President Trump’s trade war with China is showing no signs of slowing down. In the most recent salvo, the United States imposed steep additional duties on over 5,745 tariff lines of Chinese products representing approximately $200 billion in annual import value. This round of retaliatory duties (known as List 3) follows two other lists covering approximately $50 billion in annual imports from China.
The products hit with additional duties this time include a variety of fashion and beauty products, including handbags, backpacks, wallets, purses, hats, belts, perfume, cosmetics, and many others. The additional duties started on September 24, 2018 at a 10 percent rate and are set to increase to 25 percent on January 1, 2019. These duties (or retaliatory tariffs) are on top of the pre-existing (or normal) tariffs already in place.
Apparel importers, which have so far been spared from these additional duties for the most part, are now bracing for the next round, should there be one.
While the imposition of retaliatory tariffs may sound like a prohibitive “flat tax,” the reality is that not all companies will pay these duties equally. Understanding the nature of these retaliatory tariffs will bear on an importer’s ability to navigate these uncertain times and come out ahead.
Retaliatory Tariffs: What’s a Company to Do?
The imposition of the retaliatory tariffs presents a significant number of importers with a new—and potentially crippling—cost of sourcing in China. Affected companies are well advised to carefully review their importing operations to recognize duty saving strategies, including some of the following:
Every product imported into the United States must be assigned a tariff classification under the Harmonized Tariff Schedule of the United States (HTSUS). The classification of the imported product dictates the normal rate of duty, which will be applied to the product upon import into the U.S. The applicability of the recent retaliatory tariffs on goods from China also hinge on the tariff classification. Very often, the classifications that have been used for years are simply wrong or subject to interpretation.
A recent case involving iPhone covers provides a nice illustration of the importance of tariff classification. Until recently, U.S. Customs & Border Protection (Customs) classified cases for iPhones and similar smart phones under a tariff provision which is dutiable at 20 percent ad valorem, namely tariff code 4202.99.00, a subheading which covers “trunks, suitcases, vanity cases, attaché cases, briefcases, school satchels, spectacle cases, binocular cases, camera cases, musical instrument cases, gun cases, holsters, and similar containers.” However, an importer of iPhone covers challenged Customs’ interpretation in court, maintaining that the covers are properly dutiable at only 5.3 percent under a provision for “other articles of plastic.” In Otter Products, LLC v. United States, the court sided with the importer, saving the importer millions in regular duties. Interestingly, the provision under which Customs had classified iPhone cases is now also covered by additional retaliatory tariffs, whereas the classification used by the importer (and approved by the courts) is not covered by retaliatory duties. As such, the importer currently pays a duty rate of 5.3 percent, rather than 30 percent (and 45 percent starting January 2019).
Country of Origin
Every product imported into the United States must be assigned a country of origin. This determination can be complicated when finished products include raw materials or componentry from multiple countries and where such merchandise undergoes manufacturing processes or assembly operations in multiple countries.
Because the China retaliatory duties only apply to goods that are a product of China, shifting all—or in some cases relatively minor aspects of the production—may reduce tariffs from 25 percent to 0. For example, Customs has ruled that perfume oil sourced in one country (like France) and sent to another country (like China) for processing into body mists by diluting the oil with alcohol and water and then bottling did not undergo a “substantial transformation” in the second country. The result is that the perfume oil dictates the origin of the finished body mist, despite the significant processing that occurred in the second country. Thus, a company producing eau de parfum in China utilizing Chinese perfume oil will be subject to the retaliatory tariff, but if they use perfume oil from a second country, then they will not be subject to the higher tariff. Companies affected by such duties need to examine the country of origin rules and their production processes in order to develop strategies to navigate around these duties.
Customs valuation involves a number of complex formulas by which Customs determines the dutiable value of imported merchandise. The manner in which various elements of cost are identified and documented will frequently determine whether such costs are properly included in the customs value and be the subject of duty assessment. Most imported merchandise is appraised under “transaction value,” which is simply defined as the price paid by the buyer to the foreign seller when the merchandise is sold for exportation to the U.S. Where merchandise is purchased through an intermediary and not directly from the manufacturer, however, dutiable value may be reduced to exclude buying commissions, middleman company markups, and non-production overheads.
For example, Synergy Sport International, Ltd. v. United States, 17 CIT 18 (1993); involved the dutiable value of wearing apparel. In that case, J.C. Penney ordered apparel from Synergy, a Hong Kong. The Court held that the dutiable value of the merchandise could be based upon the factory price to the middleman, not the higher price charged by the middleman to the U.S. importer. Valuation at the “first sale” price (the price charged by the factory to the middleman) can often result in significant duty savings. Thus, many importers may find that they are, in fact, already buying from middlemen trading companies. This opens the opportunity for them to take advantage of a lower valuation, thus significantly reducing the impact of the retaliatory duties.
E-Commerce Duty Exemption
E-commerce companies and others have recently discovered that a decades-old duty exemption for “mail order” importations can be used to eliminate customs duties altogether, including the retaliatory duties, in connection with direct to consumer sales. Thus, individual orders valued at $800 or below may be eligible for duty-free clearance.
No one knows how long the current trade wars will last or whether additional tariffs will be imposed over those that are already in place. Smart importers, especially those impacted by the recent spate of retaliatory duties, should closely study their imports to identify whether opportunities exist to avoid or mitigate the impact of the retaliatory duties through tariff classification, country of origin, or valuation strategies. Many of these benefits will continue long after the Trump trade war ends. Those importers who do not take advantage of such strategies will undoubtedly fare worse.
Peter W. Klestadt, Esq.