As the disruptive and uncertain trade environment continues its dominance on the corporate boardroom agenda, CPAs at multinational companies are increasingly tasked with assessing its impact on their organizations and developing strategies for mitigating its potential negative effects. Although there are plans for the United States and China to sign the first phase of a trade deal within the next week, uncertainty over tariffs persists.
For many organizations, particularly those in industries that have enjoyed low tariffs and minimal trade regulation in the past, developing an effective response to address the risks of an intensifying global trade war presents a significant challenge. Notwithstanding, many are succeeding, and CPAs should know that there are strategies and tactics they can use to assist their organizations as they turn today’s trade disruption into a competitive opportunity now and in the years ahead.
Import tariffs, also referred to as “duties,” are essentially taxes levied on certain imported merchandise from select countries or companies (see the sidebar “Common Types of Tariffs Assessed on Goods Imported Into the US”). Tariffs may be used as an instrument of protectionism or as a means to raise government revenues.
For importers, tariffs are another cost of bringing products to market and often ultimately end up booked as part of the cost of goods sold.
The tariff applicable to a product varies depending on the type of product. While some tariffs are assessed as a fixed amount per unit of imported merchandise, the vast majority of tariffs are assessed as a percentage of the declared “customs value” of the goods. The percentage is referred to as the duty rate. Duty rates vary by product and by the country of origin of the item assessed. The customs value that the duty rate is assessed against is most often the price paid or payable for the imported goods when the goods are exported to the United States, plus certain statutory additions. Nevertheless, when there is no sale for export to the United States or when the sale is between parties that U.S. Customs and Border Protection (CBP) regulations consider related, another method of appraisement may be required.
Strategic tariff planning
For decades, U.S. companies have deployed a variety of methods to alleviate the cost pressures of tariffs. Some of these tactics defer the payment of duties. Some reduce or eliminate the duties payable, and others allow companies to reclaim duties previously paid. With the recent onslaught of tariffs into the United States, and worldwide, opportunities for tariff management that once were applicable only to traditionally high-duty-rate importers, such as apparel and footwear, are now an appealing competitive tool for companies across industries.
Companies implementing tariff mitigation strategies anticipated reducing the impact of tariffs by 59%, according to KPMG’s 2019 Tariff Impact Survey.
Below are some of the primary strategies leading companies are using to mitigate the effects of rising global import tariffs.
Country of origin planning
Whether or not a duty is applicable may be based on the item’s “country of origin.” For example, most recently, certain goods from China are subject to punitive tariffs imposed by the Trump administration, namely under Section 301 of the Trade Act of 1974. Accordingly, companies are increasingly evaluating their production processes to potentially alter the finished product’s final country of origin to escape the Section 301 tariff burden.
The effectiveness of this strategy is often contingent on whether CBP will recognize the processing in the second country as a “substantial transformation.” For instance, the assembly of numerous parts to create various intermediate components, and the subsequent assembly of the intermediate components to produce a new finished good, may potentially result in a substantial transformation of the parts. Generally, the country of origin of the finished good will be where that substantial transformation takes place. However, when only simple or noncomplex assembly occurs in a country, CBP has ruled that the processing is not sufficient to constitute a substantial transformation of the imported components in that country. The substantial transformation requirement is complex, fact-specific, and based on the totality of the circumstances, so a CBP ruling or professional advice should be sought when considering whether to adjust supply chain operations to affect origin changes.
Assessing tariff classification
The Harmonized Tariff Schedule of the United States (HTSUS) provides the applicable tariff rates and statistical categories for all merchandise imported into the country. For most tariffs, including normal “most favored nation” (MFN) tariffs, the HTSUS code will be a factor in determining whether tariffs apply and at what rate. It is critical that importers review the existing tariff classifications assigned to each imported product to determine whether the classification is accurate and, if not, whether a different classification, not subject to the tariffs, may be more appropriate. Similar to the country-of-origin determination, determining a product’s classification may be complex, and a single, specific component or functionality could alter a product’s classification significantly.
A simple tariff classification example
U.S. Court of International Trade conclusion: Cellphone cases are distinguishable from other protective cases because, unlike other cases, they allow for the article to be used while contained within the case. So cellphone cases would be classified under Option 2.
HTSUS Heading 4202 (15%–20% duty) — Most carrying cases and other cases for protecting/storing/carrying
“Trunks, suitcases, vanity cases, attaché cases, briefcases, school satchels, spectacle cases, binocular cases, camera cases, musical instrument cases, gun cases, holsters and similar containers” for organizing, storing, protecting, and carrying.
HTSUS code 3926.90.99 (5.3% duty) — General catch-all for plastic products not elsewhere specified
Other articles of plastics and articles of other materials of headings 3901 to 3914 . . . Other . . . Other . . . Other
In addition to getting classification right, companies will sometimes plan a product’s design, manufacture, and supply chain to account for variations in HTSUS code and tariff rate. For example, one strategy may be to import unassembled components into the United States for assembly, as the components may fall into a different, lower tariff rate than would be levied against the finished good. Another example might be to manufacture or engineer the product in alignment to a certain tariff provision to obtain a more favorable rate or complete exclusion from a specific tariff list.
Moreover, there are numerous special classification provisions that often allow for duty-free treatment when the import meets certain requirements. Below are a few examples:
- Goods previously exported from the United States and returned not advanced in value or improved overseas.
- Goods containing U.S. origin components.
- Goods imported that are specially designed or adapted for various medical purposes under special provisions (e.g., Nairobi Protocol).
- Goods previously exported from the United States for repair or alteration.
- Goods imported for agricultural use.
Eliminating tariffs — request an exclusion
Companies that have been subject to recent Trump administration tariffs may request an exclusion to such tariffs from the U.S. Trade Representative (USTR). Over the last year the USTR has approved and denied hundreds of exclusions submitted by importers and various industry associations. The criteria USTR uses to determine whether an exclusion should be granted are as follows: (1) whether the tariffs would cause severe economic harm to the company or the United States; (2) whether the product is available in the United States or in a third, non-China country; and (3) whether the product is relevant to the “Made in China 2025” initiative or any other strategic industrial policy in China. Exclusions apply to the products themselves and are effective for one year. Importers of excluded goods may retroactively apply for refunds of tariffs paid.
Deferring and/or eliminating tariffs — FTZs and bonded warehouses
For companies involved in manufacturing or distribution activities in the United States, bonded facilities and/or foreign trade zones (FTZs) may provide some protection from tariffs. A bonded facility is a building or other secured area in which imported dutiable merchandise may be stored, manipulated, or undergo manufacturing operations without payment of duty for up to five years from the date of importation. FTZs are also secured areas under CBP supervision that are considered outside CBP territory; merchandise may be moved into zones for operations, including storage, exhibition, assembly, manufacturing, and processing. The most common FTZ and bonded facility tariff benefit occurs when a product subject to tariffs is destroyed or exported to another country from the facility.
Recovering tariffs — duty drawback
Duty drawback permits companies to recover 99% of duties, taxes, and fees paid on imported merchandise when such items are exported, used in domestic manufacturing operations for export, or destroyed. Drawback may also apply to similar products that are exported, providing there are imports for which no other drawback was claimed and specific rules are satisfied.
While drawback has always been available, the incentives are significantly higher now given the large increase in tariff costs resulting from the trade war. In addition, recent changes under the Trade Facilitation and Trade Enforcement Act, P.L. 114-125, may enable companies to recover tariffs more easily and with less administrative burden than in past years. Drawback is complex, and eligibility can vary depending on the transaction, product, and other specific facts; however, as it is one of the few programs that allows for the substantial recovery of tariffs (i.e., 99%), it is one that is certainly worth considering.
Reducing tariffs — removing nondutiable charges
As in most countries, CBP uses the transaction-value method of appraisement to determine the dutiable value of imported merchandise. As noted above, this generally means the tariff rate is assigned against the invoice price and the price paid for the goods. However, in many cases, there are charges included in the invoice price that may not be dutiable. In those instances, such costs could be deducted from the transaction value, ultimately allowing for a lower declared value. Below are some common nondutiable charges that may potentially be excluded from the transaction value under certain conditions.
- International freight.
- Post-importation costs such as construction, assembling, etc.
- Certain interest payments.
- Buying commissions.
- Terminal handling fees.
- Port security fees.
- Customs inspection fees.
- Container booking fees.
- Prepaid duties and other taxes.
- Courier fees.
- Late document fees.
- Customs export declaration fees.
- Inspection fees if paid to a third party.
- Banking fees.
- Shipping document fees.
Reducing tariffs — the first sale principle
The “first sale for export” principle is a U.S. customs-valuation planning opportunity that may reduce the dutiable value of certain eligible transactions involving products imported into the United States, thereby reducing the corresponding duty liability. Under the first-sale-for-export principle, U.S. importers can reduce the amount of duty paid by using a lower dutiable value in situations where there is a chain of multiple arm’s-length sales for the export to the United States. Under the first-sale-for-export principle, the importer can declare the earlier sale (the transaction between the manufacturer and the middleman), which reduces the dutiable value by removing the middleman’s profit and other costs such as freight recovery costs possibly included in the second-sale price. As such, this essentially lowers the dutiable value of the goods and the amount of duties payable.
Below is an illustration of a common first-sale transaction.
Recovering tariffs — transfer pricing
Tariffs and income tax planning are often interconnected and impact each other. One of the most direct connections is that “transfer prices,” established between related parties for income tax purposes, are often also used by companies as the declared customs value for imported products, serving as the basis for duty computation purposes.
Post-importation adjustments of transfer prices are often necessary, for instance, when the profitability of the tested entity falls outside of the arm’s-length range established for income tax purposes. These adjustments, when related to imported products, are typically required to be considered in determining the final customs value. When the adjustment has a retroactive downward effect on transfer prices, the taxpayer may be able to obtain refunds on the duties paid on products at the time of import in relation to the amount of the downward adjustment. For example, if the average duty rate for a company’s imports from its related party is 25%, the company may be able to recover $25 in duties for every $100 of adjustment. However, to qualify for the refund, importers must satisfy CBP’s five-factor criteria, which often require proactive efforts between the company’s transfer-pricing and customs teams and advisers (see the sidebar “CBP’s 5-Factor Criteria”).
Assess mitigation options now
Planning for tariffs has never been more critical for businesses, and leading companies are looking to their CPAs to develop and drive effective tariff mitigation strategies. Fortunately, there is a variety of programs, both new and old, that can help mitigate the effects of increasing global tariff rates. The time is now to assess these options and take steps to help ensure your company remains competitive in the tumultuous years ahead.
— Andrew Siciliano, CPA, J.D., is a tax partner with KPMG LLP based in Melville, N.Y. He leads KPMG’s U.S. Trade and Customs National practice. Douglas P. Zuvich, CPA, MBA, is a senior lead tax partner at KPMG LLP based in Chicago. He leads KPMG’s Global Trade and Customs practice. To comment on this article or to suggest an idea for another article, contact Ken Tysiac, the JofA’s editorial director, at Kenneth.Tysiac@aicpa-cima.com.
Common types of tariffs assessed on goods imported into the US
Standard tariffs are assessed on imported products and enforced by U.S. Customs and Border Protection (CBP). The duties are used as a source of revenue for the U.S. government, as well as to incentivize domestic businesses to purchase goods in the United States. The duties are individually associated with over 17,000 unique, 10-digit customs classifications in the Harmonized Tariff Schedule of the United States (HTSUS), published and maintained by the U.S. International Trade Commission (USITC).
Anti-dumping duties (ADD) are assessed against certain products from select companies and countries to remedy unfair trade practices, whereby imported products are being offered below the fair market value (FMV) or “dumped” into the United States.
Countervailing duties (CVD), similar to ADD, are used to protect domestic manufacturers from foreign manufacturers who are offering products below the FMV. However, CVDs are specifically used when products are being imported from foreign manufacturers below FMV due to a foreign government subsidy.
Section 201 of the Trade Act of 1974 allows for the president to impose restrictive measures, such as additional tariffs, when the USITC concludes that an increase in imports is a substantial cause or threat of serious injury to a domestic industry.
Section 232 of the Trade Expansion Act of 1962 allows for the president to impose tariffs based on a recommendation from the U.S. secretary of Commerce if “an article is being imported into the United States in such quantities or under such circumstances as to threaten or impair the national security.”
Section 301 of the Trade Act of 1974 authorizes the president to take all appropriate action, including retaliation, to obtain the removal of any act, policy, or practice of a foreign government that violates an international trade agreement or is unjustified, unreasonable, or discriminatory and that burdens or restricts U.S. commerce.
CBP’s 5-factor criteria
CBP will accept duty refund requests for downward pricing adjustments if the following five-factor criteria are met:
- A written intercompany transfer-pricing determination policy is in effect prior to importation that takes into account Internal Revenue Code Sec. 482;
- The U.S. taxpayer importing company uses its transfer-pricing policy in filing its income tax return, and adjustments under the policy are reported in the income tax return;
- The transfer-pricing policy states specifically how the transfer price and adjustments are determined as to all products covered by the policy;
- The company maintains and provides accounting details in its books and financial statements to support the claimed adjustments in the United States; and
- No other conditions exist that may affect the acceptance of the transfer price by CBP.
If these factors are met and it can be shown that the relationship between the companies did not influence the price, CBP should allow importers to adjust their declarations and recoup past duties.
Global trade resources
CPAs considering tariff mitigation strategies are not on their own, as there is an array of available public resources, industry groups, and CPA subject-matter experts that specialize in global trade matters:
- U.S. Customs and Border Protection (CBP)
- CBP Informed Compliance Publications
- “Importing into the United States: A Guide for Commercial Importers”
- CBP Rulings (CROSS) — a searchable database of CBP Rulings
- CBP Directives and Handbooks
- World Customs Organization (WCO)
- World Trade Organization (WTO)
- The WTO Regional Trade Agreements Information System (RTA-IS)
- European Customs Information Portal
- Binding Tariff Information — European Union
- American Association of Exporters & Importers
- International Compliance Professionals Association
- National Customs Brokers & Forwarders Association of America
- National Association of Foreign-Trade Zones (NAFTZ)