.

Recommend the company consider operating in a foreign trade zone to reduce customs entries and defer duty.

THE CPA’S ROLE
CPAs can help their clients and employers manage import/export risks and capitalize on opportunities by

Making sure the CFO has appropriate controls in place to govern import/export activities and sponsors duty savings initiatives.

Helping external auditors evaluate the existence and effectiveness of the internal controls over the company’s import and export activities.

Conducting periodic audits and reviews for internal auditors including transactional testing to evaluate the effectiveness of internal controls. As weaknesses and discrepancies are identified, the internal auditors can develop and document enhanced controls and procedures.

Helping accounting managers identify financial activities that should be reported immediately to responsible parties within the organization.

Assessing whether any material contingent liabilities exist, such as underpayments of duty or penalties that have been assessed for noncompliance.

Providing information on industry-leading practices to help the company develop appropriate internal controls, assist in the mitigation of violations, facilitate government audits and conduct independent external reviews.

IMPORT/EXPORT
CPAs traditionally are trained to evaluate risks, conduct audits and reviews, develop appropriate internal controls and understand regulations. By learning the applicable international trade rules, CPAs can apply these skills to a company’s import and export activities. Coupled with their intimate knowledge of their clients and company operations, accountants are well-positioned to help clients and employers source and sell internationally.

 
  Building a Compliance Infrastructure

For import transactions, Customs expects companies to adopt internal control standards in line with the COSO internal control components as defined in SAS no. 78, Control Environment, Risk Assessment, Internal Control Activities, Information and Communication and Risk Monitoring. Its Web site lists “Best Practices of Compliant Companies” which gives the applicable COSO internal control component next to each best practice. ( www.cbp.gov ). The published list of Customs best practices follows:

1. Have management’s commitment (Control environment)
Demonstrate management‘s commitment to compliance.
Establish a statement of corporate policy that addresses Customs and Border Protection (CBP) matters.
Solicit a statement from the Board of Directors that assigns authority and responsibility to the customs group.

2. State compliance and cost goals (Risk assessment)
Identify and analyze relevant risk and develop internal goals to manage the risk.
Conduct post-entry reviews and compare these against established goals.
Determine how risk areas should be managed.
Resolve control weaknesses in a timely manner.

3. Develop formal policies (Control activities)
Develop, implement and/or modify formal policies and procedures to ensure that management’s goals and objectives are met.
Verify the accuracy of the Internal Control Manual to ensure processes and procedures achieve prescribed goals and objectives.
Modify controls that are ineffective or inefficient and report to management.
Define accountability and controls in job description.

4. Establish training programs (Information & communication)
Ensure that employees receive appropriate training and guidance to effectively discharge their responsibilities.
Convey pertinent information to the right people at the appropriate time.
Disseminate CBP information via company’s communication system (intranet, bulletin board, mail).

5. Create compliance group (Information & communication)
Establish a customs group.
Foster open communication channels between all departments that may be involved in the CBP processes.
Establish control activities and self-testing processes to verify the accuracy of the company’s internal control system since the quality of the information generated affects the ability of management to make decisions.

6. Access executives for needed resources (Control environment)
Raise the importance of the Customs group and provide adequate authority for the group to interact with other departments as needed.
Organize the customs group so that it is visible to top level management (e.g. attaching to tax or legal department/division).
Provide an awareness of supply chain structure. Many executives know their sales figures but do they know their key import statistics and suppliers?

7. Develop compliance requirements for suppliers (Control activities)
Develop contract language on purchase agreements.
Develop and implement controls to help ensure that CBP transactions are valid, properly authorized and accurately processed.
Request that suppliers provide regulatory reporting information when applicable (NAFTA, GSP, etc.).
Exercise reasonable care over operations performed by service providers.

8. Establish a record-keeping program (Control activities)
Establish a record-keeping program.
Maintain a record-keeping system that forms an audit trail from production control through payment to CBP entry.
Provide supporting documentation for CBP transactions in a timely manner.

9. Partner with Customs & Border Protection (Information & communication)
Participate in voluntary CBP programs.

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