Companies Finding Success in Mitigating Tariffs Through Valuation, Experts Say
Supply chain location changes are difficult and take time, so companies are turning to other ways to avoid or reduce Sections 301 and 232 tariffs, experts said at a March 7 Georgetown Law International Trade Update (see 1903070033) panel on the Trump administration and the supply chain. For steel and aluminum imports, there's been "a big uptake in foreign-trade zones," said Lynlee Brown, a senior manager at Ernst & Young. With Section 301, companies are using drawback, and after a recent CMS message, they may be taking advantage more often of substitution drawback. But the best bang for the buck, Brown said, is in customs valuation. Companies are making changes there not only because of Section 301, but also because of the administration's tax reform.
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Brown laid out the old way of importing, and the new way, because of changing incentives. Before, many tech firms had an entity in a low-tax jurisdiction that held intellectual property. The U.S. importer paid that entity a royalty for using the IP, and that IP was included in the importation cost, along with the price of the physical product coming from China. Now, she said, there's taxing of outbound intangibles, so it no longer makes as much sense to hold U.S.-developed IP offshore. And, she said, if a company has significant U.S.-developed IP, "carving out that additional R&D can provide significant material benefits." A process for asset computation must be developed, she said, and she directed lawyers to a 2018 CBP ruling on Valuation and Apportionment of Assists.
Brown said it only takes a few weeks to restructure entities to try to take advantage of first sale, but that companies can expect scrutiny on whether it's a bona fide sale. She said CBP will be looking at whether the entity takes credit risk, has inventory risk, and books sales from the contract manufacturer as inventory. Does the entity book sales as accounting revenue and not net revenue? If it's the latter, it will be considered an agent. "Related party analysis, that’s always going to be a risk," she said. Using the pricing method of "all costs plus a profit, that’s likely not going to work any more." She said relying on normal industry practices has the best chance of success.
The auto industry doesn't have the IP lever that the tech industry does, so it's using bonded warehouses, Foreign-Trade Zone warehouses and just shipping Chinese items directly to Mexican or Canadian plants rather than to a U.S. plant that handles supply for the entire NAFTA region, according to Steven Gardon, vice president for global indirect taxes and customs at Lear Corporation, a Tier 1 auto parts supplier. Gardon spoke during the panel with Brown.
If you can't avoid the U.S. warehouse, or use a bonded warehouse, drawback is a useful tool in the auto parts world, because of the integrated North American supply chain. The arrival of Section 301 tariffs meant imported car parts that had previously been taxed at 1 percent to 5 percent were about to be taxed at 25 percent or 10 percent, with the expectation that the lower rate would shortly rise to 25 percent. "You had a prohibitive cost to business," Gardon said, adding that the industry view is that that level is "not sustainable and not a cost you can absorb … even in the short term." At Lear, he said, its suppliers were also looking to pass the cost on.
"My prior life, I was a technician and I managed a very technical operation part of the business," Gardon said of his life before 2018. "But now I think it’s become a much more important part of the business. I’m very close now to our CEO and CFO in particular. He always reminds me he knows far more now about trade than he ever wanted to."
Gardon said that even if there is a deal with China soon, he thinks things will not get back to normal. "We’re not reverting back. It’s going to be a challenging environment for a very long time," he said. "What I try to explain and preach is: There’s been a permanent change to the attractiveness of sourcing from China." He said that initially, Lear was not seriously looking at shifting locations because the company didn't know if the tariffs would be permanent. "The timeline to get a new plant certified and able to supply and be accepted by customers … it’s a long timeline. Even if you have an existing plant in another country, even to get additional production," he said, it would take 18 months to two years.
In network switching and routers, industry had confusion about the new duties. Some companies were not paying them, and Cisco was, and was getting questions from its customers on why. Customs rulings proved useful to both Cisco and its suppliers, as some addressed components such as network interface cards and virtual interface cards.
Jill Franze, senior director for global customs/trade at Cisco, said the company only had four days to make computer changes so Cisco could track the country of origin of switchers and routers, which had been previously duty free, and put in the new duties -- but only if the item was coming from China. Before this, the country of origin and the tariff rate data was stored in two different systems. Moreover, the Harmonized Tariff Schedule code 8517.62.00.20 now had a new subset, 90, which was duty free.
"We didn’t understand the difference," Franze said. "We applied for some rulings." Cisco received favorable rulings from the CBP Center of Excellence and Expertise for Electronics in Long Beach, California, which then benefited suppliers as well.