Determination and Calculation of Custom Duty Liability
In general, Customs duty fees are calculated “ad valorem”, by multiplying the specific duty tariff and the good’s particular value, by applying specific tariffs per quantity ($ per kg / oz.) or by compound tariffs combining both methods.
Valuation of a good is regularly performed by the “transaction valuation method” under the WTO Valuation Agreement (See Agreement on Implementation of Article VII of the General Agreement on Tariffs and Trade (GATT) 1994). As the most commonly used method, it is based on the price of the imported goods. In most cases, the so-called “Transaction Value” is determined by the price actually paid or payable for the imported merchandise, meaning the total payment for the actual product minus additional fees (“Adjustments”) for freight, transport insurance etc. Under specific circumstances, for example with related entities transferring goods in a cross-border transaction, other methods of valuation might apply to determine a comparable market value of the imported goods and to diminish the influence of business relations on the duty liability.
The applicable Customs duty tariffs depend on a variety of factors, especially the good’s origin country and contents. For example when importing clothing, the tariffs vary depending on the type, contents or fabric of a certain garment and if it is meant for children, women or men. The tariffs for each product are categorized and classified under the Harmonized Tariff System (HTS) in the HTS Schedule (See HTS Schedule at https://hts.usitc.gov/).
The Schedule is divided into 12 sections, each classifying different types of goods to be imported and applying individual tariffs to particular products. Different tariffs are applicable depending on whether the country of origin has “Most Favored Nation” trade status (which is the regular status of most nations except e.g. Russia or North Korea) or is a party of a Free Trade Agreement. In the latter case, importing might even be free of charge.
Examples of HTS Schedule classification:
- Your company belongs to the apparel industry and you wish to import clothing, in particular a men’sanorak, mainly consisting of cotton → Tariff No. 6101.20.00 10 applies with 15.9% custom duty for MFN countries (otherwise: 50%) or is free of charge under a Free Trade Agreement.
- Your company belongs to the food and beverage industry and you wish to import fresh apples and corn chips → Tariff No. 0808.10.00 applies for fresh apples, so the apples are free of duty charge coming from a MFN country (otherwise: 1.1¢/kg) AND Tariff No. 1905.90.90 30 applies for corn chips and similar crisp savory snack foods with a 4.5% duty rate for MFN countries (otherwise: 20%)
- Your company belongs to the agricultural sector and you wish to import cattle, inter alia for dairy purposes → Tariff No. 0102.29.20 applies for for dairy cows classifying them free of charge coming from a MTN country (otherwise: 6.6¢/kg) OR Tariff No. 0102.29.40 applies for all other purposes, e.g. slaughter, and applies a tariff of 1¢/kg for cattle from a MTN country (otherwise: 5.5¢/kg). Under a Free Trade Agreement, the import would be free of charge.
Options to Lower Import Duty Liabilities
As Customs duty may be a significant financial burden, compliance and strategy to lower costs might help reduce costs.
Further, import amounts with a total value of USD 800.00 and below (de minimis threshold), have no import charges.
Free Trade Agreement by Engineering: Adjusting your products import route could make you eligible for a Free Trade Agreement. The core of this exercise is to ensure that your goods comply with the “rules of origin” of the particular Free Trade Agreement.
In order to be eligible for the Free Trade Agreement treatment,
- the product must be wholly obtained, meaning produced entirely, in the territory of one or more of the FTA countries.
- the product must be a good produced exclusively originating materials, meaning none of the material can originate outside one of the FTA parties’ countries.
- the product must qualify for preferential treatment as for its substantial transformation, with value added content of more than 35% of the good’s initial value within the Free Trade Agreement party (so-called 35% appraised value method, special regulations apply for Israel or Jordan).
- the product has to include a certain percentage of regional value content (“RVC”) making it reach a certain level of Regional Value Content to benefit from the Free Trade Agreement as an originating good, in particular depending on the Free Trade Agreements regulations.
- With regard to the HTS Schedule, also a Tariff Shiftmight help to qualify under the rules of origin. Transforming the good, might allow changing the HS classification of the non-originating components to the HS code of the final product (e.g., processing wood into furniture = change of HTS chapter). This type of tariff classification change shows that non-originating components have been sufficiently transformed in either the United States or FTA partner country(ies) to allow them to qualify for a preferential tariff under the FTA.
There are further combinations of (4) and (5) applied with further buildup or build down formulas and specific rules varying for each Free Trade Agreement. Global players benefit from the rules of applicable FTAs, for example Samsung from imports under the United States-Korea Free Trade Agreement (KORUS FTA). When trade sanctions were imposed by the U.S. in 2017, Apple moved many of its production facilities from China to Vietnam to still be eligible for imports from a Most Favored Nation (“MFN”) country (See Souring US-China Relations Threaten to Make Your iPhone More Expensive).
Also, Apple has initiated to reroute its products from formerly mainly China to other Asian countries, e.g. Vietnam or India, after the U.S.-China trade sanctions were imposed.
Tariff Engineering: Tariff Engineering may lower the duty charges by changing the product partially and along the HTS classifications. While at first glance, the classification in the HTS Schedule may seem to be set in stone, it can be very helpful to double-check if the classification is eligible for changing. The mechanism and effect are best understood with an example:
- HTS tariffs for clothing are influenced by the type of garment and the materials used, as well as they are meant for Women or Men. Changing the fabric content rates can make a specific garment applicable for lower duty fees, as for example, tariffs for cotton clothing are lower than for polyester. To determine the applicable tariff, it is inevitable to do well-founded research.
Reduction of Imported Value: Reducing the import value of your goods can help decrease the levied tariffs. Careful compliance can help determine the actual goods’ value as a calculation base. Therefore, deducting invoice charges unrelated to the product value, e.g. freight, insurance, port charges can have a direct impact on the imposed tariffs.
As it is a common misunderstanding, it is important to keep in mind the Customs value of a good is based upon the amount of money paid by the buyer to the seller including all costs for bringing the merchandise to the point of import and not the intended sales price. This method requires substantiated proof of the actual merchandise or product value by handing in invoices, contracts, bills or other evidence showing the additional payments to a third-party. If costs are estimated and not documented, U.S. Customs and Border Protection considers this a failure to exercise reasonable care on the part of the importer. It will disallow the deduction and the importer may face penalties.
First Sale: The “First Sale” strategy might further allow the use of a lower price as the foundation of calculating the payable fees. In a multi-tiered transaction, companies might be allowed to only pay customs on the “first” (earlier) sale in a series of multiple transactions. Therefore, the earlier sale has to be documented as a sale for exportation to the United States and the importer has to meet all other Customs requirements. A high level of transparency in a company’s supply chain is required to comply with the evidence requirements.
There are a number of further options to save money and to take control of your company’s cash flow and liquidity, for example by drawbacks or the use of Foreign Trade Zones, which are beyond the scope of this article and are therefore reserved for individual advice.
Balancing Tax Law and Customs Law
When engineering the value of imported goods, a business will have to consider tax law and reporting requirements applicable to the same transaction, in particular to the extent that the import value equals the taxable transfer price for income tax calculation. As Customs and Tax authorities use different methods to evaluate transactions, avoiding a negative financial outcome requires an interdisciplinary approach to assess each individual situation (See The Link Between Transfer Pricing and Customs Duties | BDO).
Conclusion: better stay in your local market?
As portrayed, the Customs situation is more complex than quickly and easily mastered and, above all, implemented. Identifying the particularly applicable calculation method and correct HTS classification for your goods can be a challenging task. Nevertheless, it provides the groundwork for economical performance optimization that can directly and largely impact costs and profits.
In general, we see clients benefit from the following considerations:
- determine or review your goods’ classification under the HTS Schedule, as well as the applicable tariff,
- review the correct valuation and (re-)evaluate your goods,
- reconsider the invoice “Adjustments”,
- check whether your goods qualify for preferential treatment under Free Trade Agreements or further trade exemptions, or if a general redirection to a Most Favored Nation (“MFN”) country would be useful,
- and only then reconsider the other displayed reduction options such as Tariff Engineering.
As the best practice applicable may vary case-by-case, appropriate interdisciplinary consultation and advice by service providers, lawyers and accountants is essential, as negative consequences may result with respect to tax and corporate law. Following the right advice and business plan, the Customs situation can become a valuable tool in market competition and thus, hopefully, another reason to stay active in the international business.
