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.
significant penalties if they
do not comply with relevant
import/export rules and regulations.
participate in voluntary
self-governance programs offered by the
U.S. government in exchange for not
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
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
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
services to other countries. For
the same period U.S. imports
Source: U.S. Census
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.
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
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
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.
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.
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.
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
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.
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.
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
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 |
|Bureau of Industry
and Security (Commerce
and/or $50,000 per
Defense Trade Controls
and/or $1 million fine
of Foreign Assets
and/or $1 million
$50,000 per violation
||$1,000 to $10,000
||$10,000 and/or 5
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.
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
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.
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
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.
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
| 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. |
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.
company consider operating in
a foreign trade zone to reduce
customs entries and defer
THE CPA’S ROLE
CPAs can help their clients and employers
manage import/export risks and capitalize on
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
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
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
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.